A syndicate led by Deutsche Bank launched a $1.525bn TLB to fund the buyout last week. Proceeds fund the take-private of Covetrus, a distributor of animal health products and software for the veterinary industry, by longtime investor CD&R and TPG Capital, announced in May.

On the one hand, Covetrus’s focus on pet-related end markets, widely considered “recession proof,” makes the debt an enticing investment — but high starting leverage and low margins mean the company has little room for error, according to 9fin sources.

Price talk for the debt package (B1/B), which also includes a privately placed $350m second-lien term loan and a $300m five-year revolver, is currently set at SOFR+ 475-500 with a 50bps floor and a 95-96 OID. Commitments are due by 19 September.

Who let the COGS out?

Covetrus is marketing the term loan on $278m in pro forma adjusted EBITDA and $4.6bn in revenue for the LTM June 2022 period. The transaction will bring its total net leverage to 6.6x and its first-lien net leverage to 5.3x.

The roughly $4bn buyout implies an enterprise value multiple of roughly 14.4x. The two acquiring sponsors chipped in equally to write a 55% equity check, said Covetrus executives on a recent investor call.

Meanwhile, larger comp Elanco Animal Health, a pet and livestock products supplier, currently trades at a multiple of 16.8x, based on the $1.1bn of LTM EBITDA it generated through 30 June 2022. Elanco was levered 5.2x at the end of 2Q, with $5.6bn in net debt.

“This company is over-levered,” one source said of Covetrus. “They’re trying to position themselves as a tech-enabled platform, but don’t be fooled — they’re a distributor. And as such, the sponsors probably overpaid for this LBO.”

The company is a major consolidator in the veterinary space, having completed four bolt-on acquisitions since its inception in 2019, which makes it well-positioned for future growth.

In that sense, high leverage is not unreasonable when compared to veterinary practice rollups — notwithstanding the fact that Covetrus is a service provider to veterinary practices, as opposed to actually operating veterinary practices.

“Vet consolidators have high leverage, so it’s not that atypical” of the industry one of the sources said of Covetrus’s credit profile.

One example of this is EQT-backed veterinary chain IVC Evidensia, which has made a number of acquisitions in the space, including its purchase of Canada-based VetStrategy in 2021 and France-based VetOne in January.

Evidensia levered up to 5.6x through second lien debt and 6.4x through operating leases last October when it tapped the loan market in connection with its VetStrategy acquisition.

The low margins associated with Covetrus’ distribution business model are also a particular point of concern for prospective lenders. Its EBITDA margins are around 5%, which is low even for a distributor, according to S&P.

Furthermore, low free cash flow leaves the company dependent on organic EBITDA growth to de-lever. That rests in large part of the trend among consumers (especially Millennials) to spend big bucks on their pets, as well as continued growth of Covetrus’s e-commerce platform.

However Covetrus could be susceptible to market share loss if pet owners decide to buy their products from online retailers, rather than through the veterinarian offices that Covetrus services, said a buyside source.

“It’s a good scale business and pricing is attractive, but at the end of the day, this is a distributor, so its margins are low,” another source said. “Interest coverage is going to be somewhat tight even with the big equity check.”

Off the leash

Covetrus was formed in 2019 as a combination of healthcare distributor Henry Schein’s animal health division and the prescription management platform of CD&R-backed Vets First Choice.

Around 86% of the company’s revenue is generated from the distribution of products (its own and third-party) to veterinarians, as well as supplying other services (such as equipment repair and inventory management) to veterinary practitioners.

The remainder of its sales are derived from software and prescription management services. For a more detailed breakdown on the company’s business and credit profile, read our analyst team’s QuickTake here.

Covetrus has touted its technology division as a large growth driver.

On the recent lender call, CEO Benjamin Wolin highlighted the recurring revenue model of its e-commerce division as a major success for the business, noting that 50% of customers were enrolled in auto-shipping.

Revenue in Covetrus’s software arm is also mostly recurring, with a 96% renewal rate.

Nevertheless, sources questioned whether the company’s core business had the stickiness that lenders associate with recurring revenue. “It's a distributor,” one of the sources said. “People order and re-order.”

Indeed, some were concerned that Covetrus could spin off its e-commerce and software businesses, which provide the bulk of its recurring revenue. Some buysiders plan to request doc changes to limit Covetrus’s ability to perform such a maneuver, a source told 9fin.

On the recent lender call, Wolin emphasized that Covetrus is focused on maximizing synergies between the businesses in the near-term, although it could use divestitures to create shareholder value down the road.

“Over time, we’ll figure out how to monetize the equity investment, but right now we have a lot of synergies between the businesses and a lot of running growth,” he said.

Covetrus and CD&R did not return requests for comment. Deutsche Bank and TPG Capital declined to comment.

9fin publishes a QuickTake on every new deal. To request a copy of the Credit QuickTake on Covetrus, please complete your details here.