WW - WW International: Encouraging Signs Remain Positive

2023-05-09 05:49:11 ET

Summary

• The first quarter earnings report demonstrated signs of stabilization in the core business, indicating management's view on a return to growth in the 2nd half is achievable.
• While the focus remains on integrating the Sequence acquisition, we view this as complementary to improved core member acquisition.
• While the first leg of WW's run higher is complete, we believe there will be multiple more legs to this run.

WW International (fka Weight Watchers Int'l) ( WW ; $8.50) reported earnings with results that demonstrate signs of stabilization in the core business and indicating management's view on a return to growth in the 2nd half is achievable. The new CEO, Sima Sistani, has been at the helm for one year now. In the first quarter of 2023, the Company's Customer Acquisition Cost ((CAC)) fell dramatically year over year as Sima's emphasis on increased marketing efficiency and new product features to enhance the member experience are starting to bear fruit. However, most questions during the quarterly conference call focused on integrating the Sequence acquisition. As alluded to in our earlier article , WW's Sequence acquisition removed a potential existential risk to the Company that investors fretted as pharmaceutical developments related to diet pills advanced at an increasing pace over the last few quarters. Despite the importance of this acquisition to WW's future strategy, we view this as complementary to improved core member acquisition. This latest quarterly report gives us increased confidence that the existing business has hit a nadir, positioning WW for a longer-term upward run. Coupled with an exciting new growth vehicle via acquisition, WW may finally be in a position for a longer-term upward trend. Given WW's existing market cap is still ~$700mm compared to $1,342mm in net debt (both pro-forma for the Sequence acquisition), any continued fundamental improvement or multiple re-rating would create an outsized move in WW equity to the upside just like it endured to the downside in the preceding few years. As such, while the first leg of WW's run higher is complete, we believe the stock will consolidate and hold its ground in the high single digits before its next leg higher.

Turnaround Gains Momentum

For the past several years, WW's weight loss and weight management program suffered from a lack of appeal as digital and DIY alternatives flooded the market. Under Sima's regime, the Company has shifted from relying on redundant, annual programs championed by select celebrities in late December to capture new subscribers to year-round, targeted, data-driven acquisition campaigns. The Company's current advertising focuses on member engagement and its sense of community -- the historical cornerstone of the WW program.

Sima's initial success is represented by the numbers. The CAC in the first quarter 2023 hit its best level in three years. WW gained 500k members in the quarter while spending $88.234mm in advertising, equating to a CAC of $176/member. This marks a substantial improvement from 2022 of $359/member and even 2021 of $195/member. The Company still has wood to chop to return to its 2020 level of $147/member but we are confident that WW will continue to increase its marketing efficiency as it refines its approach and introduces new product features to enhance the member experience. Interestingly, management guided to a loss of 400k members by year-end from the first quarter, or 10%. As depicted on slide 4 of the presentation below, this would mark the best retention by WW since 2019 and represent a return to membership growth in the fourth quarter of 2023.

Moreover, the Company's prior restructuring announcement to cease operations for certain non-strategic business lines and continue the rationalization of its real estate portfolio to align with its future needs will lead to higher operating margins as member growth resumes.

In short, management exuded confidence on the first quarter 2023 earnings call that the Company's performance trends will improve throughout 2023. They hit their previous guidance of 4.0mm members in the first quarter and we believe the year-end guide of 3.6mm members is achievable. The numbers are beginning to reflect management's optimism and the expected lower churn going forward bodes well as the Company ratchets up its cross-selling efforts with Sequence and resumes year over year membership growth at the end of 2023 and beyond.

Favorable Capital Structure

At the end of the first quarter, the Company held $945mm outstanding under its variable term loan due April 2028 (of which $500mm were fixed through interest rate swaps) and $500mm in 4.5% senior secured notes due April 2029. Management still estimates that at current rates, its capital stack will cost the Company $95mm in interest expense in 2023. WW also has a $175mm revolving credit facility but only ~$61mm is available under the current leverage ratio. Pro-forma for the acquisition, WW had $103mm in cash at quarter end. Importantly, the Company has adequate liquidity and no maturities for another five (5) years -- more than sufficient runway to execute on the desired turnaround.

The 4.5% senior secured notes currently trade at 64% on the dollar given the higher interest rate environment today than in 2021 when they were issued coupled with the Company's fundamental deterioration. As a reminder, on its third quarter 2022 conference call in November 2022, management indicated its willingness to repurchase the 4.5% senior secured notes at the prevailing discount. However, given the significant use of cash to consummate the Sequence acquisition, we doubt discounted bond repurchases will be high on the priority list given the existing cash on hand in addition to the future $32mm in payments for the acquisition on the first and second anniversaries of the transaction.

Risks

While bold, the Sequence acquisition does consume quite a bit of the Company's existing liquidity. Moreover, integration issues could inhibit the ability of the combined companies to effectively cross-sell products. Notwithstanding the acquisition, the existing WW platform has struggled to find its way and faces near-term free cash flow deficits. We believe Sima may have the right recipe to cure those ills, but it is certainly not a path without challenges.

Free Cash Flow and Valuation Lift

At $8.50 per share, WW stock is valued at 9.7x 2022 Adjusted EBITDA of $207.1mm -- a relatively full valuation given its recent history. However, the market is clearly pricing in substantial improvements in 2024 and beyond. It's a leap of faith but not as great a leap as merely three (3) months ago. We are believers in the Company's go-forward business model and foresee a multi-year growth spurt. For historical context, the Company generated $281.7mm in Adjusted EBITDA in 2021; $357.6mm in Adjusted EBITDA in 2020; $351.9mm in Adjusted EBITDA in 2019; and $450.8mm in Adjusted EBITDA in 2018. In 2023, we have lowered our estimates to $188mm in Adjusted EBITDA due to the headwinds of lower subscribers heading into the beginning of the year. Conversely, we are increasing our outlook on 2024 Adjusted EBITDA to $258mm (much higher than current analyst estimates) given the better-than-expected retention and forecasted year-ending subscriber count. Taking into account $95mm in cash interest expense, $30mm in cash taxes and $45mm in capex, we expect WW to generate ~$90mm in free cash flow ("FCF") in 2024. This should more than offset the free cash flow deficit expected in 2023.

Although the all-clear sign is not completely within sight, it is getting closer. As experienced investors know, the moment it is evident that the business model has been revived, the largest part of the rally would have already occurred. While WW has already hit our initial target range as part of its re-rating (although faster than expected), we believe the story is only starting to gain traction. Our next target range is $16-18 per share based on 8.5x Adjusted EBITDA of $300mm. While many will scoff at such a 2-year forecast, it is very conceivable given the operating leverage in the model once subscriber gains accelerate. The Company has done an excellent job controlling its costs on this multi-year downturn in the business, in a scenario of growing membership numbers, margins could easily surprise to the upside. We remain holders of the stock and have not sold a share. Going forward, volatility is likely to increase, and we plan to sell covered calls on out-of-the-money strikes to generate current income.

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