Zooplus AG: The digital pet store with a moat

Our public market investments at Volta Global are often long-term, concentrated bets into high-quality businesses with sustainable competitive advantages. In many ways identical to the type of businesses we look for in our private investments, these just happen to be publicly listed.

To spot businesses that fit that mold, I leverage a simple checklist during the screening process to filter ideas quickly:

  • Does the target company provide a service/product that serves a real need, and that significantly outperforms the alternative(s) customers have?
  • Is there a long runway for growth ahead, and does their competitive advantage expand as the business grows?
  • Is there proper long-term alignment of incentives between investors and management?
  • Is the company under followed and under the radar of most investors?
  • Can you make a simple valuation case for the business to be worth multiple times what it is today?

I’ll walk through the case for zooplus AG (BB Ticker: ZO1 GY), a recent portfolio addition, using the above checklist to show what makes it a compelling investment opportunity.

First, The Business

zooplus was founded in 1999 and is currently Europe’s leading online retailer of pet products — food, supplies, and toys. The business model is very simple — zooplus purchases inventory directly from suppliers of pet products, stores it in their own distribution facilities, and then sells to consumers via country-specific websites across Europe. Approximately 90% of the products zooplus sells through their website are third-party brands, with the balance being their own private label brands.

zooplus is the dominant player in the category, by far. They currently control ~50% of the market for e-commerce pet products in Europe, with Amazon the #2 player having only a 10–15% share. This makes zooplus ~5x larger than even Amazon in the category, and >10x larger than any other pure play pet products e-commerce competitor. In a world where Amazon seemingly eats a new competitor each month, it is rare to find a company like zooplus that competes effectively and maintains such a wide lead over the Amazon juggernaut.

Checklist item #1: Does the target company provide a service/product that serves a real need, and that significantly outperforms the alternative(s)?

Check. Pet owners have a constant need to purchase pet food, supplies, and yes even toys, to keep their pets happy and healthy. Transactions are therefore inherently recurring and a necessity. This leads customers to seek out low prices, consistency, and convenience. If your options are driving to a pet store to lug around a 25 lb bag of dog food vs. ordering that same bag of dog food from your couch and having it show up at your door 1–2 days later, you are going to opt for the latter. Better yet, if you can save 30–40% on that purchase vs. the exact same product at the store (zooplus products are consistently >30% cheaper than offline retailers, and even 10–20% cheaper than Amazon), the decision should be a no brainer.

And it is, customers keep coming back, and they order more when they do. zooplus has incredibly high customer retention rates of 94%, and customers average basket sizes are up +10% over the past 5 years. These metrics are remarkable for e-commerce, and a sign of providing real value to customers.

With the scale advantages thanks to the cost structure differential of e-commerce, the significant market share lead over competitors, and localized distribution facilities, zooplus can offer the widest selection of products at the most competitive price. As the business continues to grow, this competitive advantage should continue to expand, forcing the small companies out of the market and accruing more value to the industry leader.

Checklist item 2: Is there a long runway for growth ahead, and does their competitive advantage expand as the business grows?

Check. E-commerce penetration for pet products in Europe is currently ~8%, up from a mere 1% in 2010. That rapid growth in e-com penetration has fueled zooplus revenues to compound at near 30% growth rates for the past 5 years. However, the 8% e-com penetration rate for pet products in Europe still pales in comparison to the current mid-teens level in the US, and the >25% level of European e-com penetration for many other product categories such as electronics. I believe penetration levels in the pet category in Europe could easily double again over the next 5 years, and that zooplus will continue to take even more share of an expanding pie as smaller competitors struggle to compete, for the economy of scale reasons described in item 1 above.

This should provide zooplus with a sustainable revenue growth rate of >20% for years to come, potentially doubling the business to a >2 billion euro top line by 2020.

Zooplus 2017 Capital Markets Day

Checklist item 3: Is there proper long-term alignment of incentives between investors and management?

Check. zooplus is still operated by its founder, Dr. Cornelius Pratt. The management team is also invested alongside investors, owning 5% of the outstanding stock, with Dr. Pratt owning 3% himself. The business is run intelligently and with a diligent focus on “smart growth” — self-financing growth initiatives out of the cash flows and profits provided by being the market leader, rather than diluting equity investors at every chance to grab more cash through share sales or additional leverage.

This is the path to sustainable, long-term growth of a category empire, not a maniacal VC-backed company burning piles of investor cash along the way.

Checklist item 4: Is the company under followed and under the radar of most investors?

Check. The company is a complete stranger to most US-based investors. It trades in Frankfurt, and despite being a >1 billion euro market cap the stock is covered by only one investment bank (a local German bank). The company has never been covered by the Wall Street Journal, or featured on CNBC. You won’t find them doing roadshows across the US, or see their ads on US TV channels and billboards.

I want companies like that. It is rare to discover “hidden” names like this in equity markets these days, but given zooplus’ dominance, growth, and attractive valuation, I don’t expect it to remain “hidden” for long.

Checklist item 5: Can you make a simple valuation case for the business to be worth multiple times what it is today?

Check. I like businesses that I can do a valuation for using a single sheet of paper, and using simple fundamental metrics. zooplus stock listed in Germany currently trades at 0.9x 2017E Revenues. As with many high growth tech companies, EBITDA margins are currently compressed while the business invests heavily back into growth and expansion.

As the company continues to scale and become more efficient, margins should be easily able to trend to a 5–10% range in the next several years. Using our quick math from earlier, assuming zooplus can reach 2B in revenues by 2020 — at a 5% margin the current valuation would yield 10%, at a 10% margin = yields 20%. For a category leader in a high growth space with 20%+ revenue growth, those valuations would be very cheap.

A very reasonable valuation for a dominant business with long runway of growth and margin expansion

The recent acquisition of Chewy.com in the US provides an even simpler valuation case.

Given that Chewy.com is roughly the same size and scale as zooplus currently — approx. 1B in revenue with 20–30% growth, and a 50%+ market share in the pet e-commerce space — and was acquired at >3x Revenues, zooplus’ current valuation below 1x Revenue again looks quite reasonable, especially to potential acquirers like the European brick & mortar pet retailers (who are suffering from the online competition), or even Amazon who has been known to acquire in verticals they feel are strategically important but are currently far behind in (i.e. Zappos.com, Diapers.com).

Checkmate.

zooplus checks the boxes on many of the criteria I’m looking for in public market investments — a high-quality, well managed, growth business with a strong and expanding moat, and currently priced at a reasonable valuation based on simple metrics. I expect this business to continue on its growth trajectory, and to reward equity shareholders significantly as it continues to execute and deliver on its mission of being THE dominant player in online pet products.

Zooplus current price chart — Aug 2017
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