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SHORT OPPORTUNITY: WTW (NYSE)

WTW: REDUCED BANKRUPTCY RISK BUT TRADES 50% ABOVE FAIR VALUE


Disclaimer The opinions expressed in this presentation by Lateral Capital Management, Inc. (“LMCI�) are not an investment recommendation and are not meant to be relied upon in reaching an investment decision. LCMI and its employees, consultants and contractors are not acting in an investment, tax, legal or any other advisory capacity. The opinions expressed herein address a limited number of aspects regarding a potential investment in securities of the companies mentioned and are not a substitute for a comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations as to its accuracy. LCMI recommends that potential and existing investors conduct a thorough investment analysis of their own, including a detailed review of the companies' SEC filings, and consulting a qualified investment advisor. This material is based on information obtained from sources believed to be reliable, but the reliability of that source information. Any opinions or estimates constitute a best judgment as of the date of this presentation and are subject to change without notice. LCMI explicitly disclaims any liability that may arise from the use of this material. 1


Executive Summary 

Weight Watchers International Inc. (NYSE:WTW) used robust capital market conditions in 2013 to refinance its debt and delay major maturities to 2020 

This has significantly reduced the risk of default, even if revenues continue to decline

While WTW recently broke out of a long-term downtrend, and it trades at a discount to its comparable “weight loss” peers, its intrinsic value still appears to be at least 50% below current market prices

WTW management has set an explicit target of $2 billion in revenues by 2018 

This is equivalent to a compound 13% p.a. revenue growth rate from 2015

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Table of Contents 1. Credit Analysis 2. Multiples Valuation 3. Discounted Cash Flow Valuation


Section One

CREDIT ANALYSIS


WTW Weekly Closing Share Price Since 2011 WTW is a popular stock with value investors because of its relatively high operating margins combined with relatively low trading multiples. Its price downtrend appeared to be broken by mid-2014

Figure 1 Other positive developments included: • insider buying • interest rate hedging • no OBS debt • additional cash for debt service after dividend suspension • relatively high short interest • franchise value of the brand name

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The 2013 Refinancing Significantly Reduced Near-Term Bankruptcy Risks The revolver refinancing in 2018 and term loan bullet maturity in 2020 are now the major liquidity hurdles

Figure 2

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Projected Cash-on-hand & Liquidity Applying consensus research projections until 2015 and 2% revenue growth thereafter Figure 3

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WTW Net Debt / EBITDA: 2% revenue growth There appears to be sufficient debt capacity to refinance a projected 1.5x Net Debt / EBITDA in 2020. Management’s Net Debt target could be achieved by 2017

Figure 4 The horizontal line represents WTW management’s explicit net debt target of 3x EBITDA

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WTW Net Debt / EBITDA: -5% revenue growth Under a more pessimistic revenue decline scenario, WTWâ&#x20AC;&#x2122;s debt ratio would be < 3x by 2020. Depending on capital market conditions at the time, this should be refinance-able

Figure 5

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Projected Liquidity Appears to Support the 2020 Refinancing The existing loan covenants only permit a revolver drawdown of $20 million (compared to the $250 million limit)

Figure 6

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Section Two

MULTIPLES VALUATION


Comparable Companies Have Materially Outperformed (Relative to SPX) There are only a few publicly traded, pure-play weight management comparable companies for WTW. We include HLF but lower its weighting when examining comps

Figure 7

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Capital Structure & Operating Performance WTW is more effective at utilizing its existing capital base, however, it is more leveraged and has diminished growth prospects relative to its peers

Figure 8

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Trading Multiples Despite relatively high operating metrics, WTW trades at a significant discount to its peers. Partly this reflects current leverage, absence of a dividend payout and consensus growth / (decline) expectations

Figure 9

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Comparable Trading Multiples Applied to WTW As you would expect, if WTW traded closer to the multiple range of its peers, it would experience material stock price appreciation

Figure 10

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Applying Forward Looking Metrics Suggests WTW May Not Be Undervalued If consensus research estimates are correct, WTWâ&#x20AC;&#x2122;s current stock price has less upside potential Figure 11

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As Equity Markets Look Beyond 2014, WTW Could Face Renewed Pressure Indeed, 2015E multiples suggests WTW is currently overvalued Figure 12

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Section Three

DISCOUNTED CASH FLOW VALUATION


Re-Levered Equity Beta A target leverage ratio of 25% is closer to where lenders would feel comfortable extending credit to comparable companies

Figure 13

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WTWâ&#x20AC;&#x2122;s Re-Levered WACC is Around 12% (post-tax, nominal) The re-levered equity beta is based on comparable companies Figure 14

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Our DCF Valuation Applies Very Conservative Adjustments to Historical Data We give WTW all the revenue benefits associated with prior G&A spend but with a lower projected G&A level (12% of revenues). Despite noticeable G&A increases in recent years

Figure 15

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Similarly, We Assume Capex Can Be Cut With No Impact On Revenues Our 2% p.a. revenue growth projection is overly generous given our assumption of capex & acquisitions being slashed from 4% of revenues (excluding acquisitions) to 2% of revenues

Figure 16

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Projected Free Cash Flow In all material respects, our FCF projections are generous to WTW, especially given the revenue projection assumptions

Figure 17

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Regardless of Terminal Value Approach, WTW Appears Intrinsically Overvalued Despite our generous cost and capex assumptions, WTWâ&#x20AC;&#x2122;s intrinsic value under both an EBITDA multiple and a perpetual growth terminal value approach is around 50% below the current stock price

Figure 18

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The Intrinsic Value Downside Persists Over a Wide Range of Assumptions The base case valuation of a 12% WACC and 2% post-2015 revenue growth rate, is highlighted with blue shading. Given our generous opex and capex assumptions (not to mention the perpetual revenue growth assumption), the â&#x20AC;&#x153;realisticâ&#x20AC;? valuation downside may be in the upper right quadrant

Figure 19

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In Fact, Revenue Growth Is The Key Value Driver After Terminal Value Even with 4% p.a. revenue growth, the current WTW stock price is still 35+% overvalued. Figure 20

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Recap 

Even when applying arguably over-generous opex and capex assumptions, WTW currently appears over-valued by 50% on a DCF basis 

A more realistic set up DCF assumptions would imply ~ 70% stock price downside from current levels

Management’s current revenue target for 2018 implies a 12+% CAGR 

Using our opex and capex base case assumptions, the WTW current stock price implies 7.5% CAGR revenue growth after 2015

The market is clearly discounting management’s revenue aspirations (by ~ 40%)

WTW was prudent to take advantage of capital market conditions to reduce its bankruptcy risk and enhance its liquidity. However, it will need to deliver remarkable revenue growth to avoid a stock price collapse

Some former clients may return to WTW products after they experiment with free weight loss apps (and/or alternative weight loss strategies), however, even if WTW stems the recent revenue declines and manages to grow revenues at around the real GDP growth rate, it is still significant over-valued 

Disruptive technology has and will permanently reduce the franchise value of previously marquee names, including WeightWatchers 23


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