One way to uncover great companies is simply doing a screen of 10-year ROICs. Most of these companies are never available at decent valuations but Weight Watchers has had a particularly terrible year and is now trading at just under 14x trailing earnings.
My interest in Weight Watchers was piqued by its returns; in the past ten years, it returned an average of 20.7% on assets. Over the past five years, invested capital has actually dropped by $150m but free cash flow has increased by over $100m. Clearly, this speaks to the quality of the underlying business.
Weight Watchers makes the majority of its revenues from the fees charged to attend its meetings. Scepticism about this aspect of its business focuses on two points. First, there is a perception that online services (some of which are free) are just as effective. I do not know whether this is true or not but research does show that some of these services are effective; this does not nullify the fact that there is also a vast amount of research showing that Weight Watchers works too. Further, the company is growing its online business.
The second point is related; Weight Watchers is seen to be exploiting its customers. Investors are often too quick to dismiss this sort of claim. Weight Watchers really has nothing apart from a brand; perception (not truth) is key. At some level this claim seems accurate as it isn’t totally clear what the company brings to the table; isn’t Weight Watchers really just making money from bringing people together? However, the fact is that no-one else is doing this, no-one has the same record of success, and it is really hard for anyone (apart from perhaps a government) to break in and build the reputation/brand that Weight Watchers now has.
Weight Watchers was bought from Heinz by Artal (a private equity-ish company) in 1999. Since then, the company has expanded into new areas effectively leveraging the Weight Watchers brand and meetings. For example, in 1997 product sales at meetings were $30m, in the LFY they were over $330m. Another example is online revenue; this division was consolidated in 2004 with $65m in revenue, in the LFY it achieved just under $400m. The former seems to have grown to its limit and follow trends in meeting fees; the latter has compounded sales growth of over 20% for the last five years and is clearly going to be the engine of any future growth.
The hope appears to be that online will lead future growth however, by my calculations, the price that Weight Watchers can charge (per paid week) is just under half of that for meeting fees. The non-online part of the business is still valuable, although online will soon be the same size in terms of paid weeks. Moreover, the core business did surprisingly well during the recession. Attendance dropped significantly but paid weeks and, therefore, meeting fees increased. The current fiscal year was poor but this was partly due to a huge 2011 and significantly increased marketing expenses. In the future, there is the possibility of new markets and, of course, the general growth of obesity and its solutions. Both of these factors suggest that growth can still be achieved, although at a slower rate, in the non-online part of the business.
Shareholders have one other factor to consider: the 51% shareholding of Artal Group. As mentioned above, they bought the company from Heinz in 1999 although the people behind the transaction, the advisers to Artal, were Invus Group. The deal worked out well; Weight Watchers was bought for $735m of which $224m was equity. According to Forbes, Artal has taken out $3.8bn and still has 28.7m shares worth some $1.7bn. Artal appears to be committed to Weight Watchers in the long-term and so, given their success up until now, someone that it may make sense to partner with.
However, through this year the company has been recapitalized. $1.5bn of shares were bought back by the company (Artal matched the $750m worth from the public to keep their holding constant) with new debt. I don’t think we can question the motives of Artal. They cashed out $750m but there is clearly only a certain level of capex a business like Weight Watchers can take. Growing marketing expenditures suggest that the company is responding to a tougher environment and not being starved of investment. However, debt is now just over 4x TTM EBITDA. Interest expenses are up (although the lower share count means EPS is up more) and the company, by my calculations, may not be able to pay anything out in the near future (they have 4x EBITDA limit for any capital returns, they may have gotten over this in the last quarter). It is easy to see why this is good for Artal, they take more money out and just keep going but for new shareholders it is perhaps more questionable. The company has swaps and the current cost of debt is under 3% but interest rates clearly aren’t going to stay here forever.
However, they may just stay low long enough. The leverage is not totally crazy and Weight Watchers is a very strong business, although one that does rely overwhelmingly on reputation. Moreover, I don’t think this is a sign that Artal is going to make it difficult for other shareholders. They have made a lot of money and clearly had a lot of success but increased marketing expenses suggest they want to keep going. Therefore, I think this is a good opportunity to partner with a motivated shareholder, to get a slice of the growing online business, to capitalize on growing obesity, and on the pessimism that seems to be surrounding the non-online business given the performance this year. The current price is certainly not amazing, above $60 this becomes far less worthwhile however, I believe this is a good opportunity to buy a share of an interesting business.
Filed Under: Weight Watchers,