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A Petco location is seen on Nov. 23, 2015, in San Francisco.Justin Sullivan/Getty Images

The Canada Pension Plan Investment Board (CPPIB) is counting on pet parents increasingly spoiling their cats and dogs with its latest U.S. investment.

The CPPIB and private equity group CVC Capital Partners are acquiring San Diego-based Petco Animal Supplies Inc., a U.S. retailer of pet food, supplies and services. The deal is valued at $4.6-billion (U.S.) including an undisclosed amount of debt.

For the CPPIB, there's value in the current "humanization trend" where owners treat their pets like a family member, said Shane Feeney, head of direct private equity at the CPPIB. Petco's growth has been spurred by consumers' increasing demands for sophisticated care services and premium nutrition offerings for their pets.

That trend, "coupled with a business and a sector, frankly, that's pretty resilient," were attractive to the CPPIB, Mr. Feeney said, adding that Petco performed well through the financial crisis. Petco has previously called the pet industry "highly fragmented" and valued it at $74-billion.

Pet-focused businesses have attracted attention from other Canadian bidders in recent years as North Americans spend more money on their animals, and improved medical care and food help extend pet lives.

Earlier this year, the Ontario Teachers' Pension Plan's private capital group bought U.S. veterinary business acquirer PetVet Care Centers for an estimated $520-million (Canadian). And last year, Fairfax Financial Holdings Ltd. bought its second pet insurer – Oakville, Ont.-based PetHealth Inc. – for $100-million. As health expenses and treatment options for pets mount, the insurer sought to capitalize on owners seeking protection from unwieldy bills.

Petco has been a marathon investment for its largest sellers, TPG Capital and Leonard Green & Partners. These private equity firms most recently owned Petco for more than nine years after privatizing the business for about $1.68-billion (U.S.) plus $120-million in debt in 2006. Both owners had also been invested in Petco before its 2002 initial public offering.

In the deal with CVC and the CPPIB, two minority Petco owners will also exit. Abu Dhabi Investment Authority had a nearly 12-per-cent stake in the business, and private equity firm Freeman Spogli & Co. owned about 6.7 per cent through a fund.

The deal follows the $8.7-billion privatization of PetSmart Inc., Petco's major competitor with a larger market share in the U.S., led by private equity group BC Partners in late 2014. PetSmart was facing criticism about its performance from activist shareholder Jana Partners.

Rumours that the two pet companies might merge followed Petco's original plans for an IPO this summer. According to its U.S. filings at that time, Petco had "substantial indebtedness" of $2.3-billion outstanding as of Aug. 1.

The filing also notes that the millennial cohort are fond of their fur-babies – more have pets now than five years ago, and they're spending more on them. Over all, just over half of Petco's sales come from supplies and 38 per cent come from pet food. The remaining 8 per cent comes from services such as grooming and other activities.

In the next five years, increased discretionary income and an interest in premium pet products and foods are expected to lead to growth of pet store profit margins, which have already climbed from 5.8 per cent of revenue in 2010 to 8.1 per cent in 2015, according to research firm IBISWorld.

Pet stores will also be competing with grocery stores, online retailers and others for business. Petco and PetSmart, the largest retailers in the U.S., may be in a better position to deal with this shifting landscape than the roughly 40 per cent of U.S. pet stores without a household name brand. But there's also a trend of consumers spending money with specialty service providers such as pet therapists and on unrefined, organic foods.

The market for pet paraphernalia outside the U.S. may also pose challenges for both PetSmart, which has stores in Canada, and Petco, which has a joint venture in Mexico and stores in Puerto Rico. Pet suppliers tend to be domestically owned around the world, notes IBISWorld, and globalization is low for this industry.

Mr. Feeney said the CPPIB isn't making any specific assumptions around Petco's growth in market share or involvement in industry consolidation. Petco's U.S.-focused brick-and-mortar and online business has no plans to expand.

Over all, the interest in animal health investments has been high. French animal health company Ceva Santé Animale reorganized and refinanced last year with investments from new and existing private equity backers. And Ares Management LP acquired U.S. animal hospital group National Veterinary Associates for an estimated $900-million.

The CPPIB worked on the deal for about one month before the sale was announced, and was involved in a competitive process. The acquisition is expected to close in early 2016.

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