What Led to the Weight Watchers (WTW) Purchase?

by Geoff Gannon


Someone sent me an email asking:

What led to the Weight Watchers purchase?

Obviously, the 20% price drop is what directly lead to the Weight Watchers purchase. The real question  is: Why had I already researched the stock and decided to buy the moment I saw the price drop?

Quan - who writes the blog with me, and who I always talk ideas with - already owns WTW. It’s his favorite stock.

What got me thinking about WTW originally was the history of share buybacks. You’ve probably heard Mohnish Pabrai say that Charlie Munger told him about “cannibals” – companies that eat their own share count. I screen for them.

From there, my thinking was:

  • Weight Watchers is the most psychologically powerful general weight loss program I know of
  • WTW is basically a publicly traded LBO
  • The stock is much more volatile than the business
  • Investors treat marketing misses the way they treat fashion misses in apparel retail - so you should buy the stock when they mess up marketing
  • WTW has a high free cash flow yield (low price to 10-year average earnings, etc.)
  • Doesn't require net tangible assets to run the business - can pay out 100% of reported earnings (and then some)
  • Stock dropped 20% right before I bought
  • High short interest relative to float  (most trading is short-term and institutional)
  • Stock price is the same it was 10 years ago. Company has doubled in size. Each share has doubled in percentage of ownership. There are now 4 times more sales per share than 10 years ago - but the price is the same. Most stock are more expensive than they were 10 years ago. This one is 75% cheaper.

Against this:

  • They have a lot of debt.
  • Business performance next year will definitely suck. It may suck for the next few years.

How I framed it:

  • Write-off the next 3+ years
  • Imagine what the stock should trade for in a "normal" January 2017.

Under normal circumstances, I saw no justification for a price below $52 a share. This is 15 times what I expect reported earnings would be in 2017 ($3.50 a share ). Free cash flow would be higher than EPS. That's a 10% return over 3 years. I could live with that.

Do I think they will produce zero free cash flow for 3 years?

No.

Do I think they will buy back zero shares for 3 years?

No.

Do I think it will take a full 3 years for sentiment to turn?

No.

Therefore, I felt the upside was somewhere between 10% a year and a lot. The cost of getting a chance at the “a lot” is 3 years of volatile discomfort.

In my experience, it rarely takes 3 years. But I always tell myself it will.

What could derail this?

The debt:

  • If WTW issues shares, I will lose money. 
  • If WTW uses all free cash flow to pay down debt, I won't beat the market. 

Both are possible when you owe more than 4 years of EBITDA – and you expect EBITDA to decline – as WTW does.

The debt is a big risk. If the market cap was the same and there was no debt, I would have bought this stock a long time ago.

We are not talking about a low EV/EBITDA stock here. WTW is not a value stock. 

Talk to Geoff about What Led to the Weight Watchers Purchase