Source: Zoetis.
Pershing Square's Bill Ackman is probably best known for his relentless advocacy regarding his short position in Herbalife (HLF +1.31%), but he's also captured a lot of attention this year as being a key voice of support for the sale of Allergan (NYSE: AGN) to Valeant Pharmaceuticals (VRX 1.78%).
Since Ackman's involvement in Allergan was reported in April, Allergan's shares have risen by more than 38%. So it's probably not too shocking to learn that the shares of Zoetis (NYSE: ZTS) -- Ackman's latest target -- are similarly jumping. Given that Ackman is likely to lobby for someone to acquire Zoetis, let's take a closer look.
What is Zoetis?
Zoetis is the former animal health business of drugmaker Goliath Pfizer (PFE 1.02%). Facing a daunting decline in revenue following patent expiration on its multibillion-dollar cholesterol busting drug Lipitor, Pfizer spun off 20% of Zoetis in February 2013, raising $2.2 billion for shareholders.
In June of that year, Pfizer exchanged the remaining 80% of Zoetis it owned with investors in a roughly a one-for-one trade for Pfizer stock. That allowed Pfizer to boost earnings per share by retiring more than 400 million shares, but it also meant that Pfizer's interest in Zoetis came to an end.
Zoetis shares have returned 36% since June 2013, outpacing the S&P 500's 7.8% return and trouncing Pfizer's paltry 7.8% lift, so Pfizer probably wishes it had kept its stake.
Source: Zoetis
Growing demand
According to Zoetis' third-quarter earnings results, the animal business is a good one to be in.
Sales during the quarter improved by 10% to $1.2 billion, and third-quarter adjusted earnings per share (after removing pesky one-time items) jumped 21% to $0.41.
In commenting on the quarter's results, CEO Juan Ramon Alaix cited a two-pronged effort as responsible for the growth. First, he noted that revenue in the company's livestock business grew 13%. Secondly, cost-cutting allowed more of that sales growth to trickle down to the bottom line.
The strength in livestock, which includes products such as medicine for cattle, pigs, and poultry, outpaced the 5% sales growth the company notched for its companion animal product lineup.
In addition to notching growth for both its livestock and companion animal businesses, sales grew in each of Zoetis' global markets. Revenue in the United States, it's biggest market, increased 7%, but sales grew fastest in both the company's Europe, Africa, and Middle East, and its Canada and Latin America segments, improving by 12% and 17% from last year, respectively.
Lobbying for change
Ackman's stake in Zoetis totals roughly $2 billion, which means that he owns just about 10% of the company. That's plenty enough ownership to lobby the board to consider acquisition offers.
Which suitor might be likely to consider buying Zoetis remains a mystery, but The Wall Street Journal suggests that Valeant Pharmaceuticals might be interested in making a bid.
Zoetis market cap of $20 billion suggests that whichever firm comes knocking will need to have a thick wallet. Valeant fits that description, particularly if Ackman and Valeant are unable to sway Allergan into accepting Valeant's existing $53 billion takeover offer.
It's also possible that Eli Lilly (LLY +0.80%) might be willing to make a play. Lilly bought Novartis' animal health business earlier this year for $5.4 billion, making it the No. 2 player in the space, and Lilly's $72 billion market cap may allow for it to make another big buy. Merck (MRK 0.31%) could also be interested, given that it also has a successful animal health business. That business posted sales of $885 million, up 11% from a year ago, in the third quarter for Merck. Merck's $171 billion market cap and $13.4 billion in cash suggest that it certainly has the size to integrate a Zoetis acquisition.
Fool-worthy thoughts
Investors shouldn't buy stocks simply because activists get involved. Instead, investors should focus on the business, the financials, and the prospects of the underlying company. By those measures, there's little question in my mind that Zoetis -- regardless of Ackman's involvement -- is an intriguing long-term play.
Animal health is an important and growing market, and there's plenty of opportunity ahead, but Zoetis isn't necessarily a cheap stock. The company is trading at about 25 times next year's earnings and more than four times sales. Despite that valuation, a larger business could likely find plenty of cost savings that could make buying Zoetis profitable, even at a premium. The big question will be whether Ackman can persuade Zoetis' board to cooperate.
