Description
Intro
I believe E-Diets will be able to reasonably provide a potential return of 150-200% over the next year without an inordinate amount of risk. E-diets is currently trading at about 12x ‘03/5.5x ‘04E EV/CFO (industry avg. 23x), and 1.5x ‘03/.87x’04E EV/REVS (industry avg, 3x 2003), with 50% projected revenue growth, while owning the exclusive rights to number #1 branded diets (eg. Atkins, Zone, Dr. Phil). What makes E-Diets such an exciting story: High Margin (87%Gross) High Growth (50%), very significant barriers to entry, very positive operating trends, management owns 50%+, low EV/CF and EV/SLS. E-diets is one of the best situations I have come across: extremely misunderstood (by the few that follow), immediate powerful catalysts to unlock value, exceptional operating leverage (that is heading in the right direction), very attractive business model, significant hidden assets, combined with the average buy out for online subscription based business’s in the past year has avg. 4.0x revs LTM. The company trades on average 225,000 shares a day.
I will focus this write up on the simple economics of their business: revenues per subscriber per cycle (RPSPC), cost to acquire subscriber (CAPS), gross subscriber additions, retention, and key trends/catalysts in (RPSPC/CAPS). In addition, look at the as 2 cost structures in one: 2 parts variable costs (cost to acq. sub) & (cost of sales and royalty pmt’s) and one part fixed (fixed operating costs).
Note E-Diet and the diet industry are short cycle businesses by nature, with 2-8 months retention (edet avg. 5-month retention) but extremely profitable (look at WTW). In the US, 67% (180,000,000) of Americans are considered overweight and 20% (54,000,000) are considered obese. Currently, about 1% of dieters has even started dieting online, I believe this will emerge as a significant weight loss trend. . I did a poor job of writing up this idea in Jan 2003. I believe the E-Diets story is extremely compelling at these prices, hopefully this will be more clear-cut.
In a sentence: as the average revenues per subscriber per cycle continues to widen over the cost to acquire the subscriber the company should be able to approach 18-20% FCF margins and earn in CF .55-.75 for 2004 with revenues ($58-78 million, depending if they consolidate E-diets Europe and how many new diets they roll out). In addition, I think gross sub additions should be up significantly 67%+, assuming $51 (CAPS) and $37million ad spending (gross sub ads last 3 yrs: 350,000 in 2002, 430,000 in 2003E to 725,000 in 2004E). I believe there will be material catalysts that will drive these 3 levers.
For 2004, every $1 the company adds on the $117in revenues per sub per cycle on annual basis .022 should fall to the bottom line. For every 1-week retention goes up on annual basis should add $3 million dollars to the top line which about 85% will fall to the bottom line (or about .10 per share per week retention is boosted). Previously, the company boosted retention from 5 months to 7 months several years ago before the 50% price hike, I think they can do it again (see below). For every $1 that customer acquisition costs fall this will add .022 per share to earnings. E-diets potentially could earn incremental $.80 a share if they are successful (assuming RPSPC goes up $10, Customer acq. costs $50 down from $58, and Retention gets bumped up a month = .22+ .18+ .40= .80 per share). I AM NOT SAYING this is going to happen, just trying to give a feel for what could happen. If the company only gets a few of these initiatives right, shareholders would be in great shape.
The costly mistake for 1Q03: not investing in real-time ad serving systems:
Since the company made a (belated 4-2003) investment in real-time systems for ad serving and analysis customer acquisition costs have come down significantly. The new systems allow EDET to in real-time see the effectiveness of their ads while allowing the company to switch ads instantly or cancel ad space with poor yields. This is has led to a significant reduction in Customer Acquisition cost since implementation from $68.20 to $47.94. The company has a very good handle on customer acquisition costs now which is obviously extremely important. The good news is that 70%+ of company’s cost is variable and can be cancelled on very short notice, so they have a lot of flexibility in placing good ad rates now.
I estimate that E-diets will spend approximately $23,000,000 between Yahoo, AOL, and MSN mainly marketing their family of brands (or approximately $1.25 per share). For 2004, I estimate that this will grow to approximately $37,000,000 in online advertising ($2 a share or 67% of EV) marketing brands. This due to the company continuing to roll out a new branded diet every quarter, while having current brands: Atkins, Zone, and Dr. Phil in peak diet seasons. Advertising customer acquistion costs per sub (CAPS) should be significantly better due to 1Q03 disaster, and have improved significantly after the 1q03 quarter.
Most online diet ads you see are from E-diets, to see one of their ads http://health.msn.com/
Ediets net of the call center (mainly hourly employees) will generate nearly $1,000,000 in revenue per employee, which is 3x better than YHOO, 2x better than AMZN and EBAY.
I believe it is likely that Barry Diller's (Interactive, IACI), Yahoo, or a major drug company will acquire E-Diets in 2004. Interactive, because they could merge with Match.com, and customer acquisitions costs would be a fraction of Ediets, they would mint money. Yahoo because they are focused on subscription based businesses with large potential audience (dieting is perfect way to monetize traffic). Drug company’s are a very real possibility, as a customer acquisition tool. Overweight individuals consume a disproportionate amount of drugs over the average person. Abbott Labs paid $160 million to acquire the rights to the Zone Perfect. While Goldman Sachs Private Equity/Parthenon bought majority stake in Atkins for between $600-800 million in late October 2003. EDET CEO owns 45% of equity is in his late 60’s and I believe will look for exit strategy shortly (next 18 months).
E-Diets on their last conference call announced they will be partnering with major Pharmaceutical company to have a drug based branded diet. For Instance, IF Pfizer and E-Diet were to start a diet for individuals on Lipitor that will combine, cholesterol lowering drugs with a diet focused on obviously with foods that are heart healthy. Allegedly, drug companies are interested in two things: ability to tap ediets members and increase usage and focus of patients on drug to stay on prescription plan. There are currently 18,000,000 Americans currently taking lipitor for high cholesterol, so there is a lot potential for pharmaceutical partnership. Drug company’s are using diet’s as customer acquisition tools.
I believe three of most attractive online subscription based business models are in Jobs, Dating, Dieting. All three are short cycle businesses, with huge audience rotating subscriber base, are very conducive to an online model. Only an extremely small portion of the US population diets online, about 1%. I think this will pick up meaningfully over the next year, and EDET will be far and away the biggest beneficiary, simply because they are the industry leader, with multiple exclusive #1 brands, and no channel conflicts (like competitors: WTW, Jenny Craig etc).
Why use e-Diet online?
Choice
13 different diets (3 major branded diets): Atkins, Zone, Dr. Phil, ediet alt to jenny craig, heart smart, type II diabetes, low sodium, vegetarian, healthy soy, low fat, lactose free, low sugar, and high fiber. No switching cost to go from one to another, inside diets
Cost:
E-diets cost .71 per day per member or $65 per quarter, average Weight Watcher member spends close to $350 per 2-3 month stay (offline), use of peer pressure to up sell related diet products.
Convenience:
E-diets use when you want to, available 24/7 for support by experts via 800 number. Versus offline alternative of weekly meeting at preset location, travel time, parking cost, membership fees, etc (that’s why short retention)
Significant Support:
Offline as well as online huge online community to exchange info (picture the YHOO mesg board for stocks but on dieting and more a lot more friendly/helpful/useful),
85 support threads inside edet on a number of topics (there are well over 1,000 posts per day),
Every few hours E-diets online will host live health discussions, similar to a lecture with Q&A at the end all on-line
Weekly weigh ins and progress reports, will recustomize your plan based on progress
Private: E-diets is obviously private vs. offline alternatives
ATKINS: It appears Atkins is very pleased with the ediets relationship so far, in fact Atkins has very recently put a link on their homepage to Ediets Atkins service.
Ediets signed 100,000 paying Atkins subscribers within 120 days of announcing the service at $5 a week per subscriber. This is a real positive considering the majority of this was done in the end of the second qtr and halfway through the 3rd qtr, off peak diet season
What they do how model works (business model)
Ediets spends a very significant portion of their 88% Gross margin advertising their family of 13 diets/ 3 brands (in fact they are a top 12 advertiser online), in which a subscriber joins ediets pays $5 a week for a highly structured diet plan based on their personal weight loss goals. For instance, you are 6’ 250 pounds, and want to use atkins plan to lose wgt. System will provide you with a daily meal plan of exactly what to eat, you can also integrate in a fitness plan (they own efitness too). The system will track your progress weekly, via weigh in and ask series of questions. Then software will automatically adjust your plan in real time to monitor your progress and goals in a controlled fashion. A subscriber also has access to help from fitness, nutritional, medical experts (http://www.ediets.com/company/bio.cfm?bio=10)
Why do major branded diets outsource to EDET?
Many have tried this internally then gone to e-diets.
Marketing Muscle: E-diets can aggressively market brand given high GM dollars and huge online advertising budget
Experience: Ediets has done this for 6 years, has significant industry experience climbing learning cure
Customer acquistion cost: Effective customer acq costs, are really north of $90 for new entrants, without brand. Ediet’s is about half of this, because approximately 45% of new diet members come from their free weekly newsletters (Opt-in, NO SPAM) to 13,000,000 subscribers.
Maintaining customer: Once you acquire the subscriber, you have to provide support PLUS must retain on the subscriber at least 4+ months to reach B/E, edet can do it in half that time.
Infrastructure costs: Need call center, Experts on staff, Programmers, develop software to serve, Technology infrastructure costs, IT maintenance team, Must be willing to run business at a significant loss for a long time, while you try to build subscriber base to cover customer acq costs + fixed overheard.
Success: Ediets has been very successful with new branded diets: 100K atkins subs in 120 days, tightening relationship now atkins marketing ediets on their homepage.
Branded diet co: a) get recurring royalty b) cross sell products to huge diet audience (launchs Jan 2004), c) Gets brand built rapidly, aggressively, and profitabilty while allowing branded diet company to focus on driving sales of high margin food based products
Ediet has now emerged as the place to go for #1 branded diets (there really is no alternative besides going in-house)
Confusing trends not representative of business
1Q best quarter of the year (peak diet season)
2Q second best quarter of the year
3Q second worst quarter of the year
4Q Worst quarter of the year (few diet in winter, holidays/cold)
This year it has been close to the opposite of this YTD, due to opening of new branded diets.
With all the active diet brands in place I expect a very significant pick up in revenue for 1q in excess of 100%.
What makes Ediets business model attractive
No inventory
Essentially no A/R: Days sales outstanding 7.6
88% Gross Margin
29% top line 2003 (revenues: 83% subscription/17% advertising/ecommerce)
50% top line 2004E
very little capex about 15% of CFO
Subscription based business good revenue visibility
70% of revenues variable cost (cancelable in 2-3 days)
Not tied to the success of any one brand/strategy: like Weight Watcher or Medifast
Diet Depot strategy #1 brands (#1 brands coming to them)
Significant competitive advantage: 13 million opt-in newsletters (50% of acq cost from this), no one else in industry can get close (effectively cuts customer acquisition cost in half) (BUT also a Risk, see below)
Ediets has passed through a 58% price hike in July 2003 ($41 a quarter pre-paid to $65 a quarter cancel anytime). On a retention-adjusted basis E-diets is effectively generating 33% more revenue per sub per cycle, than pre-price hike.
Barriers to Entry
True customer acq costs close to $90 per sub for new entrants without brand Ediets gets 45% of new customers via 13,000,000 opt-in weekly newsletters.
Toughest competitors Weight Watchers business will get hurt online (plus they only own 39% of wtw.com/hurts high margin high price pt offline prdt)
E-Diets has exclusive rights to #1 Branded Diets: Atkins, Zone, Dr. Phil, plus 12 other proprietary diets
Access to Distribution: Ediet is 12th biggest online advertiser and climbing
E-diets oldest player and #1 player for online dieting industry
Won Best healthcare site: Beat out Pfizer.com and HealthInsurance.com (as other finalists)
Won Best customization/Personalization: Beat out NikeID.com and Yahoo.com
Ediets has very strong credibility with #1 branded diets:
3 key areas
Assumptions
2003: 400K Gross Subscriber adds ($23,000,000/400,000)= $57.50 to acq (distorted due to anomaly in 1Q03 of $68.40, $48.96, $47.64, $45E)
2004: 670-800K Gross sub adds ($38,500,000/670,000 ranging to 820K)= $45-55 to acq.
All pay $5 a week, with 5-month retention
1) Drivers for average revenue per sub per cycle
As new members sign on and old members leave (who were grandfathered in April 2003), with the pricing hike from $45 a quarter to effective $65 a quarter. This will obviously drive improvements in revenue per sub per cycle. The company stated that with $5 a week and up sales, the company is now generating a record $120 in revs per sub per cycle (5*$24).
E-diet said they will open an online store 1Q04 that will sell Atkins, Zone, and Dr. Phil nutritional products. My understanding is that edet will get royalty on each sale. This should lead to increase in (RPSPC) Revenues per sub per cycle.
Edet has opt-in Recipe builder for $2 extra a week
Edet also has fitness option for extra $2 a week
We hope that the company will develop segmented products with higher price points. Right now the strategy is open the funnel get people to try online dieting, from my understanding ($5 a week cancel anytime)
KEY POINT:
E-diet had major problem with customer acquisition costs in 1q2003: here is my understanding
EDET lacked the real-time systems that MOST significant online advertisers had. EDET would place an ad then in a few weeks they would get a report back from the portals explaining click-throughs and success/failure of the ad. Well, the company got hit very hard, because they did not realize how off customer acq cost assumptions where until it was to late. The company subsequently installed real-time systems in place that allow them to see effectiveness of ad in real-time, and if the ad isn’t working swap the ad, or cancel it. This has greatly improved the company’s success as noted below in CAPS line since 1Q 2003, immediately fell $20 in customer acq costs from 1q to 2q.
(STRICTLY MY ESTIMATES, company does not break out)
G.sub adds RPSPC CAPS Spread
A)
1Q02 100,000 7 mo * $11= $77 $29 $48
2Q02 95,000 7 mo * $13= $91 $35.65 $55.37
3Q02 80,000 7 mo * $12= $84 $41.68 $42.32
4Q02 75,000 7 mo * $12= $84 $55.24 $28.76
1Q03 80,000 7 mo * $12= $84 $68.60 $15.40
B)
2Q03 126,000 6.4mo* $16.25=$104.56 $48.96 $55.60
C)
3Q03 119,000 6mo * $19.5= $117 $47.64 $69.36
4Q03E 105,000 5.6mo * $21.50=$118.25 $50 $68.25
1Q04E 175,000 5 mo * $25= $125 $50 $75
A) sold only annual prepaid and prepaid qtrly memberships
B) sold a mix of prepaid qtrly and weekly memberships cancel anytime
C) sold/sells only $5 a week cancel anytime (RPSPC) based on $5 a week
RPSPC: this is very tough calculation to make (THESE ARE MY ESTIMATES) because the company now has a mix of subs with different pricing. However, the company stated all new $5 a week memberships are now generating $120 in average RPSPC, what is not clear is the mix of grandfathered in $45 pre-paid quarterly subs there are.
2) Drivers to decrease cost to acq sub per cycle
Partners start pushing edet brands on their sites, should result in more favorable acq cost Atkins is already advertising E-diets Atkins product on Atkins homepage
As customers build brand awareness (sub cycles)
Diet Depot strategy > Stay with in family
CO-branding:
Offline advertising: TV print yields better customer acquisition points
3) Subscriber Additions
With less than 1% of the Online diet market penetrated.
edet the #1 player with significant barriers to entry and tied up several of the number #1 branded diets, with additional brands coming every quarter. I believe online dieting will gain a very significant following online, due to the cost, effectiveness, support, and convience relative to the offline alternatives. In addition, the unit economics of E-diets business will drive significant shareholder value.
E-diets should be able to keep customer acquisition costs low: Economies of Scale for being a top 10 advertiser online (get better rates), having branded partners push.
So if the company can get to $37mm in ad spending with $51 customer acq cost, should have net sub adds of 725,000.
Drivers for Positive Operating Leverage
Pricing on retention adjusted basis +33%, up until April 2004 (yr/yr).
They have real time systems to check ad yld effectiveness (which they lacked a yr ago)
RPSPC should be going up through number of drivers
CAPS should be declining as partners advertise subs
Peak Diet season with everything in place: Brands, and control systems
Access to distribution: $23,000,000 2003 should go to $37,000,000 +/- for 2004 ad dollars spent
Have pushed up retention in the past from 5 to 7 months in the past> Diet Depot strategy where subscribers Can switch within diet family for no charge which should also boost retention.
Notes: Price hike from $45 to $65 7/1/2003 (old was prepaid qtrly new cxl anytime $5 a week), Previous accounting, realized 100% of ad cost day customer is acq, then recognized 1/90 of revenue per day.
Valuation
There are 7 analysts that follow Weight Watchers (WTW), 1 that follows EDET. Weight Watchers has had serious problems almost exactly since ediet started to aggressively market Aktins. Even more coincidental, was that WTW only had problems where EDET was marketing Atkins, Europe was fine. WTW even blamed problems on the explosion in adoption of low carb diets. Even better, WTW is severely challenged in seeing online succeed. They own only 39% of WTW.com, offer only one program, with significantly lower price points than offline business. Their online business is up over 100% YTD, simply because of offline members coming online. I would expect some of these analysts might look at EDET once it is off the bulletin board to cover.
Average take out for online 5 subscription based models over the past year is 4.0x trailing revs.
HOOV 2.6x sls (bought in Dec 2002)
Udate 3.9x sls (bought in dec 2002)
Lending Tree 5.5xsls (may 2003)
IGN Entertainment 2x (may 2003)
Hotwire 6.0x sls (sept 2003)
I would suggest, that the lower valuation take outs occurred in unfriendly environment to be selling company and few were growing as rapidly as e-diets.
Would comp edet based on above calculations:
4.0x $38mm revs 2003= $8.08 per share
4.0x $65mm revs 2004= $13.83 per share
Peer group
Ev/revs ev/cfo Top line growth GM NM (mrq)
Medifast (MED) 6.95 44x 41% 71% 7.7%
WeightWatchers (WTW) 4.54 18x 10% 51% 14.5%
Nutrisystem (THIN) 1.62 17x -22% 45% -4.6%
E-Diets (EDET) 1.55 12.5x 50% 87% 8%
Avg. 2.93x 22.75x 17% 63% 6%
Comp value
EV/Revs
2.93x
2003= $6.42
2004= $10.13 (using my $65 estimate)
Ev/CFO
2003= $6.12
2004= $12.51 (using my .55 per share)
Average all of above $8.80 per share (+150% from current $3.40), my personal opinion is that e-diet is worth far more than any company in this comp group: #1 player, fastest growing, exclusive rights to #1 brands, highest margins (gross/2nd highest net) etc.
Just looking at comp group with growing top line average multiple:
EV/sls = 5.74x
EV/CFO= 31z
Implies for EDET
Ev/Sls $12.59
EV/CFO $8.43
15x 2004 CF .65E = $9.75 per share
Revenue Net
1999: $2.4mm ($462k)
2000: $11.4mm ($5.6mm)
2001: $24.4mm $794K (acquired #2 player)
2002: $29.6mm $1.5mm
2003E: $38mm ($37.5-39) ($1.3mm)($3.5mm 1H03A loss,2H03E $2.4mm profit)
2004E: $60-80mm $6-7
Hidden Asset:
EDET has off-balance sheet asset of ownership of 60% of EDET Europe. Which is profitable and growing. Ediet got this stake for letting EDET Europe use their technology to run site.
As mentioned earlier: owning exclusive online rights to major branded diets is extremely valuable, that I don’t think is being recognized by wall street. ATKINS is a huge brand that is having sweeping changes on the way people eat.
RISKS
Risk has been and will continue to be, being filtered as spam. This is not a new issue. E-diets subscribers are OPT-In.. The subscribers are asking for these newsletters. This is potentially a serious problem. It is in the company’s hands to resolve.
Failure to sign new diets, don’t see this as a problem, said on conference call pipeline very strong with new branded diets
Lose of major branded diet: don’t see this happening either (see above, why branded diets use EDET)
Numbers are tough to get precise handle on due to mix of subscribers re: subscription fees in base (I think there are approximately 100,000 net subscribers, grandfathered in before April 2003 price hike) the positive is that as additional subs sign on at new higher price point.
There is risk due to operating leverage, if the catalyst fail to materialize:
Revenue per sub per cycle
Retention drops
Acquisition costs ramp significantly
Safety net
Discount to group: fastest growing, highest GM, very desirable services vs. food based side
Likely sale of co, CEO in 60’s insiders own 2/3, I believe it is a valuable franchise
High barriers to entry
Locked up #1 brands (and will continue to roll out addl brands)
#1 player online
Emerging industry with very little penetration to date, starting to materialize
WTW.com +100%
Trading at significant disct to industry comp take outs at 3x revs 23x CF, vs EDET 1.5x and 11x 2003
5 take outs online subscription based models YTD averaged 4.0x revs, vs. edet 1.5x revs LTM
Catalyst
100% yr/yr rev growth for 1Q04E, 50%+ yr/yr 2004E
only pure public way to play growth in Atkins, Zone, Dr. Phil
attractive take out candidate
Record revs/profits/margins> in off-peak qtrs, peak diet season starts in 2 weeks
Stated on conf call very interested in getting off BB and getting listed on major exchange
Gaap profitability
1.59x revs/.9x 2004
#1 player on line
CF .55-.75 2004E
67 yr old CEO owns 45%
1 new diet a qtr coming with diet depot strategy