Recently, Weight Watchers International (WTW) has plunged as much as 20% in one trading day to around $38 per share. The significant share price drop was mainly due to the sluggish outlook for the full year. Moreover, its CEO David Kirchhoff decided to resign. Should we avoid Weight Watchers because of the not-so-good news? Or does the market price drop represent an investment opportunity for investors?
Meeting fee is the main revenue source
Weight Watchers is considered the global provider of weight management services, with the network of company-owned and franchise operations, so-called multi-level marketing. The company derived its revenue from four main sources: meetings fees, Internet revenues, in-meeting product sales and licensing, franchise royalties and other.
Interestingly, the majority of its revenue, $935 million, or 51.2% of the total 2012 revenue, were generated from meeting fees. Internet revenue ranked second, with more than $504 million in sales, while the in-meeting product sales were only $253.2 million. The meeting fees are the fees paid by members to attend the company's weekly meetings while the Internet revenue derived from its internet subscription products and from the sale of third-party internet advertising.
Consistent positive cash flow but weak balance sheet
What I like about Weight Watchers is its consistent positive cash flow generation. In the past ten years, its operating cash flow fluctuated in the range of $233 million to $402 million while the free cash flow stayed in the narrower range of $210 million to $357 million during the same period. In the past twelve months, its operating cash flow and free cash flow were $360 million and $279 million, respectively.
However, what makes me worry is its weak balance sheet. As of June 2013, it recorded a negative equity of $(1.56) billion, while the long-term debt was as much as $2.38 billion. Moreover, it has a huge amount of goodwill, franchise rights and other intangible assets, of $922 million. Consequently, the tangible book value was much lower, at nearly $(2.5) billion. The negative equity was due to the company's consistent share buyback activities. In 2012, Weight Watchers spent as much as $1.5 billion to repurchase its shares on the market.
For the full year, Weight Watchers has reduced its full year 2013 EPS guidance, from $3.60 - $3.90 to only $3.55 - $3.70 per share, which is also lower than analysts' estimates of $3.70 per share. The company is trading at $38 per share, with the total market cap of $2.13 billion. The market values Weight Watchers at as much as 8.4 times its trailing EBITDA. What makes me worry about Weight Watchers is the fact that it does not generate most of its business from the sale of its products, but from the meeting fees.
Herbalife generates a lot of cash with bullish momentum
Compared to other multilevel marketing including Herbalife (HLF) and Medifast (MED), Weight Watchers' valuation stays in between. Herbalife is trading at $64.10 per share, with the total market cap of $6.6 billion. The market values Herbalife at 8.82 times its trailing EBITDA. Herbalife has been the short-target of activist hedge fund manager Bill Ackman, who placed as much as $1 billion short bet in the company. In contrast, billionaire Carl Icahn and George Soros have taken opposite sides of the bet, accumulating shares in the company. The good thing about Herbalife is that it has been generating a lot of free cash flow over years. In the past twelve months, its free cash flow came in at around $524 million.
Moreover, Herbalife also announced that according to Neilson report, around 3.3% of the U.S. adult population has bought the company's product within 3 months prior to the study and around 87% were non-distributors. That was quite a good statement for a healthy business. With strong second quarter earnings results, Herbalife has raised its EPS full-year outlook to $4.83 - $4.95 per share. It also announced that it would pay $0.30 in dividend to shareholders on August 17. With the strong momentum and earnings results, I would expect Herbalife could deliver good results to investors moving forward. Unless FTC has a negative opinion about the company, Herbalife stock is quite safe stock for investors in terms of financial fundamentals.
Medifast is the cheapest among the three
Medifast has the lowest valuation among the three. It is trading at $26.40 per share, with the total market cap of $365 million. The market values Medifast at only 6.9 times its trailing EBITDA. Medifast is the direct selling business, with its core products including weight and disease management, meal replacement and vitamins. Investors might get excited about the company's potential growth in the next five years. From a full-year 2012 revenue of $357 million, Medifast targets to reach as much as $1 billion by 2017, an annualized compounded growth of 23%.
Medifast plans to reach a $1 billion goal by three key actions. First is to expand its coverage in the global overweight market, which is expected to grow 40% in the next 10 years. Second is to implement "One Medifast" program, with infrastructure and process discipline. Third is to focus on acquiring talent and developing employee's capabilities to have sustainable growth. Recently, the company has undergone the transition to existing Medifast Weight Control Centers to the franchise model. This strategic transition will make Medifast more financially flexible and grow much faster in the future.
Weight Watchers is not cheap enough?
Despite the significant drop in its share price, I do not think Weight Watchers is cheap now. Moreover, it generates the majority of its revenue from meeting fees, not from selling its products. Thus, I am not comfortable to own Weight Watchers now. Among the three, I like Medifast the most, due to its low valuation and its ongoing strategic transition, which could drive more growth in the future.