| 2018 | 2019 | ||||||
| Price: | 50.00 | EPS | 2.94 | 3.63 | |||
| Shares Out. (in M): | 70 | P/E | 17 | 13.77 | |||
| Market Cap (in $M): | 3,500 | P/FCF | 0 | 0 | |||
| Net Debt (in $M): | 1,500 | EBIT | 0 | 0 | |||
| TEV (in $M): | 5,000 | TEV/EBIT | 0 | 0 | |||
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At its current price, WTW is an attractive long. WTW is in the middle innings of a conversion from a physical to a digital business model. This transition opens up numerous opportunities for long-term growth that should enable the business to compound FCF at an attractive rate over the next few years. One can assume there are minimal incremental gains in retention, net new subscriber growth further declines, and pay 10x my estimate of 2021 EBIT and the stock is a 1.45x MOIC.
History
A couple of years ago WTW was on the brink of bankruptcy due to a series of weak marketing campaigns and a slow embrace of mobile. Sales declined 30% from 2013 – 2015 in a business with high operating leverage and high financial leverage.
Piggybanker wrote up WTW on 11/10/15 and breaks down the Oprah Winfrey investment (which occurred in October 2015) and focuses a lot on the potential Oprah effect on the business.
This was a great call. While Oprah super-charged the business her involvement really accelerated some beneficial core trends that were already occurring.
For a long time, WTW had no mobile strategy, which is nicely summed up by the CFO's comments: "the other key thing was we missed the mobile revolution and had to catch up. So, look, in the – January 2015, when you're selling a one-star rated app for $19.95 a month and people have a free app alternative, we got the right results we deserve..." (12/18)
Going forward, I think there are significant incremental benefits to WTW from its mobile strategy - which should drive engagement, increase retention, and enable the business to continue to grow subscribers.
What happened
WTW peaked around $100 in June, after two 'disappointing' quarters the stock is at $48.
The street had been expecting accelerating subscription growth while the last two quarters have showed slowing subscription growth. By my estimate net new subscription growth was up about 10% YoY; however, even with flat net new subscription growth going forward, there is a long runway of subscription growth ahead.
Reardless, at the current valuation, I think slowing subscription growth is more than priced in.
The business
WTW is a seasonal business. The majority of the company's marketing spend coincides arounds the holidays, and drives substantial recruitment in the first quarter. Today, the average life of a customer is just under 10 months, up from around 8 months two years ago. The company's seasonal pattern is as follows:
3 Year Subscription Count Trends:
| 1Q15 | 2Q15 | 3Q15 | 4Q15 | 1Q16 | 2Q16 | 3Q16 | 4Q16 | 1Q17 | 2Q17 | 3Q17 | 4Q17 | 1Q18 | 2Q18 | 3Q18 | |
| Ending Subs | 2,900 | 2,800 | 2,600 | 2,400 | 3,100 | 2,900 | 2,800 | 2,600 | 3,600 | 3,500 | 3,400 | 3,200 | 4,600 | 4,500 | 4,200 |
The biggest risk with the business is that it is still fairly reliant on timely, on-point winter marketing. Successful programs like WW Freestyle can have a larger effect, while poor campaigns can hinder the business.
The company has gotten more efficient over the last few years with digital advertising allowing it to segment and target potential customers, Oprah will be featured in the winter campaigns, and absent a big fail this season, the business should substantially grow Q4 to Q1 subs, which will propel subscription revenue throughout the year.
Opportunity
WTW is a business that was tailor made for a mobile application. Customers can scan their food, share their weight loss goals, sync their activity and interact with a like-minded, private community.
Over the last few years, WTW has focused significant resources on its mobile application and it is having an effect. The company has increased retention from 8 to almost 10 months, and the company has a host of continued incremental improvements which should have a positive effect on the business. Small gains in retention due to short lifetime of each customer have a very large effect on the business.
WTW will shortly be launching Wellness Wins which is a hybrid of a loyalty program and in-app gamification.
It is "an innovative program that rewards members with WW-curated products and experiences for everyday behaviors that are proven to lead to healthier habits. Members earn wins for tracking meals, activity, weight as well as for attending WW Wellness Workshops. Wins can be redeemed for a range of products, services and experiences designed to inspire members on their wellness journeys....Early member engagement has been highly encouraging. In the three weeks following the launch of WellnessWins compared to the three weeks prior in the U.S., tracking overall is up about 20% and excluding tracking from same devices, activity tracking is up 80%. " (3Q18 Earnings)
Furthermore, WTW has used its mobile application to position itself as not just a weight loss company, but also as a companion in the wellness space. It has rebranded as WW (the long-time name of the app) and it recently begun integrations with a fitness and a mindfulness application, and launched FitPoints 2.0 which ties points to different types of physical activity.
It also has a large opportunity within e-commerce and the demographics of the business. Today, total in-studio product sales are around $140m while WTW does approx. $15m of e-commerce, and 90% of the user base is female, but recent cohorts have been up to 20% male.
In the company's words, they are: " developing an ecosystem, one that encompasses nutrition, activity, mindset, motivation and community. So with inspiration in community from Connect, gamification from WellnessWins, meditation from Headspace, and fitness content from Aaptiv, all on top of our leading program for nutrition, we're starting to truly build out a digital platform that has the opportunity and permission to be more fully integrated into our members' lives"
These small product improvements should drive engagement, which drives retention, which keeps more subscribers in the business longer, which allows them to drive higher subscriber numbers with fewer gross additions.
Valuation:
The company's balance sheet is radically improved over the last few years. Leverage is down from over 7.5x in 2015 to around 3.5x at the end of 2018, which is the company's long-term target.
The business generates a ton of cash, and even at its current interest expense of close to $140m ($1.4 bln term loan at LIBOR + 475 and $300m of notes at 8.75%) the company will likely be close to 1.5x in 2021. The company has repeatedly emphasized that it will look to refinance its debt and bring down its interest expense, which will further drive cash flow.
Subscriber Trends:
The most important things to model are gross additions and churn. I think the part that is getting lost in the recent slow-down in net new subscriber additions is the future impact of churn improvement.
One could model flat net new subscriber additions over the next 3 years but increase retention by 3% YoY --- moving from 10 months to about 11 months – and the business would still compound subscribers at mid-single digits over 3 years.
One could model 5% YoY net new subscriber growth over the next 3 years and increase retention by 3% YoY – and the business would compound net new subscribers at around 10%.
I think 5% YoY net subscription growth and 3% YoY increases in retention is reasonable.
That would drive average annual ending subs from:
| 2018 | 2019 | 2020 | 2021 |
| 4,505 | 4,913 | 5,383 | 5,857 |
| 9% | 10% | 9% |
Just to note this would put 4Q2020 subs at 4.9 million which is just under management goal of 5m
This would drive an incremental $300m of subscription revenue, if we believe they can drive another $100m of incremental revenue from e-commerce / partnerships / B2B / geographic expansion the business should do about
$650 of EBITDA - $50 of CapEx = $600 of EBIT
10x = $6,000 - $900 net debt = $5,100 / 70m shares = $72.85 target price
Descriptions provided herein are summary in nature and are not complete. Any statements constitute only subjective views, beliefs, opinions or intentions, as of the date shown, which are subject to change due to a variety of factors, including fluctuating market conditions. No representation is made that such statements or examples are now, or will continue to be, complete or accurate. Statements regarding possible future events, opportunities or growth should not be relied on and involve inherent risks and uncertainties, both general and specific, many of which cannot be predicted or quantified. No statement, example, graph or similar information should be construed as an investment recommendation or advice. These statements are not intended to be and do not constitute investment, tax or legal advice.
Solid Q1 sub additions
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