Ackman and a Former Protege Launch Campaign at Zoetis

Activist Bill Ackman's Pershing Square Capital Management LP and a smaller fund helmed by a former protégé, launched a campaign at Zoetis Inc. (ZTS) according to securities filings Wednesday, in an effort that could eventually push the animal-health company to sell itself.

Pershing Square said in its filing it had acquired an 8.5% stake in Zoetis, in an allocation that includes some common shares, a large number of put options and so-called forwards, which are commitments to buy shares at a later date at a fixed price, and other derivatives investments including cash-settled total return swaps.

The equity part of that investment, roughly 41.8 million shares, is valued at roughly $1.7 billion at Zoetis' 60-day moving average and was accumulated during the same period that Pershing Square has been in court with Allergan Inc. (AGN) as the Botox maker has battled a takeover bid from Valeant Pharmaceuticals International Inc. (VRX) , backed by Ackman's fund.

Though the Wednesday filing contained the initial boilerplate language common to activist's 13D filings, Ackman usually follows those up with detailed letters making demands and even a heated proxy fight if the target doesn't accede to the hedge fund's pressure.

The hedge fund manager will likely be able to gain some support among Zoetis' institutional investors by pointing to the company's poor showing in its bylaws when it comes to shareholder rights. According to a report by Institutional Shareholder Services Inc. obtained by The Deal, Zoetis received a 9 out of 10 rating for its shareholder rights, with 10 being the worst possible assessment. Overall, ISS ranks Zoetis as a 6.

ISS noted that the Zoetis board is classified, which means that not all directors are up for election annually. This means that Pershing will be unable to launch a change-of-control proxy contest at the company, should it decides it wants to try to back a director slate. In addition, Zoetis prohibits shareholders from calling a special shareholder meeting or acting by written consent, leaving Pershing with little recourse except to wait for the next annual meeting, which isn't expected until May 2015 at the earliest. The ISS report gave red flags to Zoetis for these prohibitions.

Zoetis has been an independent public company for a little over a year, having spun off from Pfizer Inc. (PFE) in Feb. 2013. Since then, the company has pushed to make a case for itself as an independent animal healthcare business even though most of its rivals are owned by larger conglomerate pharmaceutical companies, such as Merck Animal Health. The business provides animal health products including antibiotics or vaccines, to veterinarians and livestock producers such as poultry producers.

Despite Zoetis' stance, Ackman may push for a sale of the company. One possible acquirer candidate is Valeant. Pershing has been working together with Valeant to assist it in its hostile bid for Allergan, but one observer familiar with the situation suggested that if that effort fails, Valeant can seek to combine with Zoetis with Pershing's help.

In the filing, Ackman said he planned to engage with company executives and directors in discussions about the business' management, strategic plans, governance and board composition.

Those discussions are already underway. A Zoetis spokesman acknowledged that company officials have received a call from Ackman but declined to comment on the details of the conversation. He added that Zoetis is preparing for its upcoming investor day on Nov. 18 and is looking forward to sharing more information about its "business model and growth strategies with the investment community" at that time.

Ackman was joined with another much smaller activist fund, ex-Pershing lieutenant Scott Ferguson's Sachem Head Capital Management LP, in the effort. Ferguson also filed a 13D with a less than 1% equity stake. That, combined with its derivatives investment, brings Sachem Head to a roughly 1.5% stake. Between them, the two activist funds have about a 10% investment.

Ackman and Ferguson have known each other for a while. Ferguson had previously been an analyst for Ackman and eventually rose to partner at the activist fund before launching Sachem Head in 2012. Ackman was among Sachem Head's first investors, according to people familiar with the situation.

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