Description

THESIS outline:

WW International is a dieting/health platform with a market cap of about $1.5 billion and an enterprise value of about $3 billion. They have two main businesses that operate very differently and therefore yield very different margins. The first business offers in-person meetings and the use of their app with all of its features. Very notably, because of the recent COVID-19 outbreak, they launched meetings over video and integrated them into zoom. The second business is a regular subscription purely for their app and its content. The standard subscription service has 80%+ gross margins, against the meeting, which had a 40%+ historical gross margin but has fallen in the last couple of years. However, the subscription service has been growing almost consistently.

The whole business (enterprise value) trades at roughly 11x next year's projected ebit. We use next year's earnings because the 2020 earnings were affected by the COVID-19 outbreak and did not accurately represent the company's earnings power.

Now that the business has turned to a more digital model, we believe that the margins will grow significantly. The company will also monetize customers better and increase retention, which will increase top-line numbers and bottom-line margins. In addition, the operating leverage will decrease due to the less studio space needed for the meeting segment. We believe that the market is not valuing the non-meeting subscription service fairly, and we are buying it at a discount to intrinsic value. We think there is risk in this business, as you can see from the 2012-2015 period; having said that, the risk does not adequately justify the payout offered in this investment.

Besides the value seen in the business today, they are making an effort to grow and become an app that is not just a diet app but a lifestyle app that you use throughout the year and not just when you are dieting. There is a tremendous amount of potential value to be realized here. If WW can grow the retention rate by 10% through this change, their earnings will increase without incremental marketing costs. 

They also have implemented their product offering on their app for easy access to consumers. As a result, we believe there will be dramatic growth in the products segment of the business as they historically mainly sold in meetings. 
Note: The thesis will be discussed in more detail below.

Business:

WW International is a weight loss company that was founded in 1963 aimed to help overweight people lose weight and live a healthy lifestyle. The company started out meeting with clients to assess what they needed to achieve the best results. They have now become the leading weight loss company globally, known for the best and healthiest results. They collect revenue from meetings, and digital, subscription services, and selling products. The meeting segment consists of group meetings in one of WW studios to get a diet that fits their lifestyle and provide encouragement. The product revenue is all products sold using the WW brand and those sold by 3rd parties through a license. The products are everything from foods modeled after the WW proprietary points system and home goods sold using the WW brand. Recently WW started selling these goods on the WW app platform.

Now for a qualitative description

Although people use many weight loss programs, WW is especially set apart from its peers for multiple reasons. First, their celebrity commitments, this most notably consists of Oprah, James Corden. This gives them a significant marketing advantage and a big boost in credibility, which is a need in an industry full of false claims. Then, of course, their brand is very old and trustworthy, which, as I've said, is very important. Then one last significant advantage is their scale. Specifically, in their meeting business, their scale is a massive advantage which is uncopyable, which is one big reason they lasted so long. Now that a more significant part of their business is digital, they will lose a part of their competitive advantage, which is the required scale to compete in their meetings segment. However, they will still retain a scale advantage as the app becomes more content-driven with live classes and videos and many other things they can integrate because of their scale. When a company has a single product that scales depending on size, those are the best scale advantage. Besides all the management and organization leverage, they are building out a single product with a lot more RD spend than a smaller competitor. I like to use intel as an example; the company dominated the microprocessor market for more than two decades because of its scale on a single product. If AMD spent 10% of revenue on RD and Intel 5% with four times the revenue, it's still spending double the amount on the same product, never allowing AMD to catch up.

Competitive environment.

I will go through a bunch of competitors to understand where WW stands relative to the competition.

Jenny Craig: The business model is not very comparable as they are a food service where your diet consists of JC pre-made meals. They do not have any significant scale as they only have around $500mm of revenue with a way less profitable model than WW. The company is not particularly successful increasing revenue from $280mm in 2001 to $480mm in 2018.

Nutrisystem: The company is very similar to Jenny Craig, although it has a larger scale at about $700mm. No significant growth to take anything out of the status quo.

Slim Fast: Also the same model with a way smaller footprint at $350mm.
All three of these companies have not and are not positioned to move into total health where WW is heading.

Beachbody: Some may say they are a competitor. Although very big, they are not an up-and-coming company that will disrupt the status quo. They are also not pursuing the same thing as they are very involved in streaming services and not focused on losing weight. Some may even say they are a pyramid scheme.

All the free calorie counter and diet apps:
Starting in 2012, the company faced an extreme outflow of subscribers due to the proliferation of the smartphone and the accompanying free apps. WW did not have a viable app at the time, as the CFO of WW commented: 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). This changed in 2016 and hasn't been a problem since. The change comes from both a better well-invested in-app and the realization by consumers that these free apps are low quality and do not incentivize them to follow them. We do not think there is a material risk of this being a problem in the future.

The one company that we are very much keeping our eye on and is the one considerable risk to WW is the venture-backed Noom. The company is dubbed the WW for millennials and reportedly had about $400mm of revenue in 2020 compared to $237mm in 2019. the company just raised about $540mm from a group of VCs and reportedly looking at going public in 2022 at roughly a $7-10 billion valuation. We believe they have effectively been the first to get through (though not surpass) the digital part of WWs barriers to entry. The company now has the size and the capital to compete in all areas of growth. However, WW still has two things against them: their meeting segment, which entrenches them better, and their celebrity backers. Although Noom can get celebrities, Oprah is the perfect one for the targeted 45+ women in this industry. 

There are multiple reasons we believe Noom may not be too bad of a threat. Number one, they are an up-and-coming growth stock, and we do not think they will turn to a bidding war for customers with slashed prices and ruin this extremely profitable business model. Now from a market share perspective, as WW always says, their biggest competitor is not other industry participants but the DIY consumer. So when WW grows its base by 20%, it is generally not taking those customers from competitors; instead is taking them from the 95% of DIY consumers. We, therefore, believe although not good for them, it will not become a set market with the participants fighting for industry share. A second thought is that Noom is trying for the cooler younger generation that WW has historically had difficulty acquiring. This dynamic may benefit WW by dragging this age group into the pay for weight loss/health industry.

One last point is that there is currently a class-action lawsuit against Noom alleging that they make it extremely difficult to cancel subscriptions. The BBB Serving Metropolitan New York also reported that well over a thousand complaints against them had been filed, that their free trials are misleading, and that they cannot be canceled. The point is not so much the lawsuit monetary loss but how much their retention will fall off when they fix this problem. WW is also suing them (perhaps a sign that they view them as a risk) for various advertising abuses.

With all this in mind, this is one company that you will have to keep an eye on and all future developments regarding them.

The industry is also significantly affected by fad diets. For example, as I will discuss soon in 2018, the Keto diet (which was highly unhealthy) affected the company's performance. Although this will continue to affect the company, these cases do not last too long and will not affect the company's long-term value.

To better understand the industry dynamics and risks, I will go through the last couple of operating years for weight watchers.

Recent history

WW International had two significant dips in its short history of being a public company. I won't go into so much detail regarding the first dip between 2012 and 2015. But to keep it simple, the market panicked due to the outflow of free calorie counters and workout apps. And for a short time, nothing separated WW from its peers. That led their subscribers to drop significantly, and some say they came close to bankruptcy. 

In the middle of 2015, the turnaround started. The first move WW did to separate themselves from the free app was to give Oprah Winfrey (American talk show host) a piece of the company to promote their product and provide them with a boost. 2015 saw quick responses from consumers as the diet became popular again, as seen with the burst in subscribers and meetings. Unfortunately, it wasn't long before the company had another hiccup as their app was premature and not consumer-friendly. As a result, you can see a dip towards the end of 2015.

2016 was a slow year for WW International. They saw subscribers decline dramatically down to about 1500 by the fourth quarter representing a YoY decrease in subscribers by 25%. At the same time, WW announced they would be moving on from their CEO, James chambers. The YOY subscriber decline was attributed to the new apps still taking a toll on WW subscriber growth and the Nutrisystem diet (prepared meals that help you lose weight within the same price point as weight watchers). The decline was a continuation of the previous slide, Only that Oprah Winfrey joined the team in the middle of 2015, putting them in a little better position. But they still faced the issue of how to differentiate themselves from the free app.

2017 and the first two quarters of 2018 were a fantastic run for WW International. The stock was at an all-time high, and subscriber growth was up to 3.2 million subscribers, including the meeting and the regular subscription program. In addition, revenue was up to $1.3 billion, up 12% YoY. This performance was attributed to the Oprah effect kicking into full speed and the new CEO Mindy Grossman, whose talents are building a great digital platform. Which was the area they were struggling with before she was hired. That year they also changed their diet to include 200 zero point foods which resonated well with customers.
Along with the great year they had in 2017, they also gave excellent guidance for 2018. Management was expecting revenues of $1.55 billion driven by member recruitment growth. In addition, they mentioned that as of the middle of the first quarter in 2018, we're seeing the highest increase since turning positive in 2015. With all of this, the stock price was at an all-time high. 

The back end of 2018 and the first bit of 2019 was a terrible run for WW International, as you can see in their stock price falling from $100 down to $20, shedding %80 of their value. This dramatic decline was due to two reasons. First, they decided to rebrand their company from Weight Watchers to WW international to promote their new goal that focused more on health and less on weight loss. Unfortunately, this rebranding did work out so well at first. The second reason for the decline was a new diet that people were doing called Keto. Between the uptick in competition and the disaster, rebranding WW International lost many subscribers.

The last two quarters of 2019 were an excellent rebound period for WW International. They ended the year with 4.2 million subscribers, and at the Q4 earnings call, it had over 5 million subscribers for the first in its history. Retention was also at an all-time high reaching over ten months for the first time. The stock doubled since its low in 2019 to hit about $40. In mid-November, WW launched a new diet that assessed the client based on a survey and found the perfect diet for their clients. Revenue topped $1.4 billion. These gains were attributed to the fantastic celebrity-studded marketing campaign made by WW in 2019. 2020 started strong, but it wasn't long before COVID-19 hit the world and brought down WW as people were required to social distance and WW was forced to close their studios. 


What comes out from WWs recent history is that a few main dynamics badly affect them. Fad diets, messed up marketing messages, and no celebrity commitments. Competition has never been a big problem besides for the free apps of 2012.

The full thesis
When they announced 2nd quarter earnings, the stock flew down to $21.50, down from a recent high of $40. The company had missed guidance and dramatically changed its direction for the year. As a result, many analysts downgraded the stock, disappointed by the lower guidance.
We reached out to some analysts to understand the reason for their downgrade. Goldman's analyst Jason English explained that the company predicted a second-quarter sequential uptick in subscribers going against historical performance. Yet, although other health companies were doing well (his example was SMPL), they missed.
In other words, the way the company usually works is that they get about 40% of subscribers at the beginning of the year (New years commitments). From then, their subscriber count drops all the way to the end of the year. However, this year they predicted an uptick throughout the year, which only happened once in their history, at the start of covid.
Yet to me,it is an inadequate reason. First, SMPL was going against a decline in 2020; in addition, they aren't subject to the same seasonality as WW. Second, the business model is also very different, where SMPL sells more bars when people go out to work and return to gyms. One last thing is that the food segment did well over covid and is keeping that up; SMPL (which dropped during the covid lockdowns) is simply catching up to that trend.
WW revised lower mainly because they predicted a change from historical patterns, which did not pan out. That is not a sign of weakness, in my opinion. On the contrary, other health companies doing well will be a boon for WW next year. One point perhaps to be made is that they did have a slight sequential decline of 2.5% in subscribers compared to no decline since 2017 in the 2nd quarter. We believe the reason for this is that there was an increase of subscribers in the second quarter of 2020, which after the 10-11 month retention, fall off, which caused more subscribers than average to fall off in the 2nd quarter.

The company is predicting to have revenue of about 1.3 billion in 2021 and profit adjusted for restructuring their meeting studios of 240-260 mm. This comes after the company overspent about $10-15mm on marketing, due to the mistaken belief that this year's 2nd quarter will be another 1st quarter type period. The company currently has an enterprise value of about $2.8 billion ($1.3 billion of equity, $1.47 billion of debt, and about 31 million worth of Winfrey options), implying it is trading at about 10 times earnings. Many analysts predict higher on both sides as management got nervous after missing the 2nd quarter and overpowered their guidance. We believe the company is trading at extremely cheap levels based on those numbers or at about a 30-50% discount even without any improvement in earnings power. Another thing the market is not taking into account is that the company just unlocked a lot of value with the refinancing of its debt which lowered the debt financing cost by about 40 mm.

Then on future earnings power, we think there are a few dynamics that will make a big difference:
1)
The company has been transitioning to digital subscriptions for the past decade. As of the 4th quarter of 2020, the company had more than 2/3s of subscription revenue from their digital segment. This has got even steeper in 2021, with meetings declining since then and digital growth. Management always says its digital has over an 80% margin (about 85% for the years the company broke it out) against a historical 40% for meeting. So if you assume a 75/25 split and 83/40 margins for the future, they will have about a 72% margin on their subscription segment. This compares to their highest the ever year of 2020 in which they had 62% and 2018s 60%.

2)
The company had a big deleveraging in 2012-2015. Although they don't break out exact numbers, their meetings segment, which has a lot of operating leverage, had what we call a margin collapse. The company again experienced this during covid just as it was breaking back from its margin decline. Pre 2012, the company had about a 45% margin on the meeting, and the company currently expects to get back to 40% soon. This will get even better because of two dynamics. First, the company has significantly repositioned its meeting segment and closed many of its studios, switching them for hourly third-party rentals, increasing margins, and lowering leverage. The second covid forced the company to open digital meetings, which, although it will take time for people to transition to them they have already become very popular. As this feature scales, the margins of the meeting segment will increase as well. This is not coming to the detriment of consumer convenience. They still reach 70% of US consumers with their studios within a 15-minute drive and 90% within a 30-minute drive.

3)
The company's marketing costs have hovered around 5 dollars of subscription revenue per marketing dollar over the last many years. In addition, the company grew its subscriber count from 13,000 subscribers per 1mm marketing dollars to 19 thousand in 2018. This implies that digital subscribers who have become a more significant part of the business are cheaper to get than the meeting customer. Although those numbers are affected by rising retention rates, it still is about half the cost. Now, although the digital comes cheaper at about $21.95 per month against the meetings $44.95, the profit they make on them is not any different. This implies that the marketing costs for the company will not increase even as gross margins are going to.

4)
The company pays a specific amount of marketing dollars per consumer, so the apparent play is monetizing them more to increase profitability. Two current things will affect them in this regard. First, they have just started a higher-grade digital subscription service called 360 that is very content-driven. The cost is $29.95 against $21.95 for the regular subscription, yet the same 80%+ margins. It had a very successful launch as it increased the subscriber count from 100,000 at the start of the 1st quarter to 230,000 as of the second quarter.

The second point is their sales of goods. The company finally launched its marketplace for food and many other WW branded products on its app. Historically, it was mainly sold in meeting segments, alienating a significant part of their customer base and making it hard to buy consistently. This move should cause the company to start selling many more products relative to their base. In addition, due to the declining product sales since 2012, the companies product margins have declined straight. This will turn around as their e-commerce segment picks up. Both of these moves will come at minimal incremental costs, raising top-line and bottom-line margins. More a speculation, management has suggested that as they move to an overall health company, they may add on other services which will add value.

5)
As of 2011, WW had SGA expenses of about 11.5% of total revenue or about 200 mm against 18% in 2019 or about 250 mm. The increase was mainly caused by a deleveraging of 2012-2015 and has improved since then (of course, 2020 being a big exception). As the company scales, this will become an increasingly smaller part of its expense base.

Then there are all the other points which include, most importantly, increasing retention rates. The company has been getting good results from its drive to become overall health rather than a diet company. Although I would have doubted it would work, it does seem to be working. The company's decline in subscribers from the end of the first quarter has been getting better since 2015 when it was -18.3% to 2019, where it was -4.8%, with 2018 the only uptick. You don't have to be a genius to see the extreme value of increasing retention to their target of over a year. (perhaps even the markets will decide it is a regular saas business increasing valuations a thousandfold). 

Then another big plus is that the company is coming out with its bi-yearly food innovation by late 2021. Historically when the company comes out with an easy to convey and very beneficial program, the customers have come running. The current innovation is that the app will, through AI, be able to customize their diet personally; this is a straightforward and powerful message which we believe will help drive tremendous growth and is an excellent catalyst. This innovation is a direct comeback against Noom, which has this capability.

In addition, through this innovation, the company is coming out with a program specifically for diabetics, which has historically been underserved and will create a more significant target consumer base, and they will probably have longer retentions.

Another thing management talks about a lot but rarely quantifies it, so it is hard to understand the exact scale is their health segment. A significant recent development was the company partnering with CVS Caremark pharmacy benefits management. They currently have about 75 mm members, and now all the participating companies can offer both the WW offering and Kurbo (their app for the younger crowd) to employees and members. This type of offering has historically been very profitable as they do not need to do much incremental marketing and generally have longer retention rates. In addition, these types of subscribers do not have the same seasonality.

Given all of the above, I believe it is not beyond WW to hit its 30% margins of 2011 and even surpass it. For illustration purposes, if they hit the 72% margin on subscribers on 2019 numbers, they would have had an extra 12% of operating margin or a total of more than 32%, even after a general expense rise from 2018. I, therefore, think that being that the stock is cheap now on current numbers (30-50% upside) and has potential for substantial margin expansion from the current 20% (50-75% upside) and revenue expansion from the current 1.3 billion (upside not quantifiable) the company is a screaming buy.

Risks
There are a couple of risks that I will quickly outline, being that it's been mainly discussed already. The first is that the company is transitioning to a total health app; this can cause problems because it is already an entrenched weight loss app. For example, purposes look at WeWork. They tried branching out into WeWork Wellness spas/gyms, WeGrow private elementary schools, and other insane ideas, and it didn't work out. Radio Shack rebranding as The Shack and a cooler electronics store where they alienated their old consumer is another. Yet, we do not believe that WWs transformation is that drastic, and they are taking it slow. In addition, it is well underway with no real harmful effects.
Another risk is the general fad-driven diets, but as explained, we do not view this as a long-term risk.
The most significant risk, as I have explained, is Noom. Therefore, this company needs to be watched very closely by any WW investor.

What we will be looking out for:
We will now be watching if the company decisively acts to solidify its competitive moat. They have already moved to become a digital content-focused company which we believe is the right way to go as they've become a more digital-based company. This will allow them to keep their scale advantage. This is seen in cases like Pton, where it is hard to compete due to their platform's massive amounts of content.

More granularly, there is a new company called open-fit. The company has already gone through the proof of concept stage with about $40mm of revenue. They do precisely what WW does in the meeting segment, just in the workout space. This is a perfect vertical market that we would love to see them take up.
Another idea would be to partner with a company like Nautilus. They have perfect hardware workout products, but they are having a tough time competing with Pton on the digital side. Suppose WW would partner on app development and content creation. In that case, they can scale quickly and benefit WW by increasing more towards connected fitness type retention, increasing monetization, and increasing moats to entry. For Nautilus, it would be even more beneficial (though we do not own NLS now, we would jump into the stock if such a thing happened).
Although we will perhaps bring these ideas up to management, my point is not that they should do these very ideas but this type of idea. We believe this is crucial for the long-term success of the company.

On corporate governance:
Artal Group, the original company that bought out WW from Heinz, still retains over 20% of the company, which is over 10% of their portfolio. In addition, the company has three directors, including Raymond Debbane, the founder and CEO of Artal. In addition, Oprah owns almost 8% of the company with an additional option package to purchase 3.2mm shares at an exercise price of over $38.

Catalyst

The new upcoming food innovation and as soon as all the analysts realize they were wrong