Weight Watchers International, Inc.
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With Weight Watchers releasing its annual report yesterday, we can finally dig into the numbers a little more specifically and formulate a plan for what to do with this dog.
The first key takeaway is that, I believe Weight Watchers should be able to satisfy its $300 million debt maturity next April (2016). Currently the company has built up $300 million in cash on the balance sheet, and with $100 million in expense reductions this year, I can see the firm generating another $100 million or so in free cash this year. Furthermore, there are no restrictive debt-to-EBITDA covenants in their bonds, so it is really just a numbers game.
The enormous $2.1 billion redemption is not until 2020. That's a ways out, but I dont see any possible way the firm is going to be able to generate enough cash flow to pay that. Refinancing some of it is going to be critical, as is getting the business turned around to start generating cash again. When operating well, Weight Watchers has a great, cash gushing business model.
All of this goes to show what enormous damage a bad management decision can make. Back in 2012, prior management took on $1.5 billion in debt to buy back company stock at $82.50 per share! That decision has now put the company in critical condition. Worse yet, not sticking to my usual guns of avoiding ugly balance sheets has led us into a losing position. This will be a lesson learned for future picks... no matter how much seemingly reliable cash a company generates, you can never ignore the danger of excessive leverage.
Weight Watchers is really tricky to value right now, but I'm taking a simplistic approach and valuing it at 0.6 times expected 2015 sales. A quick rule of thumb is that a "normal" company is often fairly valued at a price-to-sales ratio 1/10th of its operating margin. That is, if a firm runs a 10% operating (pre-tax) margin, a decent price-to-sales valuation is about 1.0. Given Weight Watcher's problems, and what I feel is realistic guidance of $1.2 billion in 2015 sales at a 15% operating margin, 0.6 is a sufficiently conservative multiple. That makes the target price $13.
Weight Watchers is now a turnaround play, but a highly risky one. I would not really advocate putting new money into it, and if you are unfortunate enough to hold it (like me), selling bits of it to offset gains elsewhere might not be a bad plan in the near term.
Weight Watchers is one of the top providers of weight-loss services worldwide. The core of Weight Watchers offering is group-based support, with over 45,000 meetings and over 1 million attendees every week. Meeting fees accounted for 51% of revenues last year. Weight Watchers online program, incorporating the firm's dietary point system and offering optional face-to-face support, has been gaining traction, driving 28% of sales. Product sales account for 14% of revenue and include company-generated items such as snack bars, books, points calculators, wearable activity monitors, etc. Finally, licensing the brand name to 3rd party products and franchise royalties account for 7% of sales. Weight Watchers operates in over 25 countries throughout North America, Europe, and Australia, with international contributing 40% of revenues.
While I don't expect much growth from this pick, there are certainly opportunities that the firm can pursue to grow. Weight loss is an ever-growing need, with 70% of the adult U.S. population considered overweight and an astounding 35% classified as obese. With increasingly sedentary lifestyles and poor eating habits, the need for weight loss solutions should only increase going forward. Further penetrating the men's market is an opportunity here. WeightWatchers.com puts the firm's powerful brand into the emerging mobile app weight loss ring, and it represents a high margin growth driver. Finally, the company believes it has a large business-to-business (B2B) opportunity in healthcare, using its respected brand and proven meeting-based solution to gain acceptance as a partner to employers and health care companies looking to improve outcomes for clients and employees (and in the process, reducing health care costs).
Few industries are as competitive as consumer weight-loss solutions. Competition runs the gamut from product-based firms like Nutrisystem or Medifast, to the latest fad diet (think South Beach, Atkins, etc.), to a glut of mostly-free mobile app calorie and activity counters. However, I believe Weight Watchers has carved a defendable niche in this maelstrom of offerings. First, the brand name is easily one of the best-known and best-respected in the field, having been around since the early 1960's and licensed by numerous product firms and restaurants. Also, no firm can (or has even tried to) replicate Weight Watchers' meeting infrastructure, and it has been shown time and again that group support is one of the most successful strategies for sustainable weight loss outcomes. Still, with the weight loss category rapidly expanding through technology, I don't believe Weight Watchers has much of a defensible economic moat nowadays.
Weight Watchers is an extremely risky turnaround play at this point. The company is coming up on 3 consecutive years of double-digit subscriber declines, as competition from technology-based source (app and fitness trackers), as well as traditional competitors have torn into the firm's once steady subscriber base. Execution has been poor, with subpar winter marketing campaigns in 3 straight years. The necessary move away from a meeting-based system moves Weight Watchers further away from where its competitive advantages are. Finally, the firm has extremely poor financial health and must be closely managed to meet interest requirements and debt repayment obligations in 2016 and 2020.
Weight Watchers has an unproven management team. James Chambers joined the company in January 2013 as COO, and was quickly elevated to CEO in August, taking over for lackluster predecessor David Kirchhoff. He has held executive positions at Kraft and Cadbury, but has never been CEO at a public firm. Artal Luxembourg still owns about 52% of the company (it purchased WTW in 1999 from Heinz), giving it control of voting matters. Recently, new management has embarked on an aggressive campaign to re-invigorate the business around a more flexible consumer offering and an increased focus on business-to-business program sales, but we haven't seen particularly good results so far.
Ugly. Weight Watchers carries over $2.3 billion in debt, much of it from the ill-advised, $1.5 billion tender offer in 2012 (at $82.50 per share!). In 2014, operating earnings covered interest obligations by just 2.4 times, a dangerous ratio far below the MagicDiligence minimum of 5 times. The business is a good one that generates a lot of cash - if management can get things turned around, the company can clean up its act over time. While a $300 million redemption next year seems achievable, the $2.1 billion due in 2020 looms large over this company's future.
MagicDiligence would not advise new money into Weight Watchers - it is simply too risky at this point in time. Those who, unfortunately, do hold the stock might consider using their position to offset gains elsewhere, in the near term. As for valuation, MagicDiligence sees the stock as worth about $13 at this point in time. Much depends here on how quickly and effectively management can get recruitment trends turned around. So far, there is not much to indicate confidence on that front.
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Steve owns WTW.
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