Activist Bill Ackman Buys Big Stake In Animal Healthcare Company Zoetis

I guess we shouldn’t be surprised that one of the more active activist investors is making another big move before the end of the year.

Pershing Square, of which renowned investor Bill Ackman (Trades, Portfolio) Manages, has accumulated a stake in Zoetis Inc (ZTS, Financial) of roughly 10%. He is joined by Scott Ferguson (former protégé of Ackman), of Sachem Head Capital in this activist campaign. Sachem will consult with Ackman and Pershing.

The new stake was reported late November 11, 2014, and filed Wednesday, November 12, 2014.

Zoetis is engaged in the discovery, development, manufacture and commercialization of animal health medicines and vaccines for livestock and companion animals worldwide.

The company’s shares are up more than 8% after the announcement and are up over 35% over the past 12 months. The stock closed yesterday at $43.72 per share, making another all-time high for the stock which was recently spun off from Pfizer (PFE, Financial) in February 2013.

For its most recent fiscal third quarter, Zoetis reported revenue of $1.2 Billion, a 10% increase compared to the same quarter previous year. Net Earnings were $166 million (or $0.33 per diluted share), a 27% increase compared to the same quarter in the previous year.

The growth was driven by 13% revenue growth in livestock products as well as executing on disciplined operational expenses. CFO Paul Herendeen reaffirmed guidance for earnings and narrowed guidance toward the high end of their previous range.

Zoetis’ revenue and earnings history

03May20171302311493834551.png

Cash on Zoetis’ balance sheet totaled $598 million as of the third quarter of 2014.

The quick and dirty valuation

We use last year’s free cash flow of $497 million in our calculation of discounted cash flow.

(We are aware this is high, but it will help prove that this seems to be a very expensive purchase.)

Other inputs for discounted cash flow calculation, growth 20% for 10 years (decay rate in years 5-10), terminal growth rate of 5%, and discount rate of 10%.

03May20171302321493834552.jpg

As you see, this gives us a fair value of $24.68 using fairly aggressive inputs.

Conclusion

By many measures, Zoetis is significantly overvalued.

What we have here is a business that is currently trading at a P/E of 41, EV/EBITDA of 18, P/B of 17.5. And sports a FCF yield of 3.1% and a dividend yield of 0.70%.

It appears the everyday investor has no real edge here and therefore no great opportunity.

Bottom Line: Zoetis seems to be hitting on all cylinders. It's a great company. However, you are paying up substantially for that quality.

The animal-health industry has been active in the mergers-and-acquisitions space lately, so I would not be surprised if Ackman and company tried to push Zoetis to put itself up for sale.

Although it would be an expensive buyout, Zoetis would make an interesting "bolt on" acquisition for a big pharma company and opens the acquirer up to participating in a growing segment of the animal pharma industry.

This activist campaign seems to be a pure play on pushing for a buyout in the next year from potential suitors such as Valeant, Novartis or Bayer AG.

We see a very attractive business … but significantly overvalued stock.

On this one, we are happy to sit on the sidelines and watch the eventual drama unfold.