Zoetis IPO has pop

Zoetis Inc. on Friday unveiled the largest initial public offering since Facebook Inc. raised $2.2 billion in mid-2012. Now the largest animal health business in the world will look to do what Facebook hasn't been able to do as of yet -- grow its share price.

Pfizer Inc.'s now-former animal health division is off to a bold start. Late Thursday, Madison, N.J.-based Zoetis filed documents with the Securities and Exchange Commission pricing the IPO at $26 per share, above the $22 to $25 per share range it first outlined two weeks ago.

At $26 per share, the IPO values Zoetis at $13 billion and raised more than $2.2 billion, according to regulatory filings.

Zoetis began trading on the New York Stock Exchange under the symbol ZTS on Friday morning above the IPO price, at $31.50 per share.

Zoetis has issued both Class A and Class B common stock, with the former class going to the group of firms underwriting the IPO and investors on the open market, and the latter class going exclusively to Pfizer. Zoetis offered 86.1 million shares of its Class A common stock in the IPO.

The underwriters, however, have the option to buy another 12,915,000 Class A shares through a complex transaction with a subset of underwriters holding at least $2.48 billion in Pfizer debt dubbed the "debt-for-equity exchange parties" and identified in the document as JPMorgan Securities LLC, Bank of America Merrill Lynch, Pierce, Fenner & Smith Inc. and Morgan Stanley.

Should the underwriters exercise that option in full, Zoetis would have a total of 99,015,000 total Class A shares.

The three debt-for-equity exchange parties are to get all of the proceeds raised from the sale of Class A stock in the IPO. They are also the joint bookrunning managers of the offering.

The underwriters aside from JPMorgan, Merrill Lynch and Morgan Stanley are Barclays plc, Citigroup Global Markets Inc., Credit Suisse Securities (USA) LLC, Deutsche Bank Securities Inc., Jefferies & Co., BNP Paribas Securities Corp., HSBC Securities (USA) Inc., Loop Capital Markets LLC, RBC Capital Markets LLC, Williams Capital Group LP, UBS Securities LLC, Lebenthal & Co. LLC, Piper Jaffray & Co. and Samuel A. Ramirez & Co.

Following the offering, Pfizer may own a stake representing an 82.8% economic interest in Zoetis and 98% of the combined voting power regarding the election of directors. Those numbers would shift to 80.2% and 97.6%, respectively, if the underwriters exercise their option to buy more shares. Pfizer, however, has said that following the offering it may make a tax-free distribution of all or some of its Zoetis stake.

As it prepared to separate from Pfizer, Zoetis put both a series of notes and a revolver in place. It raised $3.65 billion in senior notes through a private placement that consists of $400 million in 1.150% senior notes due 2016, $750 million in 1.875% senior notes due 2018, $1.35 billion in 3.25% senior notes due 2023 and $1.15 billion in 4.7% senior notes due 2043. Pfizer will get all the cash raised from the note offering.

Zoetis has also raised a five-year, $1 billion senior unsecured revolver from a syndicate of banks.

Zoetis produces treatments (vaccines, parasiticides and anti-infectives) for diseases in livestock and pets. The unit brought in $4.2 billion in revenue in 2011 and $3.2 billion over the first nine months of 2012. It has products in more than 120 countries in major geographic regions such as Africa, Europe, Latin America, the Middle East, North America and Asia-Pacific, selling to veterinarians, livestock producers and animal owners.

Zoetis posted $482 million in adjusted net income over the first nine months of 2012, a 27% jump over the first nine months of 2011.

Zoetis immediately becomes a unique company. Most of the world's largest pure-play animal health businesses are buried within the umbrellas of big pharmaceutical companies such as Eli Lilly and Co. (Elanco), Sanofi (Merial) and Merck & Co. (Intervet). Some large drugmakers, such as Perrigo Co., have been building a position in animal health. Perrigo, for example, bought Sargeant's Pet Care Products Inc. for $285 million in September to create an animal health division and then bolstered that position Friday by acquiring another pet care company, Velcera Inc., for $160 million. Others, such as Pfizer and Teva Pharmaceutical Industries Ltd., are getting out of it. Teva sold its animal health division to Bayer AG for $145 million in September.

Zoetis, however, "will be the first opportunity for a pure-play investment in one of the major animal health manufacturers," Morningstar Inc. analyst David Krempa wrote in a research note.

Even so, however, Krempa believes there isn't much upside at its current share price. Krempa noted that even at $23.50 per share, Zoetis would trade at 18 times Morningstar's 2013 earnings per share estimate of $1.31. Krempa values Zoetis even lower, at $22 per share, based on an enterprise-value-to-sales multiple of 3.2.

"[T]he proposed offer price leaves limited upside for long-term investors," he wrote.

Those that are jumping into animal health are doing so buoyed by the fact that the industry has showed continued growth. Zoetis cited statistics from research and consulting firm Vetnosis Ltd. in regulatory filings showing that the animal health medicines and vaccines market for livestock increased at a compound annual growth rate of 6% between 2006 and 2011. The market was worth $22 billion in 2011 and should continue to increase at a 5% CAGR over the next five years, according to Vetnosis.

Several factors are contributing to the increase. For one, economic development in emerging markets has led to more disposable income, and thus increased pet ownership. In developed markets, people are more willing to pay premium prices for healthcare treatments for their pets, according to Krempa.

Secondly, Krempa explained, rising standards of living are driving wider adoption of improved nutrition and meat-heavy diets.

Zoetis has $300 million in cash, but given that acquisition opportunities in the animal health industry are limited, Krempa expects Zoetis to return the majority of its free cash to shareholders.