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Based in New York, N.Y., Zoetis (ZTS) scheduled a $2 billion IPO with a market capitalization of $11.75 billion at a price range midpoint of $23.50 for Friday, Feb. 1, 2013. Five IPOs are scheduled for the week of Jan. 28, 2013. The full IPO calendar is available here.

S-1 filed Jan. 17, 2013.

Manager, Joint Managers: J.P. Morgan/ BofA Merrill Lynch/ Morgan Stanley. Co Managers: Barclays/ Citigroup/ Credit Suisse/ Deutsche Bank Securities/ Goldman Sachs/ Guggenheim Securities/ Jefferies/ BNP PARIBAS/ HSBC/ Loop Capital Markets/ RBC Capital Markets/ Williams Capital Group/ UBS Investment Bank/ Lebenthal/ Piper Jaffray/ Ramire

Summary

ZTS is a carve-out a Pfizer's animal health business. ZTS is the largest player in a moderate growth industry, which expects 6% annual compound growth. On a proforma basis, comparing 2011 results with the nine months ended September 2012, net after-tax income increased to 13% from 5%. But that's result of a Herculean effort by ZTS to reduce expenses, which it did by 14% of revenue.

Managing the Income Statement for an IPO

Is ZTS's 75% growth in pretax profits sustainable? Some analysts are touting ZTS's 75% increase in pre-tax profits for the 2012 September nine months vs. the 2011 September nine months. ZTS reduced operating expenses by 9% and the pretax margin increase was only 8%, to 20% from 12%. Plus the tax rate percentage declined to 30% from 35%.

This is one of the best examples of "managing the income statement for an IPO" that IPOdesktop has ever seen. If ZTS hadn't shaved expenses by 14% it would have shown a decline in net income for the September 2012 nine months. So ZTS may be operating at peak efficiency right now, leaving little room for margin improvement.

(Glossary of financial terms)

Valuation Ratios

IPO Mrkt

Price /

Price /

Price /

Price /

% offered

annualized Sept 9 mos, proforma net

Cap (MM)

Sales

Earnings

BookValue

TangibleBV

in IPO

Zoetis

$11,750

1.9

21.8

11.1

-14.7

17%

Pfizer Nets Over $15 Billion

Pfizer gets $2 billion of debt repaid & also will receive $3.5 billion in cash from slapping ZTS with $3.6 billion in additional debt. At the price range midpoint, Pfizer's equity in ZTS will be worth almost $10 billion. So Pfizer will net over $15 billion from the ZTS IPO.

Other Big Carve Outs/Spin-Offs Have Been Successful

In 2009, Bristol-Myers Squibb (BMY) spun off Mead Johnson Nutrition (MJN), a children's products company it had owned for 42 years. Since the spinoff, Mead's shares have advanced 170%, and Bristol-Myers' have risen 83%. But their profit margins are higher and ZTS may have a hard time sustaining its most recent profit margin of 13%.

Institutions own 97% of MJN. ABBV is too new to have the institution ownership figure. In any case, ZTS is going to end up being owned mostly by institutions.

Mrkt

Price /

Price /

Price /

Price /

Profit

Compare with 2 other big spin-offs

Cap

Sales

Earnings

BookValue

TangibleBV

Margin

Zoetis

$11,750

2.8

21.8

11.1

-14.7

13%

AbbVie (ABBV)

$59,210

3.4

11.9

3.8

8.3

28%

Mead Johnson Nutrition ,

$14,120

3.6

22.6

13.3

31.8

16%

Conclusion

Buy ZTS on the IPO because there is going to be significant demand from institutions. If they want to participate in the worldwide animal health business, then ZTS is the only choice. On a purely numerical valuation basis, however, ZTS appears to be reasonably (not under) priced.

For example, upside growth in earnings seems to be limited because

  • Expenses have been managed down in anticipation of the IPO,
  • Industry growth is expected to be only 6% per year, and
  • It seems that Pfizer/ZTS already picked off most of the viable acquisitions. Growth in revenue from acquisitions, for example, was 9% for 2011 vs. 2010 and only 1% for the September 2012 nine months vs the year earlier period.

Plus, there is a risk of increased generic competition in ZTS's markets.

Dividend Policy

ZTS initially expects to pay quarterly cash dividends $0.065 per share, 1.1% annualized at $23.50, the price range midpoint.

Dual Stock Structure

With respect to the election of directors, the holders of Class B common stock will be entitled to 10 votes per share, and the holders of Class A common stock will be entitled to one vote per share.

The Distribution

Pfizer has informed ZTS that, following this offering, Pfizer may make a tax-free distribution to its stockholders of all or a portion of its remaining equity interest in ZTS, which may include one or more distributions effected as a dividend to all Pfizer stockholders, one or more distributions in exchange for Pfizer shares or other securities, or any combination thereof. ZTS refers to any such potential distribution as the "Distribution."

Business

ZTS believes it is the industry leader in animal health R&D. From 2004 to 2011, ZTS obtained approximately one-fourth of all animal health medicine approvals granted by the FDA, and approximately one-fifth of all animal health vaccine approvals granted by the USDA. The majority of the R&D programs focus on brand lifecycle development, which is defined as R&D programs that leverage existing animal health products by adding new species or claims, achieving approvals in new markets or creating new combinations and reformulations.

Diversified Revenues

Revenues are primarily derived from a diversified product portfolio of medicines and vaccines used to treat livestock and companion animals. ZTS's portfolio contains more than 300 product lines.

Customer Concentration

In 2011, ZTS's top selling product line, the ceftiofur line, contributed less than 8% of revenues, and the top 10 best-selling product lines contributed less than 38% of revenues.

6% Industry Growth

According to Vetnosis, a research and consulting firm specializing in global animal health and veterinary medicine, the animal health medicines and vaccines market for livestock and companion animals represented a global market of $22 billion, as measured by 2011 revenues. The market grew at a compound annual growth rate, or CAGR, of 6% between 2006 and 2011 and, excluding the impact of foreign exchange, the market is projected to grow at a CAGR of 6% per year between 2011 and 2016.

Risks

Generic products may be viewed as more cost-effective than ZTS's products. ZTS's patent protection for these products extends for varying periods in accordance with the dates of filing or grant and the legal life of patents in countries in which patents are granted. The protection afforded, which varies from country to country, is limited by the scope and applicable terms of the patents and the availability of legal remedies in the applicable country. As a result, ZTS may face competition from lower-priced generic alternatives to many of the products.

ZTS estimates that 80% of revenues in 2011 were derived from products that are either unpatented (i.e., never patented or off-patent) or covered by ZTS patents that, while providing a competitive advantage, do not provide market exclusivity. Over the next several years, several of ZTS's products' patents will expire.

Foreign Exchange Rates

ZTS products are sold in more than 120 countries and, as a result, revenues are influenced by changes in foreign exchange rates. In 2011, approximately 61% of revenues were denominated in foreign currencies. For the September 2012 nine months vs. September 2011, foreign exchange rate fluctuations cut 4% from revenues. For 2011 vs. 2011 exchange rate fluctuations added 3% to revenues: that's a 7% swing.

Geographic Sales Distribution

ZTS organizes and operates its business in four regions: the United States, Europe/Africa/Middle East, Canada/Latin America and Asia/Pacific. Within each of these regional segments, ZTS offers a diversified product portfolio for both livestock and companion animal customers.

ZTS business segments are:

United States with revenues of $1,294 million and $1,659 million that represented 41% and 39% of total revenues for the nine months ended Sept. 30, 2012, and the year ended Dec. 31, 2011, respectively.

Europe/Africa/Middle East with revenues of $799 million and $1,144 million that represented 25% and 27% of total revenues for the nine months ended September 30, 2012 and the year ended Dec. 31, 2011, respectively. Key developed markets in this segment include the United Kingdom, Germany and France. Key emerging markets in this segment include Russia, Turkey and South Africa.

Canada/Latin America with revenues of $549 million and $788 million that represented 18% and 19% of total revenues for the nine months ended September 30, 2012 and the year ended Dec. 31, 2011, respectively. The developed market in this segment is Canada. Key emerging markets in this segment include Brazil and Mexico.

Asia/Pacific with revenues of $518 million and $642 million that represented 16% and 15% of total revenues for the nine months ended September 30, 2012 and the year ended Dec. 31, 2011, respectively. Key developed markets in this segment include Australia, Japan, New Zealand, and South Korea. Key emerging markets in this segment include India and China.

Competition

Competitors include the animal health businesses of large pharmaceutical companies and specialty animal health businesses. The level of generic competition is higher in Europe and certain emerging markets than in the United States. However, there is no large, well-capitalized company focused on generic animal health products that exists as a global competitor in the industry.

ZTS, however, will have to contend with Merck's animal health division, as well as Merial, a division of Sanofi.

Use of Proceeds

ZTS will not receive any proceeds from the sale of Class A common stock in this offering. All of the net proceeds from this offering will be received by the debt-for-equity exchange parties.

The underwriting and the debt-for-equity exchange:

Instead of selling shares of Class A common stock directly to the underwriters for cash, Pfizer will first exchange the shares of Class A common stock to be sold in this offering with certain of the underwriters, referred to as the "debt-for-equity exchange parties," for outstanding indebtedness of Pfizer held by the debt-for-equity exchange parties.

The debt-for-equity exchange parties will then sell the shares to the underwriters for cash. This debt-for-equity exchange will occur on the settlement date of this offering immediately prior to the settlement of the debt-for-equity exchange parties' sale of the shares to the underwriters.

Senior notes offering:

ZTS has agreed to issue $3,650,000,000 aggregate principal amount of senior notes in a private placement, which is expected to be consummated prior to the completion of this offering. All the senior debt proceeds will be paid to Pfizer.

Disclaimer: This IPO report is based on a reading and analysis of ZTS's S-1 filing, which can be found here, and a separate, independent analysis by IPOdesktop.com. There are no unattributed direct quotes in this article.

Source: IPO Preview: Zoetis