December 28th, 2012 Geoffrey Horton

Weight Watchers International

Ticker: WTW | Price: $50.92 Recommendation : Buy Price Target (2013): $75.00
Initiating Coverage
Revenue Net Income EBITDA EPS EV/EBITDA P/E Net Debt $ $ $ $ 2010A 1,452 195 424 2.57 9.6x 14.8x 1,365 $ $ $ $ 2011A 1,819 305 582 4.11 8.7x 13.4x 1,052 $ $ $ $ 2012E 1,851 246 528 4.12 9.5x 12.4x 2,300 $ $ $ $ 2013E 1,926 274 557 4.90 9.0x 10.4x 2,100 $ $ $ $ 2014E 1,997 304 594 5.42 8.4x 9.4x 1,900
Market Profile 52-Week High 52-Week Low Avg. Daily Vol. Beta Dividend Yield Shares Outstanding Market Cap FINI Holdings P/E
Performance 1 Month 6 Month 1 Year 3 Year 5 Year WTW -5.42% 1.01% -12.15% 79.93% 12.46% S&P 500 -0.53% 5.52% 10.84% 27.21% -5.14%

$ 82.91 $ 40.60 579,000 1.42 1.37% 55.65 mn 2.83 bn 81% 12.3x

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.

Specialized Consumer Services

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 managements 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.

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

December 28th, 2012

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 mens 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.
Exhibit 1 Obesity rates by gender and age 20 and under 20-39 50% 40-59 60 and over 40% 30% 20% 10% 0% Men
Source: CDC/NCHS

Exhibit 2 Trends in obesity by gender, 2000-2010

40% 30% 20%

Men Women

10% 0%
Women All

2000 2002 2004 2006 2008 2010

Source: CDC/NCHS

A Fit For Everyones Needs

Specialized Consumer Services

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.
Exhibit 3 Revenue breakdown for 2011 Meeting Fees Internet Exhibit 4 Estimated revenue breakdown for 2018

24% 22% 54%

15% 46%

Meeting Fees Internet Product Sales & Other

39%
Product Sales & Other

Source: Company Reports

Source: My Estimates

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

December 28th, 2012

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 Applebees 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.
Exhibit 5 Actual & estimated revenue trends , 2005-2018 $2,500 $2,000 $1,500 $1,000 $500 $0
2005A 2006A 2007A 2008A 2009A 2010A 2011A 2012E 2013E 2014E 2015E 2016E 2017E 2018E Meeting Fees Product Sales & Other Internet Total

Exhibit 6 Global meeting attendance in millions, 2007-2014 70 60 Other International 50 40 Continental 30 Europe 20 United 10 Kingdom 0
2007A 2008A 2009A 2010A 2011A 2012E 2013E 2014E

North America

Specialized Consumer Services

Source: Company Reports and My Estimates

Source: Company Reports and My Estimates

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 WWIs 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.
2Pew

Internet mobile usage research, 2012.

December 28th, 2012

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.
Exhibit 7 Competitive weight loss services, products, and drugs

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

Specialized Consumer Services

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 models pregnancy, Jessica Simpsons 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 Barkleys weight loss success.
Exhibit 8 WWI expects obesity trend for men to continue Exhibit 9 Weight Watchers 3600 mobile app

Source: Weightwatchers.com

Source: Weightwatchers.com

December 28th, 2012

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.
Exhibit 10 Obesity statistics by state

Specialized Consumer Services

Source: CDC

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 aboveconcensus 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.

December 28th, 2012

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.
Exhibit 11 Paid weeks in company operations, 2007-2014 $250 $200 $150 $100 $50 $0
Online Other International Continental Europe United Kingdom

Exhibit 12 Actual & estimated net debt, 2008-2016 $2,500 $2,000 $1,500 $1,000

$500
$0 2008A 2009A 2010A 2011A 2012E 2013E 2014E 2015E 2016E
Source: Company Reports and My Estimates

2009A

2007A

2008A

2010A

2011A

2012E

2013E

Source: Company Reports and My Estimates

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 managements 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.

Specialized Consumer Services

Exhibit 13 Actual, projected, and consensus estimates for net income, 2007-2014 $315 $295 $275 $255 $235 $215 $195 $175 2007A
Estimate Actual/Projected

2014E

North America

Exhibit 14 Actual, projected, company guidance, and consensus estimates for EPS, 2007-2014 $6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $Guidance Estimate Actual/Projected

2012E

2013E

2007A

2008A

2009A

2010A

2008A

2009A

2010A

2011A

2012E

2013E

Source: Company Reports , Bloomberg, My Estimates

2014E

Source: Company Reports , Bloomberg, My Estimates

2011A

2014E

December 28th, 2012

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-pershare 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 WWIs 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.

Specialized Consumer Services

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.