WEIGHT WATCHERS INTL INC WTW
September 30, 2013 - 10:17pm EST by
MSLM28
2013 2014
Price: 37.37 EPS $0.00 $0.00
Shares Out. (in M): 56 P/E 0.0x 0.0x
Market Cap (in $M): 2,102 P/FCF 8.8x 0.0x
Net Debt (in $M): 2,286 EBIT 0 0
TEV ($): 4,387 TEV/EBIT 8.8X 0.0x

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  • PE Ownership
  • High ROIC
  • High Short Interest
  • Industry Tailwinds
  • Scale advantages
  • Discount to DCF

Description

Please see the following link for graphs and charts. Also, I highly recommend abra399's write-up for additional background information.

Executive Summary

Weight Watchers International, Inc. ("Weight Watchers", “WTW” or the "Company") is a leading provider of weight management products and services with 43% of the United States market (including online and in-meeting). The Company has a market cap of $2.1B and an enterprise value of $4.4B. In 2012, the Company derived 72% of revenues from its In-Person meeting segment, and 28% from WeightWatchers.com. Geographically, the Company generates ~70% of its revenues from the United States and the remainder from overseas.

Mr.Market, the manic depressive, is currently offering a high quality clinically proven franchise, with a leading market share at 5.5x/5.1x 5 yr. average/TTM pretax earnings and 7.7x FY2012 FCFE. Importantly, the undemanding multiples are associated with a business that has grown revenues and EBITDA at a ~12.7% CAGR from 2000 to 2012. Why does this opportunity exist and why isn't everyone "backing up the truck" to this opportunity? (1) Weight Watchers is controlled by the Invus Group/Artal, (owner of ~50% of shares) who often require a liquidity event/buyback, which has levered the Company's balance sheet; (2) marketing/operating mishaps (i.e. loss of Jessica Simpson as a spokesperson due to pregnancy), which set the tone for earnings for the year; (3)  introduction of free mobile applications has caused investors to question the sustainability of WTW’s model and 4) decline in meeting attendees, partially affected by marketing mishaps, mobile applications and payroll tax increase.

 

However, Weight Watchers will rebound from these events as it has in the past. The following attributes make the Company a highly attractive investment at current prices:

 

  • Diversified Business Model with a Leading Market Share - Weight Watchers serves over 1.0 million customers with over 40,000 meetings a week, leading to a diversified customer base. Further, the Company has a leading market share of 43% within the U.S. weight loss segment, which includes over 20,000 competitors. Importantly, Weight Watchers has grown its market share from ~32% in 2008 to 43% FY2012.

 

  • Industry Tailwinds due to a Global Obesity Epidemic: WTW is well positioned to benefit from the growing global obesity epidemic. For example, within the United States, over 69% of the population is obese or overweight according to the Centers for Disease Control and Prevention.

 

  • Clinically Proven Weight Loss Program: Weight Watchers has a weight loss program which has been successfully utilized for over 50 years. Multiple clinical studies have reaffirmed that the Company’s program is successful. Weight Watchers is one of the only weight loss programs supported by doctors, employers and insurance companies.

 

  • Attractive Valuation - Weight Watchers Common shares have declined from a 52 week high of $60.30 and currently trades a 7.7x FY2012 FCFE and 8.8x FY2013E FCFE. All in, this is an undemanding multiple for a asset light business with high returns on capital. I believe the common stock is conservatively worth between $48 to $60 per share, representing a upside potential between ~32% - 60%.

 

  • Scalable Fee Based Business Model which Generates Strong  Free Cash Flow while Delivering High Returns on Invested Capital - Weight Watchers business is highly scalable, given its negative net working capital model as clients prepay for meetings. Given the business's low capital intensity, ROIC is abnormally high, in excess of 30%, over the past five years. Importantly, free cash flow margins have been in excess of ~14% (FY2008 - FY2012), allowing for rapid debt repayment, share repurchases or accretive franchise acquisitions.

 

  • Focus on Corporate Clients - Leveraging off its long-time partnership with the Cleveland Clinic, the Company has started to form partnerships with corporations such as American Express which can offer Weight Watchers programs and meetings for employees onsite. Medicare costs alone could be cut by $15.0B if programs are supported/ subsidized by employers. This segment can be highly sticky given the potential cost savings for employers and importantly has grown 30% FYTD13.

Business Description

Founded in 1961, Weight Watchers is a leading provider of weight management products and services through its global network of owned and franchised operations and via its online presence, WeightWatchers.com.  Company founder, Jean Nidetch, initially arranged meetings for her friends desiring to lose weight by sharing dieting ideas (including what she learned attending an obesity clinic) and by providing support to each other.  In 1978 Heinz acquired Weight Watchers and owned it until 1999, when private equity firm Artal Luxembourg purchased the Company from Heinz in an LBO for $735.0MM ($224.0MM of equity).  Artal Group brought Weight Watchers public in 2001 and currently owns 51.4%.

 

Weight Watchers International ($1.3B Revenues / $250.3MM Operating Profit FY 2012)

Within the WW International segment, the Company generates revenue from meeting fees (71% of 2012 segment revenues), product sales (19%), and Licensing/Endorsements and other (10%). Each week, over one million members attend over 40,000 Weight Watchers meetings around the world. The primary payment structure for Weight Watchers meetings is a Monthly Pass payment plan. With Monthly Pass, members receive unlimited access to meetings at a discounted monthly price plus free access to Weight Watchers eTools, the Internet weight management companion for Weight Watchers meetings members. Monthly Pass is typically offered at a 20% to 25% discount to the Company’s traditional pay per meeting weekly fee. The vast majority (over 3/4th) of Company’s meeting paid weeks were attributed to Monthly Pass during 2012, up significantly from a few years ago (monthly pass was introduced during 2006). During the fourth quarter of 2011, Weight Watchers increased the price of its Monthly Pass payment plan to $42.95 from $39.95 representing the first price increase since the Monthly Pass payment option was established.

 

WeightWatchers.com ($507.5MM Revenues / $260.5MM Operating Profit FY 2012)

Weight Watchers offers two Internet subscription products including Weight Watchers Online and eTools. Weight Watchers Online is based on the Weight Watchers approach to weight management and is designed to attract self-help-inclined consumers. Weight Watchers Online allows consumers to learn how to make healthier food choices and lead a more active lifestyle by providing them with online and mobile content, functionality, resources and interactive web-based weight management plans. As of FY2012, WeightWatchers.com had over 1.8 million active Weight Watchers Online subscribers. Weight Watchers eTools is an Internet weight management product available to consumers who are Weight Watchers meetings members. Weight Watchers eTools allows users to interactively manage the day-to-day aspects of their weight management plans online or via their mobile devices, discover different food options, stay informed and motivated, and keep track of their weight management efforts.

In the United States, Weight Watchers Online costs $65.00 for the initial 3-month term or $48.90 for the initial one-month term. The ongoing monthly fee for Weight Watchers Online is $18.95. In the United States, Weight Watchers eTools costs $34.95 for the initial 3-month term or $14.95 for the initial one-month term. The ongoing monthly fee for Weight Watchers eTools is $14.95. In addition, Weight Watchers eTools is included for free in purchases by consumers of Monthly Pass.

 

Differentiation

 

Weight Watchers differentiates itself from its competitors and has rapidly increased market share primarily through:

 

  • Clinically proven program (over 50 occasions) which have stood the test of time.

 

  • Physicians tend to recommend Weight Watchers to their patients. Doctor recommendations tend to be "stickier" compared with celebrity television adds.

 

  • The Company uses a holistic approach, tackling eating behavior and utilizing self support, versus only suggesting company packaged food, which Nutrisystem and Jenny Craig rely on. Studies show that consumers tend to prefer to eat "real" food versus packaged meals. Further, behavior modification tends to be a permanent solution, long term.

 

  • Weight Watchers has initiated a corporate program in which employers subsidize the costs for their employees.

 

  • The Company has a combination of in person and online tools which single product/solution providers.

 

  • According to a recent study in Europe "Weight Watchers costs a lot less than a traditional dietitian or nutritionist, which costs €35 to €40 per session versus €40 each month for the Weight Watchers subscription, including the meetings, online services and the dietitian".

 

Customers

Each week, over a million members attend over 40,000 Weight Watchers meetings around the world, which are run by more than 10,000 leaders, each of whom has lost weight utilizing Weight Watchers' program. Further, customer acquisition costs are relatively low due to both word of mouth referrals (over 50 years in business)  supported by numerous clinical trials and mass marketing programs.

Worldwide annual meeting attendance in Company-owned operations declined from 60.0 million users FY2008 to 50.7 million FY2012, a decline of 4.1% annually over the five year period. Worldwide average meeting revenue per attendee, however, has increased over the same period, largely as a result of Monthly Pass’ growing penetration in North America and other markets combined with growth in product sales per attendee.

 

 

Acquisitions

Over the past decade, Weight Watchers has made numerous value creating acquisitions by acquiring existing franchises and Weightwatchers.com

 Franchise Acquisitions

The Company has been a serial acquirer of its franchisees, which has allowed the Company to capture greater margin and revenues as it now collects 100% of sales instead of a 10% franchise fee and captures excess margins from product revenues, etc. Importantly, the Company estimates that approximately 89% of the carrying value of franchise rights acquired have a fair value of at least three times their respective carrying amounts. In the United States, the region which held approximately 84% of the franchise rights acquired, the aggregate fair value of  franchise rights acquired was more than four times the aggregate carrying value, according to Company filings.

Weight Watchers initially pursued a franchise based strategy to grow the platform across the United States and benefit from the annuity like revenue streams. However, the Company realized it could capture greater growth and high returns on capital by opportunistically acquiring franchisees (some of whom were retiring) throughout the United States, and potentially capture higher margins from product sales, etc. The Company paid attractive prices for their franchises in hindsight and is supported by the Company's annual goodwill impairment tests.

 

WeightWatchers.com

On June 13, 2005, Weight Watchers acquired the remaining 70.5% interest in WeightWatchers.com, Inc. that it did not own for approximately $389.0MM or an implied enterprise value of $552.0MM. The transaction  has been highly value accretive since close, based upon the growth in operating income and revenue, which directly translates into a larger enterprise value for the segment. Since 2005, the WeightWatchers.com segment has grown revenues and operating profits at a 20.7%/54.8% CAGR, respectively. It is evident that WeightWatchers.com  is the Company's crown jewel and has significantly benefitted from WTW's management of the business.

Contrary to the opportunistic/semi-value destroying share buybacks, management has demonstrated its ability as a shrewd acquirer, based upon its franchise and WeightWatchers.com acquisitions, which have contributed to the Company's growth in revenues and operating income.

 

Executive Management

Weight Watchers is led by CEO James Chambers (previously President and COO).  Mr. Chamber's has extensive experience in consumer products – including multiple positions at Nabisco, Cadbury Adams and Remy Cointreau, among others.  Chairman Raymond Debbanne of Invus Group however, is the brains behind Weight Watchers. Since acquiring the firm in 1999 from Heinz, revenues have grown from $365.0MM to $1.8B. A 2012 article on Forbes presented below provides some insight onto Mr.Debbane: http://www.forbes.com/sites/nathanvardi/2012/09/04/the-mystery-man-behind-weight-watchers-and-the-private-equity-deal-of-the-century/

 

Revenue Trends

Meeting & Product Revenues

From FY2008 through FY2012, meeting fees grew at a CAGR of 0.7%, with growth in the UK and North American meetings businesses being partially offset by declines in the Cont. European meetings business. This increase was driven by growth in meeting paid weeks, which grew on a global basis at a compound annual growth rate of 2.1%. The decline in meeting fees from FY2008 to FY2009 primarily reflected the impact of the global recession on the ability to enroll new members as consumers reduced discretionary spending.

Beginning in North America during Q2/10, revenues rebounded from declines experienced in FY2008 and FY2009, driven by YoY growth in recruitment trends, supported by new marketing and the soft launch in the Q4/10 of PointsPlus and ProPoints in WTW's English-speaking markets. The momentum of the new program launches in WTW's English-speaking markets accelerated recruitment trends in the Q1/11, which resulted in global meeting fees that increased in every quarter of FY2011. Additionally, price increases FY2011 positively impacted revenues.

Weight Watchers entered FY2012 with a higher meeting membership base than at the beginning of FY2011, however lower enrollments in all FY2012 quarters resulted in lower meeting fees for the year as compared to the prior year. Lower enrollments in the meetings business in FY2012 were primarily driven by a decline in the English speaking-markets as the Company cycled against the momentum of prior year’s program innovations.

Global product sales were down 3.5% on a compound annual growth rate from FY2008 through FY2012.  Average product sales per attendee in the meetings business grew from $4.76 to $4.99 at a compound annual growth rate of 1.2% during that period as a result of successful new product and program launches. However, the Company experienced a decline in the number of members attending meetings which ultimately drove a decline in global product sales.

 

Internet Sales/Weightwatchers.com

The continued success of WeightWatchers.com is evident as Internet revenues have grown at a 28.4% CAGR from FY2008 to FY2012. Growth was primarily driven by positive strides in Online subscription revenue, which itself grew at a 29.6% CAGR from FY2008 to FY2012. Subscription revenue growth was driven by an increase in Online paid weeks from 38.9 million in FY2008 to 111.5 million in FY2012, a at a CAGR of over 30%. Growth resulted primarily from a combination of new subscribers in Weight Watcher's major markets and launches of WeightWatchers.com subscription products in new markets globally.

In addition, WeightWatchers.com, like the meetings business, benefited from the new program launches of PointsPlus and ProPoints in FY2010 and FY2011 and the introduction of new products, including applications for mobile. Marketing, particularly first time dedicated television advertising coupled with effective marketing campaigns in Canada and Continental Europe in the case of FY2012, continued to drive subscription growth over the period. In addition to generating revenues from its subscription based offerings, WeightWatchers.com also provides a means for companies to advertise on their websites. This advertising revenue increased at 13.3% CAGR over the period.

 

Increase in Gross Margin

As the WeightWatchers.com business grew over the period and became a larger share of total revenue mix, gross margin expanded. Within the meetings business, meetings staff is usually paid on a commission basis and space is rented as needed in most instances. When it becomes more cost effective to do so, in various geographies, Weight Watchers rent centers at reasonable rates with relatively short lease terms. Moreover, the Company adjusts the number of meetings according to demand. This variable cost structure has enabled Weight Watchers to maintain high margins even as they have experienced a decline in the number of attendances per meeting. When attendances per meeting grow, gross margins typically improve.

 

Working Capital

Weight Watchers operates under an attractive negative net working capital model, which partially drives an above average ROIC. The negative net working capital model is fueled through Weight Watcher's commitment plans (primary payment method). These plans require members and subscribers to pay for meetings and subscription products, respectively, before the Company pays for their obligations. The trend suggests that Weight Watcher's negative net working capital is the largest during the first quarter of the year, as it is their prime sign up season.

Generally speaking, as Weight Watchers grows their revenues, negative net working capital should increase, while the opposite should occur if business shrinks. Historically, the Company has been active in growing their "float", which frees up cash to either be returned to owners or for other uses (i.e. debt pay-down).

 

Industry

According to IBISWorld, in 2013, Americans are expected to spend about $2.4B on weight loss services. As the percentage of Americans who are overweight or obese continues to rise, the demand for this industry’s services strengthens. Currently, 69.2% of Americans are either overweight or obese, according to the latest data from the Centers for Disease Control and Prevention.

During the recession, with adverse demand conditions, smaller companies were forced to exit the industry or were acquired by competitors. Furthermore, instead of building out their own platforms, Insurance companies and employers are preferring to partner up with Weight Watchers given the built-out proven program.

The percentage of Americans who are overweight or obese is expected to rise to 75.0% of adults by 2015. Worsening health trends and rising per capita disposable income are expected to increase demand for weight loss services in the next five-year period. From 2013 to 2018, industry revenue is projected to increase at an average rate of 2.3% per year to reach $2.7 billion. Over the five-year period, more industry operators will begin targeting men for weight loss programs, as women currently account for the majority of clients. As such, men’s weight loss services represent a relatively large untapped market for the industry.

Growth Prospects

A relatively untapped market is men’s weight loss. Currently, the majority of this industry’s clients are women, despite the fact that a higher share of men is classified as overweight compared with women. According to the latest information from the Centers for Disease Control and Prevention (CDC), in 2010, the share of men who are overweight or obese is 73.3%, while 63.9% of women are overweight or obese. Despite this factor, an estimated 90.0% of Weight Watchers’ members are women, a trend that holds true for the majority of industry operators. As such, Weight Watchers has indicated that it will begin to focus on men’s weight loss. Industry operators in general are expected to follow this trend, given that men’s weight loss represents a large, untapped market for the industry, and could generate significant growth for weight loss companies. Over the next five years, it is expected that marketing efforts will increasingly be focused on men’s weight loss programs.

Competitive Landscape

Weight Loss Services industry has a high level of market share concentration. In 2013, the top four companies in the industry are expected to account for 71.9% of the industry’s revenue. This is a slight increase compared to 2008, when the top four companies generated 70.7% of the industry’s revenue. However, this is largely due to strong growth from Weight Watchers, which has increased its market share significantly over the past five years, rising from 32.0% in 2008 to 43.2% in 2013. The Company has been acquiring its franchises over the past five years in addition to expanding its product and service line, which has helped it gain market share. In 2008 alone, the Company acquired four franchises located in Florida, Kansas and New York.

By contrast, Nutrisystem, the second-largest company in the industry, has divested or discontinued some of its business operations over the past five years. In 2010, NutriSystem sold its subsidiary Nutrisystem Fresh Inc., in 2010. Furthermore, during the recession, meal replacement products did not fare as well as diet management services such as Weight Watchers, due to restricted income during the recession. Consequently, Nutrisystems has lost market share, falling from 25.4% in 2008 to 14.4% in 2013


Porter’s Five Forces Analysis

 Threat of New Entrants - Moderate

Risk of new entrants is mitigated given the highly fragmented marketplace, in which Weight Watchers has the leading market share. Further, new entrants must invest heavily in distribution and marketing, along with having their products or approach clinically proven.

Threat of Substitue Products - High

Weight Watcher's solution is primarily behavior based. Further, the solution is even suggested to be used concurrent with gyms, etc. Dieticians and weight professionals tend to cost more than Weight Watchers.

Bargaining Power of Suppliers - Low

Weight Watcher's products can be sourced from multiple vendors (i.e. cook books, etc.).

Bargaining Power of Customers - Moderate

The Company successfully initiated a pricing increase in 2011, with little affect on membership for the year. However, in the past downturn, membership did decrease 8.5%.

Rivalry - High

Weight Watchers has a 43% market share within the domestic weight loss industry, which comprises over 25,000 competitors. The Company has helped customers for over 50 years. Further, the system has been clinically vetted numerous times.

     
     
     
     
     
     

 Valuation

As demonstrated in our attached charts, a weighted scenario DCF analysis yields a share price of ~$48 - $60 per share, which represents signifcant upside from the current share price. Many times, often the simplest valuation methods yield the cleanest results. Over the past five years, pretax earnings have averaged $368.8MM and $397.0MM for the TTM period, respectively. At the current prices, this equates to a ultra low 5.5x/5.1x pretax earnings multiple. A high quality compounder with a decent moat such as WTW, should trade at least 8.0x pretax earnings, which would suggest an intrinsic value of ~$52 per share. Further, the share price is supported by our DCF estimation and amounts to a solid ~13% pretax return on the estimated intrinsic value of the equity.

Catalysts

Buyback of Shares

Weight Watchers trades at a materially discount (~24%) to its conservatively estimated base case valuation of $48.50 per share. At current prices, buybacks will be accretive to intrinsic value.

Marketing Execution

This upcoming November, Weight Watcher's will unveil its new marketing strategy for 2014 and beyond. End of the year marketing tends to set the tone for the upcoming year in terms of membership. Weight Watcher's is working on a convergence of its online and in-person platforms which will further solidify customer relationships.

Attractive Valuation

Weight Watcher's currently trades at 7.7x FY2012 FCF and 8.8x FY2013E FCF. Further, free cash flow has consistently been over $200.0MM over the past years. Weight Watcher's also trades at an undemanding 5.1x and 5.5x TTM 2013/5 year average pretax earnings.

Take Private of the Business

As Mr. Market is drastically under appreciating the Company's strong franchise combined with compelling industry tailwinds, we would not be surprised if the Company is taken private at 10.5x EBITDA or greater (supported by high EBITDA/FCF conversion).

 

Risks

Threat of Free Mobile Apps

Weight Watchers has competed against a wide variety of weight loss fads (i.e. Atkins) over the years and has successfully stood the test of time. Free mobile applications have no real method of monetization. Additionally, the apps lack the group support offered by Weight Watchers.

Capital Structure

Weight Watcher's debt can be viewed as a quasi-asset given the terms, as the Company tapped the 1% amortization institutional loan markets, which carry loose covenants and low pricing. The Company comfortably covers all its obligations with a (EBITDA-CapEx/Int.Exp) coverage greater than 7.0x.

Continued Membership Decline

The Company is implementing a new corporate strategy in which employers subsidize employee memberships. This strategy is a win/win for the employer and consumer. Recent membership decline can be attributed to poor marketing execution for a wide range of reasons (Jessica Simpson pregnancy among others). Given that the yearend marketing season is crucial for FY results, a turnaround will not be in place until the upcoming marketing season. The Company has changed up management, recently promoting  James Chambers to CEO from President/COO. Importantly, he is a relatively new addition to the  team  (joined in 2013) and has extensive consumer marketing knowledge.

 

Conclusion

In conclusion, Weight Watchers is a highly undervalued  franchise based upon current cash flows with a base case value of $48.5 (32% upside from current equity prices). The Company is well positioned to address and benefit from  obesity epidemic throughout the world, given its expertise and proven capital light business model. With a large business moat which is evident by its growing 43% market share, the business is attractive especially at a time when few businesses, especially compounders such as Weight Watchers, of this quality are trading at reasonable multiples of cash flow (8.8x FCFE on a forward basis). Given the potential growth in Corporate accounts and a rebound in 2014 meeting attendance, the shares could be worth as much as $60. I recommend purchasing Weight Watchers at a price of $37 or better.

 



 
 

·     

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

Catalyst

Potential catalysts include an update in the Company's strategy at the upcoming analyst day in November, buyback of shares, attractive valuation below PMV and a take private.
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