Weight Watchers International

Ticker: WTW | Price: $50.92

Recommendation : Buy

Price Target (2013): $75.00 Initiating Coverage

December 28th, 2012

Geoffrey Horton

Solving the Obesity Crisis, One

Subscription at a Time

• I am initiating coverage of Weight Watchers International with a

Buy rating and a 2013 price target of $75. My rating reflects an

above-consensus view of the growth rate for the traditional weight

management industry.

• My investment thesis is most optimistic on the continued growth of

Weight Watchers’ internet revenue stream, especially as mobile

device growth rates steadily increase. Along with a significant

increase to marketing expenses and aggressive share repurchases,

management is proving to be quite pro-active.

• I expect more of management’s near-term attention to be focused

on partnering with health care plan providers after recent passage of

major healthcare legislation. Weight Watchers is scientifically

proven and employers are wanting to reduce health care costs.

•My target price of $75 per shares implies a 47% upside for shares

and assumes Weight Watchers can trade at 15.3x my $4.90 EPS

estimate for 2013, in line with the 3 year historical multiple of 15x.

My discounted-cash-flow analysis provides support for this

valuation where I assume a 3% terminal growth rate and a 7.23%

weighted average cost of capital.

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2010A 2011A 2012E 2013E 2014E

Revenue 1,452$ 1,819$ 1,851$ 1,926$ 1,997$

Net Income 195$ 305$ 246$ 274$ 304$

EBITDA 424$ 582$ 528$ 557$ 594$

EPS 2.57$ 4.11$ 4.12$ 4.90$ 5.42$

EV/EBITDA 9.6x 8.7x 9.5x 9.0x 8.4x

P/E 14.8x 13.4x 12.4x 10.4x 9.4x

Net Debt 1,365$ 1,052$ 2,300$ 2,100$ 1,900$

Market Profile

52-Week High 82.91$

52-Week Low 40.60$

Avg. Daily Vol. 579,000

Beta 1.42

Dividend Yield 1.37%

Shares Outstanding 55.65 mn

Market Cap 2.83 bn

FINI Holdings 81%

P/E 12.3x

Performance

WTW S&P 500

1 Month -5.42% -0.53%

6 Month 1.01% 5.52%

1 Year -12.15% 10.84%

3 Year 79.93% 27.21%

5 Year 12.46% -5.14%

Competitors

NutriSystem, Inc. | NTRI

Price: $7.87

Market Cap: 224.6 mn

Dividend Yield: 8.89%

P/E: 270.6x

Herbalife Ltd. | HLF

Price: $29.39

Market Cap: 3.2 bn

Dividend Yield: 4.08%

P/E: 7.6x

Medifast, Inc. | MED

Price: $25.41

Market Cap: 394.5 mn

Dividend Yield: N/A

P/E: 23.1x

Source: Bloomberg

The Household Name In Weight Loss Solutions

Over the past five decades, Weight Watchers International (WWI) has become a global leader in

the weight management industry through scientifically-proven diets and a flexible user interface.

What has been a literally unhealthy rising trend of obesity rates in the United States and other

developed nations, has been an incredible opportunity for WWI. Nearly 36% of adults in the

United States are considered to be obese, with this number expected to grow to 42% by 2015.

These demographics are always changing, though, as men’s obesity rates have recently come in

line with women's. WWI recognizes this constant transformation, and thus their marketing strategy

is continually changing to capture the biggest slice of this more than $60 billion1 industry.

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0%

10%

20%

30%

40%

50%

Men Women All

20 and under 20-3940-59 60 and over

0%

10%

20%

30%

40%

2000 2002 2004 2006 2008 2010

Men Women

Source: CDC/NCHS Source: CDC/NCHS

Exhibit 1

Obesity rates by gender and age

Exhibit 2

Trends in obesity by gender, 2000-2010

A Fit For Everyone’s Needs

Weight Watchers has three primary revenue streams: Meeting fees, internet subscriptions, and

products sales and licensing. Meeting fees generate the most cash as it has been the original

source of revenue since Jean Nidetch founded the company in 1961 based on her experiences at a

weight loss meeting.

1 Number represents only U.S. weight management industry. Provided by Marketdata Enterprises.

54% 22%

24% Meeting Fees

Internet

Product Sales

& Other

46%

39%

15% Meeting Fees

Internet

Product Sales

& Other

Exhibit 3

Revenue breakdown for 2011

Exhibit 4

Estimated revenue breakdown for 2018

Source: Company Reports Source: My Estimates

• Nearly 1.3 million members attend over 45,000 meetings world wide. Meetings are weekly

and last one hour, scheduled all throughout the day all around the community to fit the needs of its

members. Members who have successfully met their weight loss goals using Weight Watchers are

eligible to lead these meetings and are compensated on a commission basis. Meeting fee revenues

have a 5 year CAGR of 2.98%, while the past 4 quarters has produced a CQGR of -0.89%. I

expect growth from meeting fees to contract for Q4 2012, while growth steadies back out to 2%

for the next 6 years as a growing number of health plans subsidize Weight Watchers subscriptions.

• Product and licensing sales have been on the decline as WWI concentrates more effort on

the services it offers. Products include pre-packaged food and cookbooks that highlight their

PointsPlus system.. Carefully selected licensees and endorsees include select Applebee’s menu

items, certain General Mills vegetables and soups, and specific Kraft Foods JELL-O products. I

expect a decrease of 9% for this revenue stream for next quarter, and expect a steady decrease of

revenue until it stagnates in 2016. While it contributes to over a quarter of total revenue, I do not

believe it is necessary for WWI to expand this segment in the future to achieve the rate of growth I

have outlined in this report.

• The internet has allowed for ample opportunities to increase overall earnings. WWI offers

two online services: Weight Watchers online and eTools. Weight Watchers online provides the

traditional weight management solutions to lose weight on your own, while eTools is used to

supplement the in-person meetings. WWI had 1.5 million active online users in 2011 and sales

from weightwatchers.com contributes nearly a fourth of total revenue, with a 5-year CAGR of

27.4%. I expect the majority of WWI’s future margin expansion to come from more customers

using the online services in conjunction with the meetings versus the meetings alone. Weight

Watchers online 2012 upgrade, Weight Watchers 3600, takes aim at utilizing the growing mobile

internet market as it makes collecting food data and exercise activity easier. New research2 shows

41% of cell phone-using adults use their phone to go online in a typical day, providing me

evidence to expect the new AndroidTM and iPhoneR apps to be greatly utilized by new and old

members. From these advances and the size of market yet to be touched, I expect internet revenue

to increase at an average of 15% until 2016 and then a modest 7% until 2018.

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$0

$500

$1,000

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$2,000

$2,500

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Meeting

Fees

Product

Sales &

OtherInternet

Total

Exhibit 5

Actual & estimated revenue trends , 2005-2018

Source: Company Reports and My Estimates

Exhibit 6

Global meeting attendance in millions,

2007-2014

Source: Company Reports and My Estimates

0

10

20

30

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60

70

200

7A

200

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Other

International

Continental

Europe

United

Kingdom

North America

2Pew Internet mobile usage research, 2012.

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Pro-active Management In a Variable Industry

David Kirchhoff joined the WWI family in 2000, left in 2003, rejoined in 2004, and became the

CEO in 2006. A visionary in the industry with recent appearances at TEDMED, Kirchhoff has

kept the company relevant in an era of fad diets and quick-fix pills.

• Nearly 70 trials proving the results of the Weight Watchers program have been released

in the past 15 years . The last major global study in 2011 shows that obese adults referred by their

doctors to Weight Watchers lost more than twice the weight as compared to the standard weight

loss management program led by a primary care provider. Major competitors offer little in terms of

proven scientific results and thus I expect Weight Watchers to continue being a global leader in

the space.

• Marketing is constantly transforming to fit the ever-changing lifestyle. WWI has used high

profile figures, like Jennifer Hudson, to take part in their program and use them as a prime

example for weight loss success. While there has been recent controversy over the newest model’s

pregnancy, Jessica Simpson’s weight loss after her first child will be the forefront of advertising at

the start of the new year. Furthermore, WWI recognizes the past decade of growth with obesity in

men and has started a specialized advertising campaign to appeal to this growing market. Men

accounted for 15% of U.S. Weight Watchers signups last year and I expect this number to

increase with more advertising campaigns focused on Charles Barkley’s weight loss success.

Exhibit 7

Competitive weight loss services, products, and drugs

Source: Hydroxycutt, Arena Pharmaceuticals, Nutrisystem, Jenny Craig, Atkins

Source: Weightwatchers.com

Exhibit 9

Weight Watchers 3600 mobile app

Exhibit 8

WWI expects obesity trend for men to continue

Source: Weightwatchers.com

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Government Inspired Subsidizing Opportunities

Obesity-related costs covered just 5.5% of total medical spending in 1986. Estimates show that the

U.S. spent nearly $200 billion in obesity-related expenses in 2005, close to 21% of total medical

spending and costs are expected to increase nearly $50 billion per year by 20303. With the passage

of the Affordable Health Care for America Act in 2010, the U.S. government and employers have

been put in a position where it is in their best interest to reduce health care costs as much as

possible.

In early December 2012, Weight Watchers announced that WellCare Health Plans, Inc. would

offer eligible Medicaid members in Georgia fully subsidized Monthly Pass access to Weight

Watchers programs. Members must be referred by a primary care physician or be assessed by a

WellCare representative over the phone to be eligible for the program. Those members that make

progress & are interested in the program after 6 months can potentially continue their fully

subsidized membership. This move covers over 450,000 lives in Georgia, while WellCare serves

nearly 2.6 million people nationwide. Already having major health care plan providers like

UnitedHealth Group and WellPoint subsidizing the program, I expect Weight Watchers to attract

the attention of a greater number of companies that are looking to reduce health care costs and

achieve incentives set forth in the Affordable Health Care Act.

Source: CDC

Exhibit 10

Obesity statistics by state

2012 Finishes Flat While 2013 Offers Hope

Analysts are expecting a Q4 EPS of $.87 for a 2012 annual EPS of $4.08. Furthermore, Q4

revenues are expected to come in at $398mm for a 2012 total revenue of $1,818mm. Though WWI

is a seasonal business, I expect 2012 revenue to be $1,851mm and EPS to be $4.12. My above-

concensus view comes from my expectations of increased growth in sales with the recent launch of

the Weight Watchers 3600 service. WWI has a history of beating EPS estimates, while revenue

estimates and actual numbers vary quite a bit.

3Harvard School of Public Health, 2012.

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Exhibit 11

Paid weeks in company operations, 2007-2014

$0

$50

$100

$150

$200

$250

200

7A

200

8A

200

9A

201

0A

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Online

Other

InternationalContinental

EuropeUnited Kingdom

North America

Source: Company Reports and My Estimates

$0

$500

$1,000

$1,500

$2,000

$2,500

200

8A

200

9A

201

0A

201

1A

201

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201

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201

4E

201

5E

201

6E

Exhibit 12

Actual & estimated net debt, 2008-2016

Source: Company Reports and My Estimates

Source: Company Reports , Bloomberg, My Estimates

$175$195$215$235$255$275$295$315

200

7A

200

8A

200

9A

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0A

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Estimate

Actual/Projected

$-

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

200

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200

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200

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GuidanceEstimateActual/Projected

Exhibit 13

Actual, projected, and consensus estimates for

net income, 2007-2014

Exhibit 14

Actual, projected, company guidance, and

consensus estimates for EPS, 2007-2014

Source: Company Reports , Bloomberg, My Estimates

With the recent jump in paid weeks, especially online, I expect internet revenue sales to increase

the greatest. Though WWI recently completed the acquisition of a weight management service in

Asia, I expect Continental Europe and other international sales to remain low until obesity-related

costs grow to the size of current U.S. costs. I expect North American meeting revenue to increase

slightly with more companies starting to subsidize the Weight Watchers program.

WWI took on a larger portion of debt with their credit revolver recently to fund the repurchase of

nearly $1 billion in stock. The company believes this low interest-rate environment, along with

weak overall stock performance, provides a prime opportunity to reward shareholders by

increasing EPS. I agree with management’s decisions and expect there to be no issues in paying

off the debt in the near future. The company paid no special dividends in the wake of fiscal cliff

debates, leading me to expect that the dividend will remain the same for an extended period.

Valuation Methodology

I believe the market recognizes the plethora of expansion opportunities for WWI, but is under-pricing

the impact and rate of growth of these opportunities. My analysis leads me to expect earnings-per-

share to be $0.04 (1%) above consensus for 2012 and $0.16 (3.4%) above consensus for the next

year. Using a 3 year historic price-to-earnings ratio of 15x and assuming the earnings multiple

remains stable, I expect shares to appreciate between 30% to 50%. This represents a valuation range

of $65 per share to $75 per share; a range that I expect to be reached in the next 8-12 months. My

price target comes from the higher end of this range and the earnings multiple I have used falls in line

with a list of comparable companies. Furthermore, the price target EV/EBITDA multiple of 10.0x for

2012 and 11.2x for 2013 falls in line with the 5 year historical average of 11.3x.

Using a Discounted Cash Flow analysis, strong support is drawn for my price target. For this

valuation, I use a discount rate of 7.23% (reflecting a 1.8% risk-free rate, an 8% equity risk premium,

and a beta of 1.00 derived from a list of comparable companies), and a terminal growth rate of 3.0%.

The critical assumptions involve the growth and decline rates of WWI’s three revenue streams. Cash

generated from internet operations is expected to expand by 30% in 2012, 15% in 2013, and 10% in

2014. Product sales and licensing are expected to continue to decline, while global meeting fees

revenue is expected to fall in line with the 5-year CAGR of 3.0%. The $.175 dividend has remained

the same since first issuance in 2006 and I do not expect it to be raised.

Risks

The downside risks for WWI reaching my price target include growth for online paid-weeks slowing,

larger than expected losses from product sales and licensing, failing to convert marketing expenses

into overall revenue, and missing the opportunities created from recent healthcare legislation.

The WWI direct-to-consumer model could suffer if the United States and Europe fall back into a

recession and discretionary income decreases. Furthermore, WWI would also be negatively affected

if significant strides are made in weight loss medications, providing consumers with an easier way to

manage their weight.

Disclosures The information set forth herein has been obtained or derived from sources generally available to the

public and believed by the author to be reliable, but the author does not make any representation or

warranty, express or implied, as to its accuracy or completeness. The information is not intended to

be used as the basis of any investment decisions by any person or entity. This information does not

constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security.

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