Description

WW is one-half COVID Recovery stock, one-half call option on a business transformation that could produce a structurally higher earnings multiple and valuation. In 2021, If WW can earn a more normalized $2.00/share, the stock could be up 50-100% at 15-20x P/E.

             Longer-term, the business may benefit from its investment in its digital platform and market expansion beyond weight loss into the broader health and wellness category. WW has a durable brand (almost 60 years old), a growing digital subscription business model, a global presence,  the only long-term sustainable weight management program, and a strong and incentivized CEO.  

            The Covid-19 related challenges to WW’s business are two fold: 1) the in-person meetings business, a core driver of ARPU and consumer product sales, has been negatively impacted by the social distancing---groups cannot meet. 2) work from-home/shelter-in-place phenomenon has negatively impacted WW customer growth as people are spending money on other items and are generally less concerned about weight management/health as they stay-home and nest. Comfort food and comfort clothes have worked well during Covid. The preceding factors negatively impacted WW’s business performance in Q2 2020: revenue was down 8.7%, EBIT was down 50% and EPS was down 72% (there was about $43mm of non-recurring expense in the quarter related to stock compensation expense for Oprah and a restructuring charge. In 2018 and 2019, WW earned $3.19/share and $1.72/share, respectively. Consensus EPS for 2020 is $1.68/share. ). This is a subscription business model with operating leverage, which will work against WW in 2020.

            I believe these headwinds will begin to abate in 2021. WW’s meeting business will eventually come back, albeit with a smaller footprint (the company has announced plans to rationalize the physical meeting  footprint). Core to the WW program is a sense of community and connection with other people working to lose weight and get healthy. For many people, the in-person meetings will remain a key part of the program. For others, behaviors may have shifted to a more digital-centered program; WW should be well-positioned because the company will launch its digital coaching service soon, and has also launched WW connect, an online, in-app social network type service for its members.

            Second, if we get a vaccine, there could be a lot pent-up demand for weight management/wellness programs. As people return to work and play, there should be a renewed interest in managing/losing weight and getting healthy. Similar to the New Year’s phenomenon (i.e. January is a huge month for sign-ups as people get motivated to lose weight for the new year), there could be a similar effect here. WW should a very good chance of meaningfully growing its subscriber base in 2021.

            Covid-19 took hold of this business right as WW was in midst of a full scale attempt to evolve its business model and brand from a dieting/weight loss business to a health and wellness business with a weight loss component. The evolution is led by CEO Mindy Grossman, who took over the CEO role at the Company in 2017. Ms. Grossman has a lot of experience with consumer brands from past stints at Tommy Hilfiger, Nike, and most recently, HSN. It makes sense that Ms. Grossman wants to move WW away from the diet based-business because it has several unfavorable characteristics: highly seasonal and cyclical, under constant assault from new fad diets, and short-term customer relationships that end when the customer goes off the diet. Ms. Grossman envisions WW becoming a brand that can build deeper, longer-lasting relationships with customers by delivering a broader suite of products and services beyond weight loss. The healthier lifestyle could include clean eating, nutrition, mediation, spirituality, and physical activity. Ms. Grossman wants to build this relationship through a digital wellness ecosystem super-app that provides customers access to wide swath of wellness-related services.

            WW faces several challenges in executing this strategy shift. Weight Watchers has over fifty years of brand equity in the weight loss space, so transitioning to a health and wellness brand, risks alienating and confusing current and prospective customers (this happened in 2018-early into 2019 when the new brand positioning was introduced). Weight Watchers also has to defend its core weight loss businesses, including its in-person meetings business, and its digital subscription business, while simultaneously establishing new businesses in the health and wellness space. It is hard for a business to do one thing well, let alone two. In recent years, the core weight loss business has been under attack from free/low-cost apps that allow calorie counting/fitness tracking, with Noom being the most well known. Lastly, WW has a fair amount of debt for a business that is cyclical, and does not offer a lot of visibility. It is not easy for a leveraged company to attempt a strategic pivot in the public market under the scrutiny of quarterly performance. WW has definitely felt the sting; the stock has fallen from a high of  $100 in summer of 2018 to ~$20 today.

            If WW can execute on the shift to a health and wellness business, it should open up many new and attractive business opportunities that would be unavailable to legacy Weight Watchers, including high-valued added packaged goods, location-based businesses, and licensing the WW trademark. As almost all legacy CPG companies are working to prune/reduce their portfolios of processed, synthetic or unhealthy lines of products. WW could potentially become one of the leaders in an attractive, growing space. Presumably this would translate into a structurally higher earnings multiple if the underlying economics of the new businesses are good. I could also see a large CPG conglomerate like Unilever, P&G or Nestle making an investment in WW. WW is one of the few global wellness-oriented businesses with direct consumer relationships and real-time granular data on consumer behavior---that could be attractive to a large CPG that has predominantly wholesale relationships and no retail digital presence.

            I don’t have a strong view on whether the WW transition will be successful. I can understand why the company is attempting to make this shift, and how a variety of new businesses opportunities will become available to WW.  Mindy seems like the right leader for the challenge. I can also see how the transition could falter. It is difficult to move a 50+ year-old brand with decades of experience in one industry, and a lot of accumulated brand equity in one particular type of business, into a new industry, particularly one that is not developed-while concurrently working to defend the legacy business. I could also be wrong about the commercial opportunities in the health and wellness industry-it may sound good in theory, but there may not be a lot of ways to monetize the business. Reasonable people could come to difficult conclusions regarding the probability of success for WW. The reason the investment has become interesting is that the stock has been pushed down to a level that creates a favorable risk/reward in light of the potential of the shift working, or the business just returning to better performance in 2021.

             If Weight Watchers succeeds in evolving the business while defending its core weight loss franchise, the business should be able to add new high-margin revenue streams in packaged goods, licensing, location-based experiences, and potentially B-B through by playing in a role in employee sponsored health care plans. As noted above, WW would become one of the only branded consumer companies in the health and wellness space—it would have an attractive asset base upon which to leverage its new market position on a global basis, including decades of customer lists, an installed base of 5mm subscribers, and global retail physical distribution (through WW studios/meetings business). In 2019-2020, the company entered or expanded partnerships with Blue Apron, Amazon, and Kohl’s; each partnership leverages the new WW brand in a different way. Oprah (a large shareholder) can continue to appear in marketing campaigns that will attempt to communicate the new WW brand proposition. Oprah is a uniquely powerful marketer, and was a key driver or the brand’s revitalization when she became involved in 2015. If some of these known initiatives can take hold and demonstrate the WW transition can deliver new lines of profitable business for WW, and potentially pave the way for others, the stock is pretty cheap. It is also worth nothing that Mindy Grossman is strongly incentivized. Upon becoming CEO, Ms. Grossman was awarded an option package that will reward her if the stock goes up: a summary of Ms. Grossman’s option package:

            1-Time-Vesting Options and RSUs to attract her to the position of President and Chief Executive Officer and to compensate her for the forfeiture of equity awards arising from her voluntary departure from her prior employer, as well as to ensure retention and to reward and incentivize performance and creation of shareholder value. Ms. Grossman received her hiring award consisting of a combination of Time-Vesting Options and RSUs in the following amounts and with the specified option exercise prices, as applicable, on July 5, 2017: 300,000 Time-Vesting Options with an exercise price of $32.67 per share, 500,000 Time-Vesting Options with an exercise price of $40.00 per share, 500,000 Time-Vesting Options with an exercise price of $60.00 per share and 200,000 RSUs. These stock options and RSUs granted to Ms. Grossman vest proportionately over four years on each anniversary of the grant date and the stock options terminate on the seventh anniversary of the grant date. The above-referenced stock options with exercise prices of $40.00 per share and $60.00 per share were all out-of-the-money

Ms. Grossman has also been a buyer of WW stock in the open market, acquiring 12,000 shares on March 1 2019 at $21.70/share, and acquiring 7K shares at $50.10 on Nov. 6, 2018.

If the brand transition to WW fails, I think legacy Weight Watchers will be fine. The primary reason that Weight Watchers has endured for so long is that counting calories is really the only sustainable way to manage and sustain weight loss over the long term for most people.  By developing modern iterations of its core calorie counting system (points), supplemented by a large meetings business, Weight Watchers created a fairly resilient business in a notoriously fickle and fad-driven industry. Unfortunately, the problems of obesity and people being overweight are not going away, so the need for sustainable and manageable weight loss programs will remain.            WW’s core weight loss business was not a great business due to cyclicality and constant threat from new competition and low-cost digital substitutes, but it also was not a bad business. From 2015-2018, WW consistently earned gross margins between 50-54%, and EBIT margins in the low-to-mid 20% range. The business generates good cash flow due to low levels of working capital and PP&E. A lot of the overhang around legacy WW had to do with an excessive level of leverage and being late to digital. Both areas have made improvements. Lastly, the stock is about ~10x  E2021 EPS, a relatively inexpensive price for a highly resilient consumer brand with a  growing digital subscription business that could return multiples of the current price if the new strategy begins to work.

Catalyst

1-Better business performance in 2021

2-Business model transition begins to work