Simply stated, when consumers are facing a sudden crisis over their savings, livelihood, and standard of living, the natural inclination is to comfort eat, not to lose weight. From an historical perspective, we saw similar behavior in the aftermath of 9/11 and Hurricane Katrina. The impact those two events had on our business lasted about six and three weeks respectively, but we think this current crisis will last longer.
David P. Kirchhoff - President, Chief Executive Officer and Director, Weight Watchers International (11/4/08) (source: Seeking Alpha)
I have to admit I really like this guy for his honesty. I also have to admit that I think that Weight Watchers (WTW) (26.67, $2 billion market cap) is a tremendous brand and one of the few weight-loss companies that has a proven trackrecord over the years. With that said, despite the fact that the stock is way down from its levels a year ago and even more from its all-time high in 2007 (and 2005) and that it trades at "just" 9.5X the current analyst consensus for 2009, I think that the stock will continue to be pressured.
I came across the name recently when I was beginning to think about how the market might start to differentiate between companies. As I wrote in late December regarding "Big Bad Balance Sheets", "... the changing environment will most likely demand changing valuation metrics. As companies likely begin to generate losses or at least substantially lower earnings as the economy deteriorates in a manner unprecedented in most of our lives, the popular PE ratio will likely prove to be rather useless." As I will describe below, WTW is a have-not in many ways. Their growth will continue to be challenged, perhaps significantly. Their debt levels are extremely high. Their profitability should be negatively impacted for many years by higher borrowing costs. While I don't think that the company itself is in any danger of being wiped out in the continuing economic implosion, its shareholders certainly are at risk. This is a company that has never had to go on a "debt diet", but let's just say that their captital structure requires drastic action. Unfortunately, the company doesn't have much in its wallet to to pay for this restructuring.
First, a little history. The company started in the 60s. Heinz (HNZ) bought the company in 1978 and transformed its business model from purely a service to a hybrid with products. It sold the company in 1999 to the Artal Group and management for $735mm. I got this part of the history from a prescient Business Week article written two years later in late 2001, after the company did an IPO. The author, Robert Barker, really called it well:
"Two years later, the stock market values the company at $3.4 billion.... What the market seems to be missing entirely is the company's weak capital structure. Liabilities, including $481 million in long-term debt left from the buyout of Heinz, outstrip assets. That leaves Weight Watchers with a net worth of negative $194 million... The IPO did nothing to help lower those costs: Instead of paying off some of the debt, Artal and a few minority partners are taking all of the deal's $455 million in estimated proceeds. This means that Artal, which will continue to hold more than 76% of Weight Watchers' equity, has gotten its original investment back several times over. In other words, it's now playing with money put up by public investors in the IPO. Will that necessarily stop Weight Watchers from continuing to thrive? No, but to me it suggests that the easy money has already been made."
Flash-forward now to 2009. Artal Group still owns about 1/2 the company. The stock has been a huge disappointment, lingering near its IPO price of 24. The PE compression has been extreme, as you can see below:
What's going on? After all, 2008 sales of approximately $1.5 billion and EPS of about $2.75 compare quite favorably to the levels from the time of the IPO, as the company reported EPS in 2001 of .78 on sales of $624mm. To examine the company without looking at the rest of the financials, one would have to wonder why the PE has plunged 75% since the first trade out of the box despite years of growth. In all fairness, expectations of growth have been hurt by a lack of new marketing initiatives and increased competition (Atkins, Nutrisystem, etc.), and this has certainly hurt the multiple, but here is the real problem: The Balance Sheet.
In Barker's article above, he correctly points out that the company was loaded up with debt relative to assets from the get-go, with "negative equity". It has gotten worse, as one can see in the snapshot below:
The company has actually become even MORE leveraged! While Assets have grown overall, intangibles have essentially kept pace. The company still has very little hard assets. Part of the reason why is that they have paid dividends over the past three years of about $165mm. They actually hiked the dividend slightly in early 2008. Debt has increased, though, by over $1.15 billion, with all liabilities increasing by $1.441 billion. This has caused equity to drop by almost $800mm to $-900mm and tangible equity to evapoarte even more. The book value per share is almost -$12 per share, with an even more substantial cut to the tangible book value per share to almost -$23 per share from -$4.50 the quarter during which they sold themselves to the public. A ratio of indebtedness that I like these days - Total liabilities compared to tangible assets - has worsened from a pretty bad 6X to an even worse 7.5X. All of this at a time when the company was growing and making money?
What happened? The company repurchased stock, as you can see in the huge reduction in the number of shares outstanding. Guess who sold the bulk of it? Yes, Artal Group, though the public had a chance to participate as well a couple of years ago. For those who have held onto the stock, the company finds itself in a new world, where there is little money available to borrow to repurchase stock - game over. Going forward, the company will face some repayments in 2009 ($165mm) and 2010 ($215mm) that are possibly manageable, but the burden in 2011 is extreme at $490mm. With only $58mm in cash, I see the following possibilities:
- Elimination of the dividend
- Much higher borrowing costs
- Possible restructuring (debt swapped for equity)
- Equity sales
None of these sounds too good for the stock, but there is one thing I wish I had a better feel for: Artal Group. Since they are private, finding information is extremely challenging, so I am not in a position to know if they would pay the current price to control the equity but have to absorb all of the debt. Do they think that the company is worth $3.5 billion (all the stock at the current price plus all of the debt)? Does anyone? If they do, do they have the financial strength to refinance the debt that is coming due in the coming years?
It is a shame to see this type of situation, but I expect that the have-nots, those companies who need cash rather than have cash, will really struggle in the coming years as capital remains scarce. WTW is certainly not unique in this regard, and it is fortunate that it does have a brand with some underlying value. The coming year will be challenging operationally, as the CEO admits. The company has had problems finding new members and selling product, but it had had success in getting more financial commitment from its members who have been switching to a different pricing model and boosting overall sales. Further, internet sales have been very strong but are now facing very tough comps. The need during an extreme recession to pay extra money to lose weight seems a little silly to me, as how one looks vs. how one will survive becomes decreasingly important. Expect to see continued flagging demand for products and new memberships but now also attrition.
The chart below addresses the final dynamic: The stock, technically, is troubled:
Note first that despite the rough performance over the past year, the bottom panel highlights that the stock has essentially tracked the overall market over that time-frame. It did take out the IPO price briefly at the lows of the market, but it quickly bounced back. As we approach 24 again, the outcome could be much worse. The stock is back at its relative strength lows, unable to do hold the 50dma or turn it upwards as the broader market was able to do. I have set a one-year target of 20 based upon the EPS dropping due to either an equity issuance or higher-cost borrowing and weaker margins but the PE holding at 10, but I believe that the downside could be to the single digits. Bottom line, absent some surprise out of Artal Group, I don't expect WTW to offer much upside in any event and to offer significant downside in the likely scenario that we remain in a bear market.
Disclosure: No position