Zoetis - Successful Offering Fails To Lift Pfizer's Shares

| About: Zoetis (ZTS)

It has been two weeks since Zoetis (ZTS) made its public debut on the first day of the month. Shares of the animal health business, which is a spin-off of Pfizer (PFE), ended their first day with gains of 19.3% at $31.01 per share. Shares have continued to gain ground from that point in time, currently exchanging hands at $33.55.

The Public Offering

Zoetis is a leader in the discovery, development and manufacturing of animal health medicines and vaccines. The company has been an important business unit of Pfizer for the past 60 years, which has recently decided to divest the business.

Zoetis sold 86.1 million shares for $26 apiece. The company raised $2.24 billion in gross proceeds in the offering process, valuing the company at $13.0 billion.

The offering was a huge success. The offer price was set above the preliminary $22-$25 price range set by the firm and its bankers. Some 17.2% of the shares outstanding were offered in the public offering. At Wednesday's closing price of $33.55, the firm is valued at $16.7 billion.

The major banks that brought the company public were JP Morgan, Bank of America/Merrill Lynch, Morgan Stanley, Barclays, Citigroup, Deutsche Bank and Goldman Sachs, among others.


According to its sales, Zoetis is the world's largest animal health medicines and vaccines business with operations in more than 120 countries, across five major product categories. The company employs a sales force of over 3,400 employees. The company has a strong presence in emerging markets including Brazil, China and India, which make up 27% of annual revenues.

The company reported annual revenues of $4.23 billion for the full year of 2011. The company reported a $245 million profit for the year.

For the first nine months of 2012, Zoetis generated revenues of $3.16 billion, up 2% on the year before. The company reported a net income of $446 million, up 89% on the year before, due to strong cost control throughout the organization.

Zoetis will not receive any proceeds from the sale of the stock in the offering, with all proceeds going to Pfizer. On a pro-forma basis, the company will operate with approximately $300 million in cash and equivalents and without the assumption of debt.

Based on Friday's valuation of $16.7 billion, the market values the firm at roughly 4.0 times 2012's expected annual revenues of $4.25 billion. The company is on track to earn roughly $600 million for the year, valuing the firm at approximately 28 times annual earnings.

Investment Thesis

As noted above, the offering of Zoetis has been quite a success. Shares were initially offered 10.6% above the preliminary offering range and closed 42.8% above the preliminary midpoint range on Wednesday.

CEO Juan Ramon Alaix commented on the future prospects of the spin-off, "An expanding middle class world-wide is fueling higher demand for meat and animal protein, as well as spending on health-care for pets. At the same time, land and water resources are limited, which puts a premium on products that can help increase productivity of animal protein."

The prospects for Zoetis look good. CEO Alaix predicts that the global market for animal medicines and vaccines will grow by an annual 5.7% in the coming five years. Zoetis has grown rapidly, partially as a result of Pfizer's acquisition of Wyeth back in 2009, when both firms combined their animal business.

The public offering of Zoetis has raised roughly $2.2 billion for Pfizer, after the company sold a roughly 17% stake in the company. Shares of Pfizer rose 1.3% in a response to the successful offering on the day of the public offering, but have traded around $27 per share ever since, despite the fact that the company still holds a 83% stake in Zoetis. Pfizer has already indicated that it will use the proceeds of the divestment for future share buybacks.

Unlike other pharmaceutical companies, Pfizer does not see the animal business as being complementary to human drug development. CEO Ian Read says that the public offering of Zoetis leaves the company "better positioned to focus on our core business." Competitors Merck (MRK) and Eli Lilly (LLY) already indicated that they have no intentions to spin off their animal divisions. Merck's CEO Ken Frazier commented on their animal business, "We think it is a good business. It dovetails nicely with our human health business."

While the prospects of Zoetis look promising, the valuation already reflects the expected steady growth in the future. Shares are valued at 4 times annual revenues and 28 times earnings.

While earnings growth was spectacular so far in 2012, earnings growth will undoubtedly come more in line with revenue growth in the coming years. With an 89% increase in net income for the first nine months of 2012, and just a 2% increase in revenues, it seems that Zoetis has cleaned up their house in order to report strong results into the public offering.

While the business expects organic revenues to increase by approximately 5% in the coming years, and consequently a similar pace of earnings growth, the valuation is not appealing enough to me at 28 times annual earnings.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.