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MEDIFAST INC MED
November 25, 2019 - 5:21pm EST by
tac007
2019 2020
Price: 83.00 EPS 6 7
Shares Out. (in M): 12 P/E 14 12
Market Cap (in $M): 900 P/FCF 12 10
Net Debt (in $M): -100 EBIT 95 110
TEV (in $M): 1,000 TEV/EBIT 10 8

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  • Potential Leveraged Buyout
 

Description

Medifast Price $82   
 
In traditional VIC formatting - I apologize. 
 
 
 
Medifast has been written up twice, in 2013 and 2014. The stock since has been a 3x+. I think it is time
to go long again.
 
 
Medifast is dietary nutritional company that makes money by selling its products. Its biggest product
line is Optavia, representing ~95% of revenues. Its competition includes WW, Nutrisystem and other
diets. Medifast was founded in 1980 by William Vitale, a medical doctor. His products were sold directly
to other doctors, who in turn prescribed them to their patients.
 
 
If you screen for Medifast, you will see that between 2010 and 2016 the company’s revenues did not
change much (slightly positive) and that adj. EBITDA was around 14%. The company is capital light, so it
generates a decent amount of cash (the company currently pays a 3.5% dividend as well as purchases
back stock). During that time the company was run primarily by the MacDonald family (Michael and
Bradley, as well as daughter Margaret Sheetz). You can google Medifast nepotism for more details. The
company was quite lackluster.
 
Engaged Capital, activist fund, gets seats on the board in early 2015. By October 2016, they add the
current CEO, Daniel Chard. Dan’s previous experience was President of Global Sales and Operations at
NuSkin. Dan then transforms the business.
 
 
Instead of selling Medifast products via chiropractors’ offices, Daniel focused on a product called Take
Shape for Life and branded it Optavia. Optavia’s business model is direct marketing (some would refer
to MLM — I will address concerns below). Optavia works on a Coach – client model. Once clients lose
weight, they can become a coach if they wish to do so. Coaches do not receive discounts, nor do they
handle inventory or cash payments.
 
Here is how it works in real life: I recently saw my sister and it was obvious she had lost 10 lbs., she told
me it was through Optavia. She said she did it when she saw her friend lose weight. While my sister
didn’t want to be a coach, she referred several clients to her coach.
 
 
Three VERY important takeaways here:
▪ Losing weight is the best marketing — people will notice and ask
▪ Losing weight with a coach is MUCH easier when a) you have spent money and b) when you
have a coach. You have bi-weekly FaceTime calls with your coach
▪ The product works. It’s not magic. It’s simply eating ~1,250 calories a day. However, part of the
product is the Coach-Client model
▪ Social media is free marketing for coaches. We’ve spoken to many of them and they go to
Facebook groups and simply post before and after pics of themselves and their clients.
▪ There is an (almost) endless supply of people who should and want to lose weight in America
The cost of Optavia is about $400 a month. While meaningful, you do save on some food. Because you
enter in caloric deficient mode, you lose weight quickly, and you should save some money from other
type of food.
 
During the past two years Optavia’s revenue growth exploded 3.5x in less than 3 years by increasing the
number of coaches from 12,500 to 32,200 from Q4’16 to Q4’19, respectively, and by having the revenue
per coach increase from $4,158 to $5,715.
 
In regards to the coach MLM model. Coaches do not buy inventory, nor do they get discounts. This is
very different to Herbalife. The coaches I’ve talked to think about it as a side gig. They are accountants
or stay at home moms who are very well tuned to social media – most use facebook and Instagram. Most of them seem to be women, they enjoy extra cash, the social aspect, and very importantly many women feel that being a coach forces them to keep track of what they eat. 
 
As EPS started to grow, the stock went from mid-30’s to ~250 in the next two years (proving the
previous VIC writer correct). As the stock went full momentum upward expanding P/E ratio from 25 to
75x, the same momentum crushed the stock down now to roughly 14x past twelve months earnings.
 
 
Chart is from WW -- vic messed up the formatting of the chart.  I use it to illustrate seasonality in the diet business. 
 
 
 
Q3’19 quarter call the company missed Q4’19 analysts’ estimates — only three analysts cover the stock.
Management was hit with several operational issues as well as seasonality. Management called 3
reasons why this occurred:
▪ Credit cards were stolen, orders were placed, these orders were re-routed to a different
address, then the product appeared in eBay and Amazon.
▪ IT Issues: Management is moving their ERP system. They had hired a small company to do it,
now they’ve hired Deloitte to help them with the process
▪ Supply Chain issues: MED is increasing its supply chain by 40% and upgrading equipment.
Several of the favorite orders were not available or were shipped late causing disruption in the
program
 
The exact results of this are impossible to pinpoint. From the credit card data management believes that
cost about $3M. However, the operational issues will affect Q4. Management pointed that Q4 guidance
is lower due to lower retention rate in Q3 of clients, we know that there are less clients who will be
coaches in Q4. This client coach cycle should fix itself in Q1 as the clients new to the program should
have a positive experience with Optavia. 
 
Just like there is the chicken cycle, there is a diet cycle. I just made that term up, but it exists,
nevertheless. The name of the game is that most people want and go on a diet in Q1, the goal is to hold
on to them as long as possible. If you started your Q1 with a poor number, you will have a challenging
year.
 
 
An important piece here is that I believe Q1 earnings expectations are only ~1% higher than last years.
After MED was trouncing earnings quarter after quarter, analysts moved their expectations higher,
making it more difficult for the stock to beat consensus.
 
 
 
Last week we saw Engaged Capital, the previously mentioned activist investor, buy ~15% of the
economic interest in the stock via the common and swaps. We also saw MED file for poison pill
protection.
 
Valuation: Medifast trades at net cash and can generate 7-10% free cash flow in the next two years and
trades at an ex-cash of 12x. I think that if the stock returns to growth at mid-20’s which is what
management expects, I see the company potentially re-rate at 20-25x. If you think they can do $8 per
share in 2021, that’s about $180 per share in two years. The company has been around for 40 years so
with no debt and a variable cost structure the downside to this business seems very mitigated. Perhaps
the biggest reason I like this investment is the asymmetric risk/reward.
 
 
 
 
 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

 Earnings,  potential acquisition, engaged capital being an investor again

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