IMPORTANT – Please read this Disclaimer in its entirety before continuing to read our research opinion. The information set forth in this report does not constitute a recommendation to buy or sell any security. This report represents the opinion of the author as of the date of this report. This report contains certain “forward-looking statements,” which may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential,” “outlook,” “forecast,” “plan” and other similar terms. All are subject to various factors, any or all of which could cause actual events to differ materially from projected events. This report is based upon information reasonably available to the author and obtained from sources the author believes to be reliable; however, such information and sources cannot be guaranteed as to their accuracy or completeness. The author makes no representation as to the accuracy or completeness of the information set forth in this report and undertakes no duty to update its contents. The author encourages all readers to do their own due diligence.
You should assume that as of the publication date of his reports and research, Aurelius and possibly any companies affiliated with him and their members, partners, employees, consultants, clients and/or investors (the “Aurelius Affiliates”) have a short position in the stock (and/or options, swaps, and other derivatives related to the stock) and bonds of PetMed. They therefore stand to realize significant gains in the event that the prices of either equity or debt securities of PetMed decline. Aurelius and the Aurelius Affiliates intend to continue transactions in the securities of PetMed for an indefinite period after his first report on a subject company at any time hereafter regardless of initial position and the views stated in Aurelius’ research. Aurelius will not update any report or information on this website to reflect such positions or changes in such positions.
Please note that Aurelius, the author of this report, and the “Aurelius Affiliates” are not in any way associated with Aurelius Capital Management, LP, a private investment firm based in New York, and any affiliates of or funds managed by the latter company.
Up until now, an online pet pharmacy named PetMed Express (NASDAQ: PETS) has been able to conceal its efforts to exploit America’s Opioid Epidemic.
In 2015, Opioids killed 33,091 people, equivalent to one overdose death every 15 minutes. Within the past several months, many government agencies have announced Opioid task forces while Attorney Generals have expanded investigations into the “pill mills” feeding the epidemic. This month, President Trump formally designated the opioid crisis a national emergency.
PetMed’s origins trace to convicted felons named Yali Golan and Engin Yesil, who were imprisoned in the early 1990s for conspiracy to distribute Cocaine. Mr. Golan’s status as PetMed’s co-founder was hidden from investors through shell entities at the time of the company’s IPO. PetMed’s CEO, Menderes Akdag worked for almost a decade at Lens Express, a company that Golan and Yesil founded.
Faced with increasing competition, PetMed’s business had stagnated for most of the past seven years before sales and earnings suddenly began to surge. Having posted the best financial results in the company’s history over the past two quarters, PETS shares have skyrocketed.
Yet PetMed operates as a distributor without proprietary products in a mature industry--not exactly the dynamics that lead to sudden windfall profits. Cryptically, Mr. Akdag has repeatedly credited the company’s change in fortunes to a purported “shift to new generation medications”, a narrative that has enticed unsuspecting investors.
But Mr. Akdag must have thought no one would scrutinize his claims.
It is our belief that the actual “secret sauce” lies in PetMed’s efforts to aggressively market dangerous painkillers to human opiate addicts and drug users.
Mr. Akdag and his team sell painkillers coveted by human opiate addicts. Chief among these is a dangerous and addicting synthetic opiate named Tramadol, unique in that it is prescribed by vets to animals as well as by doctors to human cancer patients. The demand for Tramadol, a class IV substance, is now so high that addicts are even maiming their pets to get prescriptions.
PetMed is exploiting this crisis through a broad marketing blitz that features Tramadol in ads that specifically target human opiate users.
Using Google, which drives over 55% of the traffic to 1800petmeds.com, PetMed has deployed a vast predatory campaign that dangles ads featuring pictures of Tramadol to drug users searching for how to get high or quickly score a variety of different opiates, narcotics, and street drugs without a prescription. Egregiously, PetMed’s ads even specifically bait opiate addicts searching for remedies for their withdrawal symptoms.
Online advertising is the lifeblood of PetMed’s business and, according to data cited in this report, Tramadol ads are estimated to drive at least 25% of PetMed’s paid search traffic. It is no coincidence, in our view, that PetMed has reported record financial results over the same period that its opiate ad campaign has expanded.
We believe that PetMed’s marketing of dangerous drugs to human opiate addicts is likely to capture the attention of regulators. Both the FDA and DEA have taken a dim view of direct to consumer advertisements of controlled substances and we can find no precedent of a pet pharmacy advertising to humans.
More immediately, Google can bring a sudden halt to PetMed’s activities. Google has recently been on “a rampage” against predatory ads and we have notified Google of PetMed’s advertising tactics. Google has strict policies for advertisers and, in our opinion, Google could choose to suspend or ban PetMed altogether.
PETS trades at over 30x earnings and 3x sales, a valuation that suggests the party will continue indefinitely. But for most of the last decade, PETS shares were valued at substantially lower multiples. As the true nature of PetMed’s activities come to light, at minimum, we see shares reverting to below their average historical valuation, which would imply a sub $20 stock and 50%+ downside.
Petmed’s “New Generation Medications”
PetMed Express is an online veterinary pharmacy that sells pet medications through www.1800petmeds.com. Faced with increased competition, the business had stagnated for most of the past seven years. PetMed’s revenues and profits were actually lower in FY 2016 than they were in FY 2010.
But then suddenly PetMed’s business began to boom.
Over the past two quarters, PetMed has posted the best financial results in the company’s history. During the March 2017 quarter (FY Q4), PETS sales grew by a full 14%, the company’s best growth rate in roughly 8 years. EPS surged to 37 cents, PetMed’s single most profitable quarter ever.
The most recent June 2017 quarter (FY Q1) was similarly spectacular with sales growing by 10% and EPS growing by 39% to a windfall 46 cents per share.
As financial results have taken off, PETS shares more than doubled to all-time highs.
So, what is really behind the sudden improvement in PetMed’s fortunes?
PetMed is merely a veterinary medicine distributor with no proprietary products of its own. This is a mature and highly competitive industry with a host of other online pet pharmacies that now include PetSmart.
These are not exactly the industry dynamics that lead to record growth and profitability. Yet PetMed appears to have found a “secret sauce”. When questioned on recent conference calls about the drivers of PETS recent success, Mr. Akdag has repeatedly referred to supposed “new generation medications”.
After the blockbuster results in the March 2017 quarter, an analyst from Craig Hallum, a sell-side research firm who currently has a hold rating on the stock, asked Mr. Akdag to give more specifics. Akdag replied “all I’m going to say is there is a shift to new generation medications”, later highlighting that PETS spent 17% more on advertising as part of the company’s online ad shift.
An almost identical exchange occurred during the most recent earnings call. Mr. Akdag highlighted an increase in online ad spend before again referencing a “shift to new generation medications” without elaborating.
Petmed’s Covert Campaign to Target Opiate Addicts and Drug Users
It’s important to understand that online marketing is the lifeblood of PetMed’s business. To sell its products, PetMed must drive a constant stream of potential customers to its website. This requires spending a significant amount of money to advertise on Google, the world’s dominant digital ad platform. According to data from SEM Rush (an online marketing intelligence service that we describe later) Google referred roughly 55% of the total visitors to 1800petmeds.com.
Bulls view PetMed’s online marketing skills as a competitive advantage. PetMed’s board includes two Directors from comScore, a leading digital marketing analytics company, including comScore’s founder and CEO, Gian Fulgoni. After PETS discontinued TV-based advertising in favor of more online ads last year, Craig Hallum even anointed PetMed as “the poster child for the efficiency of online versus TV, just very impressive”.
But what makes PetMed such an effective online advertiser? And what are Mr. Akdag’s “new generation medications”?
In a report issued earlier this year, Craig Hallum postulated that the financial results are being driven by “greater adoption of oral medications, such as flea & tick products NexGard, Bravecto, and Simparica”.
But if these products were driving the results, then we should expect to see them featured prominently in PetMed’s online marketing campaign.
Yet they aren’t
Instead, our research demonstrates that the centerpiece of PetMed’s marketing efforts are human crossover painkillers.
Mr. Akdag and his team sell painkillers coveted by human opiate addicts. Chief among these is a dangerous and addictive synthetic opiate named Tramadol, unique in that it is prescribed by vets to animals as well as by doctors to human cancer patients.
Tramadol is Class IV controlled substance that is at the center of the Opioid Crisis in many foreign countries and increasingly fueling a wave of addiction and abuse in the United States. Tramadol can have a stronger impact on users than Morphine and produces opioid effects similar to Oxycontin, even producing seizures within the recommended dosage range.
For years, PetMed did not sell controlled substances because, as an old SEC filing explained, “we believe dispensing these drugs carries with it increased risks, including fraud, illegal resale of prescription drugs, as well as the special storage, shipping and handling requirements.”
After Tramadol was made a Class IV Substance by the DEA in August 2014, competitors stopped selling it. PetMed, by contrast, obtained federal and state registrations in FY 2015 allowing it to dispense class IV substances.
As a result, PetMed appears to be the only major online Pet Pharmacy currently selling Tramadol.
(Source: Internal Research Checks. Competitors assembled by advertising activity in SEM Rush)
As the Opioid epidemic has expanded, Mr. Akdag and his team have deployed an aggressive ad campaign featuring Tramadol to prey on opioid addicts.
PetMed ads now dangle pictures of Tramadol to drug users searching for how to get high or quickly purchase a variety of different opiates, narcotics, and street drugs without a prescription. Egregiously, these ads specifically target opiate addicts by marketing Tramadol to people searching to detox or for remedies for their withdrawal symptoms.
This vast predatory campaign includes ads that can generally be categorized into three primary categories (Below).
Note: We captured and archived a considerable number of PetMed’s Google ads that were live this month. The SEM Rush also has archived PetMed ads that were displayed on various search terms in some point in the past (displayed in red). Please see the appendix for a more expansive archive of PetMed’s ads.
- PetMed Baits Human Opiate Users and Addicts
PetMed displays ads that target people looking to get high or purchase a wide variety of dangerous drugs. Petmed’s Tramadol pills are flashed alongside searches for drugs including Oxycontin, Oxycodone, Vicodin, Hydrocodone, Conzepam, and even “Pink Pills” (Synthetic Heroin).
Ads have also been displayed on searches for Ultram (Human Tramadol), “Trammies” (the street name) and Tramadol formulations not recommended for pets. PetMed also targets non-recreational users by marketing its drugs to people merely searching for remedies for their back pain, tooth ache, joint pain, or arthritis.
Search Terms archived by SEM Rush include:
- tramadol snort 50 mg
- can u inject tramadol
- tramadol fun
- tramadol high
- amitriptyline high
- tramadol opiates
- can u get high off tramadol
- street price for tramadol 50mg
- sildenafil & tramadol tablets
- tramadol and codeine
- tramdadol conazepam
- tramadol acetaminophn 37.5 325
- PetMed Preys on Opiate Addicts Experiencing Withdrawal Symptoms
PetMed baits addicts by displaying ads alongside searches by people seeking to detox or fight their addiction. Egregiously, some ads imply that Tramadol is a remedy for withdrawal symptoms. PetMed even displays ads for people looking to purchase Suboxone, a drug used to treat addiction.
Search Terms archived by SEM Rush include:
- Tramadol overdose effects
- Why does tramadol make me itch
- Tramadol nausea stop
- Suboxone for tramadol
- PetMed Targets People Searching for How to Get Opiates Without Prescriptions
As we explore later, human Opiate users, by definition, should be impossible for PetMed to convert into paying customers. Yet PetMed’s Ad Campaign specifically targets people searching for ways to obtain various opiates and narcotics without prescriptions.
Search Terms archived by SEM Rush include:
- Buy gabapentin no prescription
- Tramadol need prescription
- Where can I buy tramadol without a prescription
- Ultram without prescription
- Buy tramadol no rx
- Tramadol mexican pharmacy
- Tramadol no script
- Can you order tramadol online legally
- No prescription tramadol
PetMed Goes “All In” On Its Opiate Campaign
It is our opinion that the actual “secret sauce” lies in PetMed’s efforts to aggressively market dangerous painkillers to human opiate addicts and drug users. Two of the strongest financial reports in the company’s history have coincided with the expansion of the Opiate advertising campaign. In our view, this isn’t a coincidence.
We gathered intelligence on the scope of PetMed’s Opiate campaign using SEM Rush, an analytics platform that tracks and archives Google advertisements on 120 million search keywords (Read more about SEM’s data here). SEM Rush provides insight into what keywords PetMed emphasizes, how its advertising dollars are being allocated, and estimates how much web traffic its ads on various keywords are driving.
Prior to 2017, data from SEM rush shows that PetMed’s online advertising was centered around predictable keywords related to PetMed’s brand and common pet drugs. For example, as of December 2016, 22% of the website traffic was being driven by ads on searches for “1800petmeds” with another 8% coming from “comfortis”, a popular flea medicine.
That changed earlier this year. Suddenly in February, SEM Rush shows that “gabapentin high” became a top 10 traffic generator.
Gabapentin is a psychoactive drug prescribed for humans to treat nerve damage and to alleviate pain in animals. The drug is increasingly being abused nationwide and is often used in conjunction with opioids to both increase the high and decrease the withdrawal symptoms. As a result, the opioid epidemic has sent human demand for Gabapentin surging.
By April, the data indicates that PetMed went full throttle with its ongoing Tramadol ad blitz.
According to data from SEM Rush, Tramadol is PetMed’s single most effective advertising term, driving roughly 25% of the total paid search traffic to 1800Petmeds.com. This includes search terms like “Tramadol High” where we have continued to see PetMed ads.
We also engaged an online marketing expert to complete an analysis of PetMed’s Tramadol ad campaign. The expert found that PetMed often ranks number one in Tramadol search terms, meaning that the company is paying more to advertise on these terms and also getting high click through rates on its ads. The expert also noted that PetMed’s ads offer discounts for Tramadol (below) and, notably, fail to explicitly state the medication is for Pets.
Backdoor Opiate Dispensary?
PetMed’s origins trace to convicted felons named Yali Golan and Engin Yesil who were imprisoned in the early 1990s for conspiracy to distribute Cocaine.
As described in a 2006 Barron’s article, Mr. Golan’s status as co-founder was hidden from investors by using shell entities to conceal his holdings at the time of PETS IPO.
Mr. Golan and Engin Yesil were business partners and founded a different company named Lens Express together. Prior to its IPO, PetMed received a cash infusion from a Gibraltar trust tied to Mr. Yesil’s family. The Gibraltrar trust became PetMed’s largest shareholder, owning over 10% of the float, until a 2006 SEC filing reported that it no longer was the beneficial owner of more than 5%.
Neither Golan or Yesil have any current role at the company that we’re aware of, but prior to joining Petmeds in 2001, Mr. Akdag worked for almost a decade at Lens Express.
In 2002, PetMed was charged by the Florida Pharmacy Board for allegedly creating a program involving contracts with veterinarians to write prescriptions for animals they never actually examined. As described by the prosecutor,
“essentially, Petmed was engaged in an enterprise whereby a customer could log onto their website, fill out a questionnaire regarding their animal’s health complaints, and that information would then be forwarded to a veterinarian who was either employed by, or under contract with, Petmed”
The company went on to settle the charges in Florida, without admitting guilt, along with similar charges in Ohio and Texas. A significant amount of time has passed since these regulatory settlements and, as far as we can tell, the company has kept out of regulatory trouble since.
However, this brings up a fundamental question of why PetMed spends money to specifically target opiate users and addicts who have no prescriptions?
Addicts without prescriptions, by definition, should be impossible for PetMed to convert into paying customers. But PetMed is too savvy of an online marketer to be spending ad dollars without getting a financial return.
The most likely explanation for the company’s expansion of its opiate marketing campaign, in our opinion, is that Mr. Akdag and his team must know that opiate addicts are getting drugs from PetMed.
Approximately 56% of Americans own either a cat or dog and these animals are now increasingly being used to score drugs for their owners. Shockingly, the demand for Tramadol has become so high that opiate addicts have resorted to maiming their pets to procure prescriptions.
A grisly post we found in an online forum (below), of parents intercepting 200 Tramadol pills shipped by Petmeds to their addicted daughter for a dead dog, was posted six years ago and suggests addicts have been using PetMed for a while.
PetMed’s Opiate marketing campaign may have simply fanned these existing flames.
Orders for Tramadol and other painkillers are approved through PetMed’s in-house prescription authorization system that Craig Hallum has touted as being “overlooked and under-appreciated” due to its “high order fill rate for prescription medications, over 80%”.
In an April 2017 report, Craig Hallum explained that PetMed customers “often do not have to talk to anyone to get a prescription filled…86% of customers go to 1800petmeds.com and fill out an order for prescription pet medication, then PETS’ in-house procurement staff will contact the appropriate veterinarian”. We confirmed this with PetMeds support who explained that customers can submit orders before they have prescriptions and PetMeds then contacts the vet to obtain a prescription for the customer. Craig Hallum also noted that vets rarely “make it difficult and require patients to visit their office in person”.
Stories of human “pill mill” closures abound, whereby corrupt doctors have been caught churning out massive quantities of prescriptions for painkillers in return for cash under the table. However, media reports documenting the existence of veterinary pill mills are sparse.
The controls for veterinary prescription controls are looser than for physicians. Doctor shopping can be thwarted through Prescription Drug Monitoring Programs, active in 49 states and the District of Columbia, which track prescriptions made by physicians to patients (logging social security numbers). However, most states don’t require vets to report their prescription activity.
Now vets are still bound by state prescription laws, many of which require a Veterinarian-Client-Patient Relationship, and we doubt many vets are knowingly writing bogus prescriptions. However, PetMed’s authorization system could be so easy and seamless that it is easier for drug addicts to game.
We invite whistleblowers to contact us (here) to help us better understand how Tramadol and other painkillers are being procured from PetMed. Anyone with relevant information or stories is encouraged to come forward.
We See a Minimum 50% Downside in PETS Shares
Our thesis is that PetMed’s earnings surge is being driven by the company’s opiate marketing campaign. As such, we view PetMed’s record profits as being inherently unsustainable and likely to end.
Yet at present, PETS shares appear to be valued as if the party will go on forever. The stock trades at over 30x times earnings and 3x sales which represent multiples far above the company’s respective 10 year average of 17x and 1.5x (below).
As the true nature of PetMed’s activities come to light, at minimum, we see shares reverting to below their average historical valuation, which would imply a sub $20 stock and 50%+ downside.
Earning windfall profits amidst a national opioid emergency, we believe PetMed’s activities will likely capture the attention of regulators. Both the FDA and DEA have historically taken a dim view of direct to consumer advertisements of controlled substances and we could find no precedent of a pet pharmacy advertising drugs to humans.
Importantly, Google can bring an immediate end to PetMed’s opiate ad campaign.
We have notified Google of PetMed’s advertising tactics. Google has a strict “zero tolerance” policy for bad advertisers and, in our opinion, could choose to ban PetMed as an advertiser.
In 2011, Google agreed to pay $500 million to avoid Justice Department charges that it knowingly accepted illegal advertisements from Canadian online pharmacies for years. Google has recently been on “a rampage” against bad ads, taking down over 1.7 billion ads that violated its policies in 2016 and has banned hundreds of thousands of advertisers since 2014.
As quoted in a Wired profile from earlier this year, Google’s Director of Product management explained that “In the past year, what’s really changed is that we’ve expanded our policies so we can better protect consumers against issues like misleading ads and predatory offers”. Last year, for example, Google banned all payday loan ads from its website/
We believe PetMeds has been able to abuse Google’s ad platform because it technically sells a legal product, at least when its prescribed for pets with legitimate prescriptions. But the fundamental problem is that PetMeds is using Google to flash ads of dangerous drugs to entice human drug users and addicts—people who PetMeds should not legally be able to sell to.
We are confident that Google will do the right thing.
Due to size limitations, please visit Aurelius Value - In-Depth Research for the full appendix.
Disclosure: I am/we are short PETS.