Tivity Health (TVTY) announced a very large deal which was not at all welcomed by its investors as its management is willing to pay $1.3 billion to acquire Nutrisystem (NTRI). Investors do not like the combination of a steep premium, sky-high leverage (at this point in the cycle) despite the promise of synergies, as investing in weight management systems has traditionally been a very hard business.
While the pullback in shares of Tivity has been very large, which makes me naturally attracted to the shares, I am anything but really appealed to the shares just yet. This follows the potential devastating impact of the leverage incurred.
The Deal
Tivity has reached a deal to acquire Tivity Health for $38.75 per share in cash and 0.2141 of its own shares. That works down to $47 per share, for an equity value of $1.4 billion, which including net cash amounts to a $1.3 billion deal.
With the deal, Tivity will combine its own portfolio of fitness nutrition and "social engagement solutions" with weight management solutions as well, critical to "solve" chronic diseases. With the expanded portfolio and scale of solutions, the goal of the new Tivity is to benefit a greater range of stakeholders which includes healthcare plans, fitness partners, and, of course, consumers.
Tivity has been appealed to the growth of Nutrisystem as revenues of the company have doubled between 2013 and 2017 to $697 million, with adjusted EBITDA having risen to $109 million. The key weight loss plans of the company and 45-year heritage have been reasons for Tivity to buy the company.
That means that the deal tag comes in at 1.9 times sales and nearly 12 times EBITDA. It should be said that anticipated synergies of $30-35 million a year have the potential to reduce the EBITDA multiple to roughly a low 9 times multiple.
The Pro Forma Combination
Tivity is expected to generate revenues of $607-610 million this year, with EBITDA seen at $139-142 million. That earnings contribution should deliver on earnings of $2.15-2.20 per share, if all goes well, for earnings of $95 million in real dollar terms, and based on GAAP accounting.
Trading at $40 per share ahead of the deal announcement, and having 43.5 million shares outstanding, equity of Tivity is valued at $1.74 billion, for a $1.79 billion enterprise valuation. This values the company at nearly 3 times sales and a high 12 times EBITDA multiple.
With net debt of $50 million ahead of the deal, the combination will take on quite a bit of debt. The deal calls for a $1.15 billion cash component, including the purchase of $100 million in net cash, for a pro forma net debt load of $1.1 billion. With 6.5 million shares being issued of Tivity, the share count rises to 50 million shares. At $40, that implies that equity is valued at $2 billion, as the overall valuation rises to $3.1 billion if you include net debt.
With pro forma EBITDA rising to $223 million, leverage comes in at 4.9 times ex-synergies, as EBITDA increases to roughly $255 million, for a 4.3 times leverage ratio, if promised synergies are delivered upon. With Nutrisystem adding $73 million in adjusted EBIT, and pegging additional interest expenses at $55 million (let's assume 5% on $1.1 billion in net debt), additional earnings before taxes rise by $23 million.
With stand-alone operating earnings of Tivity seen around $128 million based on a 26% tax rate, I peg pro forma adjusted EBIT at $151 million (before synergies). With a 26% tax rate, that works out to $112 million, or about $2.25 per share with 50 million shares outstanding. That marks very modest accretion although synergies really have the potential to add half a dollar in expected earnings per share in the coming years, with deleveraging allowing for further growth in earnings per share.
The Market Reaction
The roughly $13 premium being offered for shares of Nutrisystem is quite sizeable, representing a $390 million premium in actual dollar terms. Compare this to the reaction of shares of Tivity, which are down 33% to $27. Including the to-be-issued shares in Tivity, that works down to $650 million in value going up into smoke, for a combined market value drop of $240 million.
That in itself is quite large on the back of a $1.3 billion effective deal, given the projected synergies. In fact, with shares down to just $27 and seeing a real roadmap for earnings of $2.20 per share and more to come in the coming years, valuations look appealing. On the other hand, leverage is sky high, and investors are cautious to factor in synergies given that these are uncertain while investments in dietary and weight management related business have a real "troubled" past.
To sum it up, I see the appeal of the situation but might be inclined to agree with investors. Despite the good track record of Nutrisystem, Tivity is leveraging up the balance sheet in a big way at potentially a wrong point in time. While the tie-up might make sense from a strategic point of view, there are very real risks to this in deal, including a fast changing operating environment and leverage being taken on.
To put it bluntly, I believe that Tivity could have pursued another route to create value as this might not be the logical way. This concern is already priced in by other investors given the massive plunge in the share price, creating a lot of concerns. Yet that same plunge does not create enough comfort for me to buy the dip, in part because leverage increases to such high levels, making this a wait and see game for me, for now.
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