I think it’s important for anyone who writes an article about the investment merits (or lack thereof) of a company’s stock to revisit the situation as time goes on, for several reasons. The primary reason, for both readers and the author him or herself, is to better understand what has changed with either the fundamental picture of the company or the sentiment of the market to warrant the change in price since the original discussion. These price movements can completely back the ideas discussed in the original discussion, or – sometimes more often than one might like – it can teach us valuable lessons that we can take with us in our future investing decisions.
While a month is generally too short of a time frame for long-term investment decisions, I think it’s important to revisit what has happened since I first wrote my Value Idea Contest article last month covering Weight Watchers International, Inc. (WTW) as an investment opportunity.
How have shares performed lately?
When I first wrote the article, shares of WTW had closed at $5.49/share during the previous trading session on June 5, 2015. Taking a peek over at today’s closing price, you can see that shares are now sitting at $3.78/share, a staggering decline of 31% in just over a month.
WTW shares have been on a precipitous decline this year, having plummeted an unbelievable 78% from its closing 2014 price of $24.84/share up to the point I wrote the article. However, it would be foolish to think this momentum would not continue throughout this past month as well. While catching a falling knife is never wise, and admittedly hurts, our focus as long-term investors cannot be to focus on the day-to-day ticks of a company’s shares or to even fret over the change in a stock’s price over a single month if nothing has changed with the fundamental picture that warranted the investment in the first place.
Because of momentum like this, I generally recommend entering a new position through writing near-term put options at strike prices lower than the current market price. In the article, I offered the $5 strike price as an alternative for potentially purchasing shares of WTW if they fell below that price by the July 17 expiration date for the options. Not only would that have allowed you to buy shares at a discount of about 8.93% to the price at the time, but you also would have collected $0.30/share in premiums for writing the options regardless of where the shares wound up. (Yes, they will give you money just for you being willing to buy shares of the companies you like for prices even lower than today’s!)
So what has changed?
In short, absolutely nothing. There have been no earnings announcements, no company news expressing more pessimistic outlooks, nor any overall market collapses – the S&P 500 has only finished down 1.98% over the same month period.
Instead, the market’s negative outlook on WTW has simply continued its downward momentum, further burying the company’s share price. Weak-handed investors abandon their shares at low levels, convinced that shares will never rebound and not helped by the increase in short selling of the company’s shares. In fact, short interest has increased from 43% of the float on May 15 to over 56% of the float over the course of a month.
Was there any other news?
Well, investors did receive some potentially great news earlier this week when a New York Post article reported that the company may now have an active hedge fund viewing the company as a takeover target due to its depressed share price. Three sources familiar with the situation have reportedly said the suitor has acquired much of WTW’s remaining $144 million in senior loans due April 2016 and is in talks with potential partners – perhaps even the lenders of the junior loans due in 2020 – to make an offer to WTW’s majority shareholder. Invus Group’s Artal Group owns approximately 51% of WTW’s outstanding shares, so the decision behind any deal would ultimately be Artal Group’s alone to make.
What took most readers by surprise was the mentioning that the hedge fund and a partner would like to offer perhaps double the previous session’s closing price of $4.09/share. Including debt, which could be bought at a discount, the total deal could be roughly $2 billion, per the sources.
What would a takeover deal mean for WTW shareholders?
First, it’s important to realize that everything right now is only speculation, a lesson many “investors” who immediately poured into the shares hoping for a quick deal announcement are currently realizing now that there has been no news from the company or Artal Group regarding the rumor. (After the initial jump in price on the news, WTW shares quickly fell back to its previous levels and have continued its downward slide even further throughout the week.) Even if confirmed, there is still no guarantee any deal would be reached between a potential bidder and Artal Group, let alone at what terms.
That being said, many investors are still curious as to what this takeover chatter will mean and how the different alternatives might play out. So, let’s entertain those thoughts. From here, we are going to take a look into just a few of the different outcomes surrounding this news, including the possibility that nothing amounts from the story at all.
Takeover Alternative #1
Let’s start by assuming the story plays out as already speculated and widely-understood: an activist hedge fund and other partners make an actual offer to Artal Group for a complete buy-out offer for the entire company, which Artal Group ultimately accepts.
After this deal, our role as investors in WTW is done. We will be paid a certain amount per share for each WTW share we own and the company would be taken private (at least for immediate future). Arguably even better is that we would likely receive cash as our consideration since the deal is being offered by a hedge fund and not another competing publicly-traded company (much like when Artal Group purchased WTW from Heinz in the late ‘90s).
From here, the ultimate question is price. The article’s sources do not discuss a specific price that would be paid since this would ultimately be up for negotiation, but $8/share is the magic number that stuck in the minds of most readers from the article’s reference that perhaps double of $4.09/share would be offered. We do not know the sources’ extent of knowledge to the terms whether this would be the starting offer (which Artal Group could potentially negotiate higher) or if this would be the bidder’s final offer. Conservatively speaking, $8/share could be the expected amount for our discussion purposes though.
This takeover price would represent a premium of 112% over today’s closing price of $3.78/share. For newer investors, this is an incredible return on your invested capital. It’s not an infamous Peter Lynch tenbagger, but the gain realized in as little time as it would take the market to quickly correct the current share price would certainly produce a wonderful annualized return few would be unhappy with.
The downside though is that many long-term investors might have purchased at levels much higher than this. Shares of WTW have traded over $80/share less than even four years ago, so a deal at $8/share would be locking in losses of 90% for investors who purchased back then. Yes, it’s a lot better than the current share price, but a far cry from the price these investors had hoped for. A takeover offer at $8/share only robs these investors of the potential they thought the company had. (As a side note, you should always be wary as an investor when a company takes on large amounts of debt to repurchase its own shares, especially when the controlling shareholder is among the ones selling the shares back to the company. Trust me, they generally know when to cash out, and this is exactly what happened when WTW was trading at those excessive levels.)
As a personal note, and as an investor who has been able to continually average down since initiating a position in WTW a few months ago, I am fortunate to have an average cost below the $8/share mark. This price is now the minimum I personally expect back from my investment in WTW, given the current news and environment.
The reason for this is simple. Raymond Debbane’s Invus Group has had a wonderful track record in knowing when and at what prices to make investments, and also when to capitalize on those investments. Some of these were highlighted in my original article. Mr. Debbane turned his original $224 million investment for the company in 1999 into over $3.8 billion in cash through dividends and selling shares at the company’s highs. This is the classic case of knowing when to buy low and sell high. So when he just purchased an additional 694,000 shares through the Artal Group last November at prices over $21/share, he clearly did so thinking the company’s future would be bright and that these prices offered him a deal to further ensure Artal Group’s controlling position in WTW. If he truly thought $8/share was the right price to now sell out at, that likely means the future for Weight Watchers is potentially very bleak.
Investors might hope for higher prices, but if $8/share is the ultimate deal price Artal Group agrees to, I have to believe it’s for very good reasons, and we should be fortunate to get it given where the market price currently is. The alternative could very well be bankruptcy or a capital restructuring very unfavorable for current shareholders.
While this is the base case and the most widely-anticipated one by those speculating after the New York Post article, it’s important to explore other potential alternatives, which we will begin to do now.
Takeover Alternative #2
This will be the only other true takeover alternative I will explore. Obviously different prices could happen or other bidders might want to put in offers, but I will defer to the first alternative above for at least a conservative estimate.
This second alternative is actually the one weighing more on my mind once the initial euphoria of reading the New York Post article had passed, and for more worrisome reasons. When I read articles talking about potential mergers or takeovers, sometimes the devil is in the details or even what isn’t being said versus what is being said. Let’s now consider the following situation instead of our base case above.
The activist hedge fund is able to bring in other junior debt lenders as partners and they make Artal Group an offer of $8/share. That sounds familiar. However, in this case, their offer is only for Artal Group’s shares. Artal Group accepts the offers and now the debt holders hold the majority share of the equity as well.
This might sound odd, but you should consider the fact that this particular activist hedge fund has been reportedly going after the company’s debt as opposed to its equity. Granted, with WTW already controlled by a single shareholder, going after the equity doesn’t do much good. But if it’s being purchased at the current discounted prices, it would still be a better investment in itself if you are ultimately still willing to pay $8/share to the controlling shareholder for its shares.
It doesn’t take too much imagination to see what could happen next. Building off the first alternative above, if Artal Group is selling at $8/share it’s because the future for WTW might truly be much worse than originally anticipated. With the debt holders then in voting control, capital restructuring is all but imminent. Unfortunately for the current shareholders, this almost always turns out terribly. The lenders can take a substantial amount of newly-issued shares (maybe even in addition to some cash too) in relief of the debts, allowing the company to refocus on its competitive advantages unburdened by debts but essentially diluting the current investor’s out of any meaningful piece of the restructured company’s profits.
Do I think this will ultimately happen? No. But it’s important to realize that other possibilities do exist for this deal than what we might initially believe just from reading one article, even while using the article’s own reportings to reach these alternate conclusions. After a brief email correspondence with the article’s author, I don’t believe this was the author’s intentions by any means though. It seems that a full takeover of the company would be the ultimate deal that might be reached – if there is one – based on the author’s sources.
Takeover Alternative #3
So I said that there were really only two takeover alternatives I’d talk about here. While that’s true, there of course is a third one: the no takeover alternative. Since any takeover is speculation at this point until a deal is announced and then ultimately closes, we have to realize that the most likely course is that no deal happens at all – at least not yet – whether it’s because the reportings are never confirmed by the company or Artal Group or because Artal Group simply declines the deal offered.
To some extent, I think this idea – particularly where the reporting is never confirmed – has already taken hold in the market. I’m sure there are still several who jumped in after the news of a potential buyout, but I have to imagine that many speculators have given up and sold out after the few days of no news whatsoever from the company, hence the continual decline in share price. If that’s the case, I believe share price will continue on its downward momentum and that investors should be aware and prepared for this possibility.
In that situation, do I think that the price decline will continue forever and that the future of Weight Watchers is in jeopardy? Absolutely not. Again, nothing has fundamentally changed whatsoever since my original article last month, so I will simply refer you back to it for my case on the investment merits of the company. As previously suggested, your biggest worry as an investor in this case is that Artal Group will see the signs of the turn-around before the market does and offer a buyout of the remaining shares it doesn’t already own at a premium on these incredibly low prices instead of waiting for the share price to recover before doing so.
The other potential here is that the speculated takeover bid is confirmed but that Artal Group declines it. The acknowledgement itself would be the only thing needed to send shares higher, knowing that there is a legitimate offer at a price substantially higher than the current price. Given the current short interest that would also need to start covering, the pace of the price rise would be quite the sight as well for long investors and one I would personally enjoy watching.
The decline of an offer would only add fuel to the fire, because it would be the confirmation the markets needed that Artal Group believed in the turnaround story and that the value of the shares would be much more than whatever offer came back. Yes, it could turn into a price negotiation that is ultimately accepted by Artal Group, but when the assumed $8/share base case is already a 112% premium, anything higher would just be icing on the cake.
Conclusion
As investors, we have to take a lot of the information we get from media outlets with a grain of salt. Honestly you should take investment idea articles such as this one with several grains. But again, I believe it’s important to revisit our investment ideas as authors, not only to hold ourselves accountable to our original synopsis and but to challenge the premises on which we built our investment decisions. As readers and users of investment ideas, this is even more imperative to ensure your long-term investing success.
Despite the pessimistic market sentiment for shares of Weight Watchers, I stand by my original analysis and have continued to add to my holdings of the company’s shares given the depressed nature of share price. This exercise in exploring alternative outcomes for this reported takeover possibility only furthers my belief in the long-term story for Weight Watchers and its investors.
Disclosures
All views expressed in this article are the current opinion of the author and are for discussion and illustrative purposes only. The information in this article should in no way be regarded as individual investment advice. Readers should consider the risks before making any investment decisions and consult independent advice where necessary.
The author is long WTW through his ownership of common shares and of long-term call options in the company.
