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Buffett Munger Portfolio - Weight Watchers International Stock Analysis

November 10, 2013 | About:
1. Business Description from Reuters: Weight Watchers International, Inc. (WWI), incorporated on February 19, 1974, is a global-branded consumer company and a provider of weight management services, operating globally through a network of Company-owned and franchise operations. Through WeightWatchers.com, the Company offers Internet subscription weight management products to consumers and maintains an interactive presence on the Internet for the Weight Watchers brand. As of December 29, 2012, it provided two Internet subscription offerings: Weight Watchers Online and Weight Watchers eTools. Weight Watchers Online provides interactive and personalized resources that allow users to follow its weight management plans via the Internet. WWI offers its two Internet subscription products in eleven countries, including the United States, the United Kingdom, Germany and Australia.

The Company’s program is a clinically-studied commercial weight management program. WWI presents its program in a series of weekly meetings of approximately one hour in duration. The Company sells a range of products, including bars, snacks, cookbooks, food and restaurant guides with PointsPlus values, Weight Watchers magazines and PointsPlus calculators, which complement its weight management plans. WWI sells its products primarily through its meeting operations and to its franchisees. In fiscal year ended December 29, 2012, sales of its products in its meeting operations represented approximately 14% of its revenues.

Weight Management Plans In each of the Company markets, it offers services and products that are built upon its weight management plans, which consists of a range of nutritional, exercise and behavioral tools and approaches. As of December 29, 2012, PointsPlus and ProPoints, WWI’s weight management plans, are systems with similar methodologies, developed from a combination of the latest nutritional scientific research and insights of customers who experienced prior Weight Watchers plans.

WeightWatchers.com Offerings WWI offers two Internet subscription products - Weight Watchers Online and Weight Watchers eTools. The Company has offered these products in the United States, the United Kingdom, France, Germany and Australia. Through WeightWatchers.com, the Company is well positioned to benefit from the self-help weight management market as well as several trends taking place in the global Internet marketplace, including an increased willingness of consumers to access and pay for Web content, the proliferation of broadband and mobile access and the growth of e-Commerce and Internet advertising. During the year ended December 29, 2012, WeightWatchers.com reporting segment contributed 27.8% of its total revenues.

Weight Watchers Online is a product based on the Weight Watchers approach to weight management and is designed to attract self-help-inclined consumers. Weight Watchers Online helps consumers adopt a healthier lifestyle, with a view toward long-term behavior modification a key aspect of the Weight Watchers approach toward sustainable weight loss. 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. The Company’s interactive resources include PointsPlus Tracker, PointsPlus Calculators, Power Foods lists, Weight Tracker and Progress Charts, Nutritional Guidelines, Hunger Tracker, Fitness Workouts and Videos, Recipe and Food Databases, Recipe Builder, Meal Ideas and Restaurant Guides. During fiscal 2012, WeightWatchers.com had over 1.8 million active Weight Watchers Online subscribers.

2. History of business:

Weight Watchers was found by Jean Nidetch in the early 1960's when she began inviting her friends into her home in Queens once a week, to discuss how best to lose weight.

In May 1963, Weight Watchers was incorporated and the first public meeting was held in a loft in Queens. The meeting was a huge success.

The company rapidly began to expand, as former members who had successfully completed the program and extensive training opened franchises throughout the U.S. and abroad.

In1978, Weight Watchers International was sold to the H.J. Heinz Company.

In 1999, Weight Watchers was acquired in a leveraged buyout by Artal Luxembourg and

In 2001- Weight Watchers International went public.

In July 2005, Weight Wacthers acquired control of its licensee and affiliate, WeightWatchers.com. Subsequently in December 2005, WeightWatchers.com redeemed all shares owned by Artal in it.

In Feb 2008, Weight Watchers entered into a joint venture with Danone Dairy Asia to establish a weight management business in China.

3. Business Model:

Weight Watchers International’s business model has been enviable. At the core of Weight Watchers' business model are weekly meetings, which are held throughout the world and provide group support and promote weight loss through education and interaction among meeting attendees. The economics of the meetings are extremely favorable as both the cost of running a meeting, which includes commissions paid to part-time meeting leaders and rent expense for meeting locations (most of the locations are rented on an hourly basis), and the capital expenditure requirements are low. Furthermore, meeting fess are usually paid up front or at the time of the meetings while most expenses are deferred, which result in negative working capital and strong cash-flow generating ability.

To sum up, Weight Watchers’ business model inherently enables the business to achieve the following:

· High profit margin and operating margin

· Strong operating cash flows

· High return on invested capital

· Negative working capital

· Low capital expenditure requirement

Although Weight Watchers’ business has been shifting from the physical meeting model to the online model, the above attractive features will likely remain intact.

4. Competitive Advantages:

Weight Watchers’ moat has been wide in the past as it has a reputable and a differentiated brand in the industry where false claim is abundant. In fact, according to the Company’s 2012 annual report, the U.S. Preventive Services Task Force endorses Weight Watchers’ multi-component intensive behavioral therapy (MCBT) as the only weight-loss treatment. They recommend that doctors refer patients to community-based program, which is Weight Watchers’ network of leaders and members it built since the 1960s. This network is extremely difficult to replicate.

The results of participating in Weight Watchers’ program may explain its wide moat. As of 12/31/2012, 37% of Weight Watchers participants lost at least 10% of their starting weight, which exceeded only 11% for standard weight-loss treatment and 15% for a combined approach.

However, the fact that Weight Watchers has enjoyed a wide moat in the past does not mean it will continue to do so in the future. Mobile apps and regional and community weight loss programs have been eroding Weight Watchers’ moat gradually, as evidenced by the decline in both paid meeting weeks and total paid weeks. The challenge is acknowledged by its management during the Q2 2013 earnings call:

“We think there's a lot of competition for trial and forces distracting the enrollment mechanism associated with free apps and with activity devices in general. But I think it's critical to make a distinction between competition for trial and alternatives to our proven and effective program. And as a stand-alone activity with consumers, we're reasonably confident that these things are not going to change the trajectory of the obesity challenge. Turning that around and looking at them as the potential additives to a strong program like ours, we think through time, there are real opportunities for us to strengthen our offering on the basis of what we're seeing have a real appeal for consumers.” - CEO James Chambers

5. Competition:

Weight Watchers’claims that there are no significant group education-based competitors in any of its major markets, except in the United Kingdom and even in the UK, it believes that it possesses the largest share of the commercial weight management market.

In its biggest market, North America, Weight Watchers compete with self-help weight management products, services and programs, internet and mobile apps, nutritionists and dieticians, fitness centers and companies that sell pre-packaged meals and meat replacements.

In its second biggest market UK, aside from the competitors mentioned above, Weight Watchers also has a significant competitor. Although the name of the competitor is not disclosed in the 2012 form 10K, a little research would reveal that it is most likely Slimming World, a company that was founded in 1969 and has a weekly attendance of over half a million. What’s interesting about Slimming World is that although based in UK, it has expanded to Ireland, Cyprus and now U.S. The current impact of Slimming World on Weight Watchers in the U.S is not material enough for Weight Watchers to disclose but as the business model is very similar, Slimming World poses a potential threat to Weight Watchers’ dominant position in the U.S.

6. Important Operating Metrics:

· Net Revenues

· Paid Weeks (including meeting paid weeks, online paid weeks and total paid weeks)

· Lecture income per paid week

· In-meeting product sales per attendee

· Number of end of period Online subscribers

· Gross profit and operating profit.

· Operating expenses as a percentage of revenue.

Below are excerpts from the most recent form 10K that shows the 5 year data for paid weeks, attendance, gross profit and operating profit. 1548650410.jpg

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7.Profitability and Financial Strength (data from S&P Capital IQ):

2010 2011 2012 2013

YTD

Return on Assets % 22.40 31.20 26.50 23.50
Return on Capital % 33.10 50.00 43.60 38.90
Gross Margin % 54.40 57.60 58.50 58.10
SG&A Margin % 27.60 27.30 31.30 30.20
Net Income Margin % 13.40 16.80 14.10 13.20
EBIT / Interest Exp. 5.1x 9.2x 5.5x 4.6x
Total Debt/EBITDA 3.3x 1.8x 4.5x 4.4x


As discussed in the business model section, Weight Watchers’ business is very profitable (high operating margin and net income margin) with strong operating cash flows. The company has incurred a good amount of debt to finance its shares repurchases. Weight Watchers’ diluted shares outstanding has decreased from 109.7 million shares at the end of 2003 to a little over 56 million shares at the end of the latest reporting period – a whopping almost 50% reduction in share count. However, long term debt has increased from merely $454 million to almost $2.4 billion during the same period.

The increase in long term debt is mainly due to the fact that the Company commenced a “modified Dutch auction” tender offer and simultaneously entered into an agreement with Artal Holdings to purchase its common stocks at $82 per share for a total of approximately $1.5 billion financed by debt offering. The purchase price is almost 20 times earnings per share and more than18 times free cash flows per share, both multiples are at the high end of Weight Watchers’ historical PE and PFCF ratios.

The likelihood of Weight Watchers defaulting on its debt is very low given the high profitability of the business and its cash generating ability. However, management’s capital allocation ability is best described as mediocre.



8. Management and Board:


The Company was led by David Kirchoff before his resignation in August 2013. James Chambers, president and COO, replaced David Kirchoff at the time of his resignation. Chambers has a limited history with Weight Watchers as he joined the Company in January 2013. Previously Mr. Chambers held roles at a variety of companies including Kraft, Remy Cointreau, NetGrocer.com and Nabisco. Mr. Chambers is a graduate of Princeton University, where he obtained a Bachelor's degree in Civil Engineering, and holds an M.B.A. from the Wharton School of Business of the University of Pennsylvania.

From reading Chambers’ bio, I get the feeling that he tended to jump from job to job. This type of managers typically makes short-term decisions because they are not there for the long term. Since Chambers took the reign at Weight Watchers, the Company has been expanding into the corporate employee weight-loss program, which has shown some early success. However, this has not been enough to offset the revenue declines in meetings and weightwatchers.com. How to address the challenges of increasing free and low cost online and mobile application will be a key task for Mr. Chambers.

Weight Watchers’ Board has 9 directors and 6 of them are not independent. The Artal Group controls 44% of voting rights and has significant influence on the Company. Artal’s interest may not be aligned with the remaining shareholders. The $82 purchase agreement is a good example of conflicts of interest. Artal arguably sold the shares to the Company at a good price at the cost of all other shareholders.

9. Employee Satisfaction:

Weight Watchers has a 2.4 start rating on glassdoor.com, based on 174 reviews. This low rating indicates that employees are not happy overall, which is a big concern for a service-oriented company like Weight Watchers. If employees are treated well by management, they will in turn treat their customers well. On the other hand, disgruntled employees are less likely to put on happy faces with customers. Below is a compilation of the pros and cons listed by Weight Watchers’ employees:

Positive:

"Helping people lose weight and keep it off is very rewarding"

"I was always uplifted by helping others to get healthy and reach their goals"

"Plus I got to really help people in a meaningful way"

"Wonderful helping members reach their weight loss goals"

"The experience of helping members through the weight loss journey is very rewarding"

Negative:

"Many required training sessions that are mandatory but paid at minimum wage"


"Not enough meeting to make it a full time job in south florida market"

"There is a set base pay plus commission on product sales and number of members in the meeting"

"Upper management doesn't make changes when suggested by front line employees"

"There is NEVER a raise in salary, not even cost of living"

“It's a very bumpy ride right now. The transformation of this old-guard company is going to be slow and painful.”

10: Customer Satisfaction:

After the research I have done regarding Weight Watchers’ employees, I am not surprised by what the customers are saying about the business, especially the meeting business. Many customers are not happy because:

· Meetings have been canceled

· Customer service is ineffective

· the Company is spending more time during the meeting promoting its products

Here are two reviews from consumeraffairs.com

“Weight Watchers has a good product in spite of itself. However it does not have customer service. First, I purchased the Active Link and it took me six months for me to get the problem resolved. (It was defective.) After numerous calls and promises that they'd call me back - they never did - it was unbelievable. Second, the meeting sites do not have a phone number. Third, I tried to get a receipt today and it took three transfers and a 30 minute hold. At the end of the call, the survey asked about my customer rep. The customer rep was fine, but they didn't even ask the right questions. Their business needs better management, and processes. Too bad, because their product isn't bad.” - Customer from Madison, WI

“Two weeks ago in Spring, Texas, the Territory manager came to our meeting and informed us that there would no longer be a Wednesday meeting. When asked why, she stated to provide a "better customer experience". Well since when is cancelling all the meetings on a particular day better for customers? She denied that Weight Watchers was cancelling the meeting to improve their bottom line. Well I may be overweight but I don't lack intelligence. She then proceeded to hand out schedules with a coupon as if that made up for our inconvenience. Her manner was very condescending as if she was doing us a favor. All of the members at the meeting were totally disgusted. Wake up Weight Watchers! You in your fancy corporate jobs! Change your attitude! The weight watcher leaders who run the meetings are the important ones. You would not have your jobs if your leaders did not help members.We, the members, pay for the services. Yesterday I complained and was contacted by Corporate Affairs. I was asked to furnish my phone number and told that the District Manager would call me today. I received no such call. Apparently member complaints are not a priority at Weight Watchers. I am done dealing with this company!” -Customer from Spring, Texas

Here is a Yelp review:

“I love weight watchers and have joined several times. This time I am losing weight but am a bit disillusioned at the meetings. I am not sure if it is the leader or just a change in the culture of the meetings, but the meetings seem like non-stop commercials for weight watcher products. I would like to see more support; perhaps it is the leader in this instance.” - Customer from San Francisco, CA.

11. Bear and bull argument:

What the bears are saying:

1.“These days, Weight Watchers International looks like one more old-fashioned business getting killed by a smartphone app. Its sales are down, meetings attendance is down, and competitors are giving away for free the online dieting tools that Weight Watchers expected to sell” – Seeking Alpha Article

2. “WTW has a great deal to do to fix its business and the process is likely to take multiple years. We feel some optimism given the new management team and our view that the diagnosis of the problems is correct and effective plans will be developed over time. Execution remains a question mark, however.” – Barclay’s Research Report

3. “Attendance trends a concern: Despite a number of positives in 2013(new program/marketing, upgradedreal estate, and a small accounts B2B rebound), recruitment trends continue to be weak, which we think highlightslong-term secular challenges,including the lack of convenience ofattending meetings. Slowing .com Growth: Increased competition from free apps is pressuring the online business, which is a major issue given it has been the key growth driver at WTW over the last few years. Valuation Does Not Look Compelling: Valuation of 10.1 times2014 EV/EBITDA does not lookattractive given fundamental struggles, although potential aggressive cost-cutting and B2B optionalityshould protect stock downside.” - Morgan Stanley Research Report

What the bulls are saying:

1.“The company can fix its numerous problems more quickly than we currently expect, thereby increasing recruitment and revenues sooner.” - Motley Fools Article

2."The fundamental strengths of the company: Strong Brand, Capital Light Business Model, Growing Market and the Strong Infrastructure are all still intact." – Seeking Alpha Article



3.“Longer term, as the world fights against obesity, we believe Weight Watchers is well positioned to further grow its business and increase traction with consumers and corporations, especially as they develop the right marketing campaign for men (which has been suspended for now), make further inroads with women, and bear fruit from increased effort behind gaining more self-insured corporate clients.”
-JP Morgan Research Report

12.Valuation:

As Weight Watchers’ revenues and expenses are relatively stable because most of them are recurring, discounted cash flow (I actually used earnings, which is a more conservative for Weight Watchers, as a proxy for cash flow) is an appropriate method to use in calculating intrinsic values. As the future of Weight Watchers is highly unlikely, I assign an equal weight to 3 different scenarios assuming declining sales, flat sales and improving sales. Using gurufocus’s DCF too, the results are as follows: Bear Case:

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Base Case:

1747270114.jpg


Bull Case:

90951044.jpg


Fair value assuming equal probabilities:

(50.21+34.13+24.74)/3= 36.36

Margin of Safety based on closing price at 11/8/2013 of $33.67:

7.4%

13. Risks:

The biggest risk is obviously a medical breakthrough that will almost eliminate the need of overweight people to go to meetings or to purchase products online, which will effectively put Weight Watchers out of business. This could be the “Super Catastrophe Risk” Warren Buffett refers to in his first step analyzing a business. Other main risks include:

· Continually increasing competition from apps.

· Competition from Slimming World in the U.S Market.

· Declining customer base due to free or low cost apps, unsatisfactory customer services, and declining meeting qualities.

· High employee turnovers, which will affect the occurrence and the quality of the meeting business.

14. Conclusion:

Weight Wacthers International is a capital light, high return and cash cow business that has been facing challenges recently. Both the meeting business and the online business have been declining due to a variety of factors. While the stock has fallen considerably from its historic highs and valuation may seem appealing to many value investors, elevated employee dissatisfaction and customer dissatisfaction is likely to affect Weight Watchers’ business in a negative way until a change of management. Furthermore, investors should be aware of the “Super Cat Risk” that can potentially put Weight Watchers out of business.

Disclosure: No position in WTW.

About the author:


Rating: 4.4/5 (34 votes)

Voters:

Comments

graemew
Graemew - 5 months ago


Excellent indepth analysis. Thanks
graemew
Graemew - 5 months ago
Something must be wrong with the system which records votes. I just clicked on 5 stars (definitely), to give the third 5 star vote...but it came out as though I had given you a one star vote. I feel so bad about this....so sorry.
graemew
Graemew - 5 months ago
My main concern about Weight Watchers from reading the above, is the large increase in debt, which now coincides with a reduction in sales and profits. The debt interest is only covered 4.6 times according to the above figures. However as described above the company has a good reputation, effective plans, and excellent profit margins. In addition the share price has dropped around 40% over the last year and the company is currently trading at a P/E of only 8. But with important strategic changes required to adapt the company to the new on-line environment and with competitors emerging, the overall impression is one of uncertainty. I think this is the kind of company to monitor closely....

20punches
20punches - 5 months ago
Graemew: Thanks for commenting and no worries about the vote at all:)

With regards to WTS's debt, as I mentioned in the article, it is due to the "Modified Dutch Auction" WTW did in 2012. I think this is a big big capital allocation mistake from management at the repurchase price of $82. I'm not worried about WTW not able to pay back its debt but the lingering effect of the capital mis-allocation may last for a while and combined with the challenges WTW faces now, even at 8 times earnings, I would not initiate a position.

Another point to note is that this is a company that is subject to "Super Cat Risk." Buffett probably won't buy it.
Cesc
Cesc - 5 months ago
Hello Ning,

Thanks for your article.

WTW is going to do well over time, I think that your base case valuation with 0% growth is way too low, but it's just an opinion.

Customer valuation are pretty good and the system works because it's sticky from a psychological point of view, it's quite a similar system used by alcoholics anonymous, group dynamics are powerful but it's true they should be gaining traction in this field instead of losing it.

Apps may just work for those self-conscious motivated individuals that want to lose 5 lbs or so, but some other users need a more supportive system.

Cesc

20punches
20punches - 5 months ago
Cesc- Thanks for your comments.

To address your comments-



WTW has been doing well and I certainly hope it will continue to do well in the future. As value investors, we'd rather err on the side of conservatism so hence the 0% growth rate for base case. I don't have a position in WTW and one of the reasons I stay away from WTW is that it looks like the new management team is trying to cut expenses to boost short term bottom line at the expense of long term prosperity (such as the cancellation of meetings and other cost cutting steps that will hurt customer service). Also from what I read, they've been trying to spend more time selling its product during the meetings, which has pissed off some customers. I agree it is a sticky business but at the end of the day, if customers are not happy, they have every reason to leave.

My other concern is employee morale, which is reflected in employee reviews on glassdoor.com. WTW's employees are grumpy and this will be reflected in their services and the customer may feel it. Not all of them are doing it for the money but just a handful of disgruntled employees can do enough damage.

WTW's system does work the best among the alternatives so the moat is still there. But in my opinion, a new management team is needed in order to unlock the long term growth for WTW.

itzarjuna
Itzarjuna premium member - 5 months ago
Good Article Ning, They entered China in 2008, whats the percentage of chinese population that is overweight? . I don't think it is significant is it?. Any idea how business in that part of the world is doing?

Also what is Super Cat Risk?
20punches
20punches - 5 months ago
Arjun - Thanks for commenting. The Chinese somehow have much lower obesity rate using the Western standard. But Chinese girls tend to think they are overweight anyway:) I don't know how WTW is doing in China.

Super Cat Risk is short for Super Catastrophe Risk, which is the risk that if materialized, will put the company out of business.

itzarjuna
Itzarjuna premium member - 5 months ago
Thanks for clarifying, I've not met a obese chinese so far in my life :-)
20punches
20punches - 5 months ago
Arjun - I like the implication (that I am not obese) lol.
AlbertaSunwapta
AlbertaSunwapta - 5 months ago
Graemew, thinning down the weight watcher's vote may be a good thing. Or maybe you naturally invert and read from the right to the left.

Anyway, for the sake of improved design and symmetry (that ever elusive healthy appearance) maybe the voting system should work from the centre out. :-)
Cesc
Cesc - 5 months ago
Thx Ning Jia, long WTW by the way, I think they will do well over time, decent moat, good ROIC, low capex, negative working capital and good FCF, they have issues as you pointed out, hope they will fix it.

Khursheed
Khursheed premium member - 2 months ago

1. There's no medical breakthrough for the problem of obesity on the horizon, so that risk is merely theoretical - at this time.

2. WTW is currently like a patient with serious pneumonia. That is an easy observation; the harder part is the judgement about underlying patient. If you think the patient is a 90 yr old with debility and cancer, then the pneumonia is more likely deadly - so stay away. If you think the patient is an otherwise healthy 35 yr old, then pnumonia is more likely curable - so bet heavily.

3. Psychology: The fraction of investors who commit to serious, detailed study of businesses is very low just like the fraction of adults who exercise regularly and the fraction of overweight individuals who seriously atempt to lose weight. If you're a serious investor, you're not going to rely on newsbites; a serious athlete is not going to depend on apps (they go to gym / track) and an obese individual who is serious about losing weight may try some apps but is not going to stick with them -- that person is going to move through the psychological filter, comimit more thought, time and money and will seek behavioral counselling among other costly options.

4. Ask, if WTW is removed from the landscape of the overweight world, which firm will take its place.

5. If one thinks that business is not being run properly (poor quality mtgs etc), ask if that problem is fixable. Remind yourself how Howard Schultz fixed the coffee problem.

6. Are there any similarities to recent non-related doom & gloom scenarios: BOA mortgage problems, AIG CDS problems, DECK problem of rising raw materials and not-so-cold winters, reduced shipping demand of DRYS, reduced coal transport of NSC, car battery problem of TSLA, opaque book value of GS etc etc

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