Description

Introduction
E-Diets (EDET.OB) $1.50: Hold on don’t fall out of chair laughing just yet. Why would you do that?: a) Internet bubble broke almost 3 years ago ( 99% failed) b) E-Diets is a contarian play (internet + wieght loss online). (I was skeptical at first, but users and media rate the site highly, (from survey’s on the site), and retention is increasing). c) Internet misperceptions by the masses (valuations were excessive at the top to low at the bottom, survivors are left). There are many broken net cash Internet stories, but very few cheap, rapidly growing, cash generating Internet subscription based businesses. Strategic buyers (Barry Diller & DNB) are rapidly stepping up pace to acquire these under-followed companies at significant premiums (3 deals last 60 days).

E-Diets has substantial barriers to entry*, 5 GAAP profitable qtrs, growing very rapidly (22-24% this year, 35-40% in 2003), well managed (Former PM from Fred Alger, CFO formerly with EQNX (acquired), CEO successful entrepreneur holds 17 patents, formerly with Sensormatic), insiders own 63% of the equity (and one director was buying more in Dec 2002) and is dirt cheap (50% of forward sales, p/e 14x ttm, ROE 33% first 9 months 2002, FCF +111% yr/yr). The company is the #1 online dieting subscription business, rated # 1 diet site by independent 3rd party out of 200 sites (see below), and Forbes has rated it Best of web last 2 yrs for nutrition/fitness. E-diets is a top 20 online ad buyer in North America (this helps their competitive position because many of the major portals want and need to do business with EDET). This sets EDET apart from 99% of the competition in: 1) they have access to distribution (most do not) Edet pays MSFT $9mm a yr and YHOO $4.5mm per yr. (and EDET cut off deal with AOL last Feb, one of the reasons the company’s growth has slowed, but still 22% profitable growth is not bad). Americans spend $7.8Bn per year on dieting products (excluding gym memberships). E-Diets is a compelling growth story trading at a value price (50% sales, 35-40% growth for 2003) and has significant value to strategic buyer (Diller, MSFT, YHOO, AOL). EDET IS FAIRLY liquid for bb stock trading 750,000 shares in the month of December.
Ediets (EDET.ob EV= $24mm)
Revenue Net
1999: $2.4mm ($462k)
2000: $11.4mm ($5.6mm)
2001: $24.4mm $794K (acquired #2 player)
2002E: $30mm $1.5mm
2003E: $40-43mm

I think the business is worth $3-4 (based on EV/Revs 2x ’02, HOOV cash buy out Dec 2002 @ EV/sales 2.6x trailing revs, Udate.com was bought by Barry Diller’s USAI for Ev/sales 3x) to a strategic buyer over the next 12 months (such as USAI/TMCS, YHOO, MSN, or AOL). Internet subscription based models are exactly what the portals want to acquire because of recurring high margin revenues plus they have the distribution already.

Arguably the three best online subscription based business dating (TMCS, Match.com is grew 185% this yr with 26% ebitda margins 2001 to 2002), Dieting, and Jobs. Simply there is almost always demand for these services that will never change: healthy living (looking better), finding a partner, earning a salary. Nearly all of the Internet Portals listed above are making a HUGE push into Subscription based models: YHOO is aggr going after jobs and Dating currently. I think in 2003, ONE OR MORE of the portals will go after E-diet because of its strategic value.

Competitive Advantage/Barriers to Entry:
1) Capital Markets Closed to New Entrants (Large Scale potential competitors will Buy vs. Build)
The most logical buyers of EDET: Ticketmaster (TMCS), Yahoo, MSN, and AOL. For $60mm they can own the #1 brand, that is PROFITABLE, growing rapidly, and MOST importantly from MSN or YHOO perspective Would be Incredibly accretive (EPS power would jump for MSN .45+ in 2003 (about 3x EPS for 2003) because of ad buying and for YHOO .25 in EPS (5.3x EPS), EDET has aggressively advertised for 3 years on all of the major portals (spending $42mm 2000-02). Replacement cost for EDET is I would estimate to be north of $55mm. Retention is short 7 months, customer acquisition $35 per sub and had a total of approx. 1mm paying customers in EDET history since 1997.This is not an easy business for new entrants.
2) Aggressive spending on S&M and LOW COGS limits new entrants 2001 spent 67% of revenues, 50%+ of revenues in 2002 + led to EDET to picking up low hanging subs.
3) Access to Distribution,
a) EDET is a top 20 on line ad buyer in US (smaller players cannot compete on same scale) ,
b) Significant Competitive advantage: EDET has 11mm subscribers to weekly Opt-in newsletters where the company acquires 50% of new business comes which has a very low customer acquisition cost.
c) Offline, considering working with mass market retailer to sell in stores
d) Home Shopping Network (HSN) sold product on TV, North Carolina BlueCross/Blue Shield bought subs offering to sell to members.
4) #1 Internet based subscription diet service #1 ranked in quality of service (see link below)
5) Low cost leader
6) Clearly differentiated against WTW
EDET WTW
Convenience Anytime, Anywhere vs. Weekly meetings, urban areas

Privacy Home/Office vs. Peer Pressure in public forum (effective)

Value Various, annual PP sub $99 vs. $150 for online program (cannibalizes franc)

Customization 100’s of individual customized plans Point system

Support 24/7, online offline/online community vs. Weekly meetings/online support


Attractive Business Model
1) ROE 33%, Top line growth 22%, P/E 14, 50% Ev/Sales, $7.8BN market

2) Extremely low capital intensity business (CAPEX 2001: $538K and 2000: $510K) High asset turnover: 2.35x, DSO’s 8 days, $644K in A/r, no inventory, Cash makes up 63% of CA.

3) Successful Internet Based business: A) no inventory, B) good revenues visibility with Subs based business with deferred revs, C) GAAP profitable

4) Commitment to writing profitable business

5) Strong Free Cash Flow, retention has grown from 5 to 7 months

6) EPS Power strong estimate peak 20%+ OM with 13% NM (after rapid growth slows)

7) Attractive Business Prospects for edet: cost company about $39 to acq customer and the average member spends approximately $100+ over subscription lifetime (and this is increasing). Rapidly growing industry: According to Marketdata Enterprises, annual expenditures on commercial weight loss, medically supervised diets, low calorie entrées, meal replacements, and diets books and videos is $7.8BN as of 2001 (or per capita $29 per person).

2003 growth of 40% should come: from 50% new product (e-fitness) and 50% from expanded distribution of products. More on this later.

RECENT INDUSTRY BUYOUTS:
In my mind there is unquestionably significant value to a growing and profitable Internet Company due to a number of competitive factors and exceptional unit economics of the business. Two Internet Subscription based deals have occurred since October 2002: HOOV (Acq by DNB Dec 2002), TMCS (acq by USAI Oct 2002), Dec 2002 USAI (Barry Diller) acquired UDAT.ob (Bulletin Board stock) for 100% + premium (stk actually moved from $1.10 to $4 in 3 weeks (paying 3x sales and 5x Bk) vs. (EDET .67x sales) .On the truly exceptional Internet business side: YHOO was unchanged 2002 while trading at 12x revenues and EBAY unchanged in 2002 despite trading at 19x revenues). I would NEVER own either but just for a reference purposes.



Recent History
In October 2001, E-Diets bought Dietsmart (#2 player online) to create the #1 online subscription based dieting service, strengthen competitive position, increase growth and profitability. The company has put up 5 GAAP profitable quarters and management is unhappy with EDET current valuation.

Ediets hired Piper Jaffary 3 June 2002 to look to enhance shareholder value (not exactly good timing in hindsight). From what I have learned of the situation there were several offers that were made for significantly more than the current share price that the company deemed unacceptable to the board (I think they want $3+). Ediets ended the engagement with Piper in Nov 2002.

EDET is undergoing two changes that has put near term pressure on the company (and created an opportunity knocking stock down from $2.50). First, EDET ended their deal with AOL(feb 2002), because they were not happy with their current agreement(this slowed growth to 22% for 2002). From what I understand many people on the AOL side who were the root of the problem have been booted and more rational employees are now in place (so I would not be surprised to see the relationship start back up shortly). Second, the company is transitioning from a (cost per acq) CPA model to (Cost per thousand) CPM model. Under the CPA model the company would pay MSFT $40 for every paying subscriber MSFT would sign for EDET through their Ad banner and in turn EDET would get $45 subscription fee then have to retain subscriber over initial sub period or cross sell other products. Now EDET, is going with a CPM model where they pay for the ads by number served not, number of paying subs signed. I think longer term this will be a much better business plan.
CPM’s allow the company more bargaining power in the placement and pricing of ads on the site. Ediets, having spent $45mm in online advertising over the last 3 years has adequately climbed the learning curve of what works and what doesn’t (they can accurately guage effectiveness of ads).


The government has several initiatives (healthypeople 2010) underway to start to encourage Americans to live a more healthy lifestyle. (see 10K for more on this)

Competition
Weight watchers is in a very difficult position in terms of competing with EDET. First, WTW ROI is far more significant for buying back/developing offline franchisees than using capital to compete online. Second, problem is that they cannibalize franchisees territory and undermine their own offline program with pushing dieters online. (lower margin undermines core business)

Ediet 10K:
“We estimate that our revenues from diet and fitness services of $22.5 million for fiscal 2001 were among the largest of any commercial online weight loss program in North America, and that we are the leading Internet-based provider of diet services as measured by revenue, paying members, unique visitors and the number of individuals in our marketing database. Our aggregate weekly attendance, which is the number of weeks of subscriptions used by our customers, who come primarily from North America, was 10.0 million for fiscal 2001. This level of attendance represents 43% of the attendance reported by the our primary competitor, Weight Watchers(R) International, Inc.”

FROM Wall Street Journal 26 Dec 2002: (my comments in parathensis)
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Weight Watchers

URL: www.weightwatchers.com

Cost: Many free offerings; online membership costs $44.90 for the first month and $14.95 for each additional month, or $59.95 for three months and $14.95 for additional months. (That compares $10 to $15 for each weekly offline meeting on top of $15 to $20 for the real-world registration.) Members who attend Weight Watchers International Inc.'s offline meetings can access the online tools for $12.95 a month or
$29.95 for three months and $12.95 each additional month.

Services: Online users can employ the plan's system for tracking "points," assigning different calorie and fat
values to foods (an apple is worth one point, compared to five for three ounces of lean steak).

Minuses: (MAJOR PROBLEM FOR WTW competing with EDET) At $59.95, the three-month online membership handily beats the total cost of $135 to $200 for three months of real-life meetings. But as online plans go, it's one of the most expensive out there. It's also tough to get the same experience online as at one of the company's successful real-world meetings; keeping records online on your own is an easy way to get around the hard truths that could come from a weekly weigh-in.

EDiets
(Can effectively compete in rural areas without any WTW franchisees)

URL: www.ediets.com

Cost: Many free offerings; users pay $45 for a nine-week personalized diet, and $10 for each additional month. Users may also pay $99 for a one-year program.

Services: Ediets .com Inc., West Deerfield Beach, Fla., packages personalized meal plans with online bulletin boards and support groups, recipes and consultations with nutritionists through e-mail or during chats.

Members start by setting weight-loss and nutrition goals, says Susan L. Burke, eDiets' director of nutrition services, and eDiets delivers a personalized meal plan each week based on those goals. Users can rejigger the meal plans to fit their budgets and schedules, then print an accompanying shopping list to take to the store. If you know you might end up grabbing dinner at McDonald's, for example, the site steers you away from a Quarter Pounder by suggesting other items -- a hamburger and salad -- so you're not sidetracked
from your diet plan.

Members have access to nutritionists and fellow dieters 24 hours a day, either on the Web or through the site's call center. "You have the ability to post questions and get a tailored response, not just the general advice that's out there," the University of Pittsburgh's Ms. Bonci says.

Pluses: A fitness section tailors programs for users to increase strength, endurance or flexibility, complete with 3D animations for each exercise. Also, the site's information-packed pages look like a magazine and function like a browser home page, complete with workout schedules, a daily meal plan, fitness news updates and a quick workout, weigh-in, pounds-lost personal snapshot.

Minuses: The site's casual style could get grating after a while, and might be too easygoing for those dieters seeking a tough-love approach.
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Our goal at Chase Freedom is to give people the information they need to make an informed choice about the diet or weight loss program that fits their needs. We have spent hundreds of hours researching diet programs to bring you the 200+ reviews. We offer a pro and con opinion for most featured diets so you can make up your own mind. We have also included articles on sensible dieting and our highest review.
#1 ranked Diet plan out of 200 is Ediets (discuss pros/cons)
(here is the Link: http://www.chasefreedom.com/ediets.html)

Market Statistics
85% of subscribers are Women
1st company to the Internet in 1997 for dieting
from 1980 to 1999 obese population increased from 15% to 27%. And over 60% adult population is overweight or 128mm individuals vs. Ediets sub base of 188,000.
Americans spend significantly on weight loss:
1998: $5.8BN
2001: $7.8BN and is growing @ approximately 10% per year.
Company also owns 60% of E-diets UK which is much smaller than US but profitable as well (got this for lis. Technology to UK company).

Management
Highly competent mgt.:
Chief of strategy/IR: Alison Tanner, CFA, former Analyst/PM for Fred Alger Mgt.
CFO: Rob Hamilton, former CFO of EQNX (company acquired)
CEO: David Humble, owns 49% of the equity. CEO of 2 publicly traded company

I have found management to be very sharp, responsive to investor inquiries, and has a high sense of urgency to build shareholder value.

Statement from CEO: (I think sums up EDET investment thesis in one paragraph)
"Online diet and fitness makes sense for business, too. Consumers have been paying for offline diet and fitness programs for decades, but they can get much greater value and lower prices with online programs because those programs are less expensive to operate. With an attractive cost structure and a critical mass of hundreds of thousands of members, eDiets continues to achieve sound, profitable growth."

Shareholder Value
The company believes the best way to build Shareholder Value is to rapidly grow the business 40%+ (not capital intensive business) and believe that longer term the company can reach 20% OM. Versus the alternative of showing good profitablility while on BB exchange.
I view the BB especially on micro cap side so inefficient similar to private equity.
I think there is a very good chance EDET gets listed on Nasdaq or Amex sometime 1H03.

2003 expectations:
GAAP loss this 4th qtr. (.05) because of big ramp up in subscriptions (company PAYS UPFRONT full advertising cost, then recognizes the revenues over the subscription period) CPM offer pay for both e-mail list and subs vs. CPA pay for each customer as they join.
CPM much more predictable pressence in front of the customer
CPA less pressence on the internet
Company should pay off all Debt 31 Jan 2003
2003 Cash $2.5mm (avg cash balance) and end year with $3mm+ while growing to $40mm+ in revenues


Negatives:
Customers acq costs will increase short term, decrease longer term
WTW is a good competitor
Cash is thin (but very very little Capex)
Capital Structure + generous options grants (however, this has come to rapid slow down in aggressive option grants, mostly done in 1999 and 2000)
Will generate cash but should run 2003 close b/e during ramped up growth

Arguably the #1 player (NOT SURE where WTW stands, because they do not break out online subscribers or success.. i would have to imagine simply due to their large offline base that they have to be at least close to EDET in number of Subs, however they do not want this market strategically but will not "give it away" either.

What is the business worth:
1) Replacement value: last 3 years $45mm in Advertising, Site and database $5mm, Value of Patent ??, 60% Ediet UK $1mm, $5mm NOL(worth $3mm) = $54mm? or $2.50-$3 per share. Plus on going business $30mm ’02E and low $40’s ’03E, has to be worth at least 1.5x Sales (given recent acquisitions at 2.5-3x ev/sales) possibly 2.5x+ revs which could imply $45-100mm vs. $25mm EV.

If MSFT were to acquire EDET in the first year: MSFT would make $10mm + and only have to pay $60mm assuming EDET sold for $3. EDET will spend close to $9mm with MSFT in advertising this year ($9/19.7(share count fully diluted with all options))

If YHOO were to acquire EDET in the first year: YHOO would make $5.5mm+ vs. cost to acquire of $60mm. BOTH YHOO and MSFT should be able to make far more than what I have stated because of distribution capacity.

2) Comps (WTW, TSCM, ONES, UDAT HOOV)

I THINK THESE COMP Metric’s ARE PARTICULARLY VALUABLE: Due to HOOV and UDAT being ACQ DEC 2002 (value to strategic buyer):
TSCM ONES HOOV WTW UDAT EDET avg
Ev/sales (TTM) 2.48 1.03 2.58 6.75 2.6x .73 2.87
Ev/sales (FTM) 1.96 .97 2.10 5.62 2.0x .52 2.37
Revs growth (TTM)28% -2% 5% 26% 100% 21%* 29%
Revs growth (FTM)27% 5% 23% 14% 30% 40% 23%
Asset Turnover 2.25 .87 1.35 .73 1.57 2.31 1.81
Total sub 66,000 814 300,000 n/a 237,000 188,000
Revs per sub $274 $71,000 $103 $151 $160
Value per sub $682 $73,710 $267 $600 $111
EV/EBIT loss 10 107 37 16 11 36

*WTW growth comes via acq. franchisees
N/A: WTW does not break out
Implied Value off comps:
With WTW W/O WTW
Value $5.49 $4.08
(blended: Ev/sls (TTM+FTM), EV/FCF, EV/EBIT, Asset turnover)
I would argue that w/o WTW (or the pure Internet comps) Understated value of edet because lower multiple co’s revs are declining and TSCM is not profitable (versus EDET which is growing rapidly and put up 5 GAAP profitable qtrs). . Finally these stocks have been hit esp. hard with market so they might be worth more to strategic buyer (EG. HOOV bought out)

I think some of the above business comps are undervalued (I also own ONES). Here is what HOOV’s own banker, SG Cowen said about deal say this is a bad metric because DNB is buying them for 50% of what they think business could be worth. We bought some of our HOOV almost exactly 2 years ago as low as .67 on tax loss selling. I think EDET represents a similar opportunity over the next 1-2 years.

23 December 2002 (HOOV PROXY)
In addition, SG Cowen estimated a range of values for Hoover's common stock based upon the discounted present value of the projected after-tax cash flows of Hoover's described in certain aggressive growth financial forecasts provided by management of Hoover's for the period December 4, 2002 through March 31, 2003, fiscal years ended 2004 through 2007, and of the terminal value of Hoover's at March 31, 2007, based upon multiples of EBITDA. The financial forecasts in this version included aggressive lead generation and revenue growth assumptions which are significantly above Hoover's current growth rates. In performing this analysis, SG Cowen utilized discount rates ranging from 18% to 30% and terminal multiples of EBITDA ranging from 6.0 times to 7.0 times.
Utilizing this methodology, the per share equity value of Hoover's ranged from $10.63 to $15.83 per share. Because of the risks associated with achieving the aggressive growth projections and because the historical business growth rate was considerably less that the projected growth rate, SG Cowen ascribed little significance to this analysis in reaching its opinion.

3) DCF MODEL: value =$3.75
Assumptions
WACC =12.6%
Top line: 35% ’03 and 35% ’04, then 33%, 30%, 28%, 27%, 25%, then 10% for 12 years
EBIT margin: 2% ’03, 8% ’04, 13% ‘05&’06, 14% ‘07-’13, 12% ‘14-’17, then 10% to ’22
TR= 40% (through ’22)


NET NET: I think a strategic buyer will acquire EDET because of strong EPS power and low valuation (.46+ 2003 to MSFT, EDET will spend nearly $9mm with msft, and .27 EPS for YHOO). Buying EDET @ 50% of forward sales, with 35-40% top line growth, for a very attractively positioned Internet subscription based model is like paying approximately 50% of replacement value or 33% of peer group value. I have followed the company for about 9 months and just started buying in November/December 2002. I think what unlocks value here: the resigning of AOL (in the best interest of both parties: EDET top 20 online ad buyer/AOL more rational now than in the past), New Product E-fitness, lowering customer acq costs via cross selling E-fitness and pulling more users in through newsletters, possibility of strategic buyer coming in, and/or getting listed on NASDAQ or AMEX early 2003 (which is a priority). I definitely feel that management has a high sense of urgency to unlock shareholder value.

Catalyst

Catalysts:
1) Management, Sharp and committed to WRITING PROFITABLE subscription business.
2) Mgt/board owns 63% of the equity and are committed to enhancing shareholder value
3) #1 online Internet Subscription based diet business, #1 ranked by users, High growth + high margin potential 20% OM when business matures.
4) Bulletin board+ underfollowed
5) Trying to get listed NASDAQ/AMEX early 2003 (meet listing requirements: except share price but waivers can be granted based on qualitative factors
6) Strategic buyers have paid EV/Sales of 2.6x+ in the last 30 days to buy similarly positioned Internet subscription based businesses (HOOV and UDAT.ob) Buy out probable: USAI/TMCS, YHOO, AOL, MSFT
7) Expanded distribution: offline mass retailer?/AOL?/Expand with Insurance company’s
8) Should continue to generate substantial FCF
9) Cheap stock (EV/Sales 67% trailing, 10x EV/EBITDA) + Rapid profitable growth +40% top line
10) Management has high sense of urgency to enhance shareholder value and the right people in place