Weight Watchers: A Little Debt-Heavy?

Weight Watchers International (WTW) went public just as the nation started its pig-out season. Stroke of genius or mere coincidence? I don't know, but investors are gobbling up the stock. From a Nov. 14 initial public offering at $24 a share, Weight Watchers added 23% its first trading day and kept gaining. The stock recently traded above $32 (chart).

In this post-Net Mania era, Weight Watchers' allure doesn't stop at the instant comprehensibility of its business plan (more fat people means more profit). Brightened by spokeswoman Sarah Ferguson, Duchess of York, the Weight Watchers brand attracts more than $1.5 billion in global sales. Unlike so many Net-era IPOs, Weight Watchers has let public investors in on an indisputably thriving business, with a long record of profits. After inspecting its financials, though, you may think twice before betting its stock will fatten your portfolio.

Founded in 1961 by a trio of New York City dieters, Weight Watchers was bought in 1978 by H.J. Heinz (HNZ). The food giant eventually tainted the franchise by peddling prepackaged meals to dues-paying members at the company's signature weight-loss classes. In September, 1999, Heinz sold control to a private Luxembourg firm, Artal Group, which did a 1980s-style leveraged buyout: Artal bought from Heinz 94% of Weight Watchers' equity. In return, Heinz got preferred stock and cash, most of it borrowed by Weight Watchers itself. New managers put up $4 million to close a deal valuing Weight Watchers at $735 million. Two years later, the stock market values the company at $3.4 billion.

EASY MONEY. One reason may be that investors are focusing on the $1.5 billion in retail sales brought in by the Weight Watchers brand. Yet most of that goes to franchisees and licensees, such as Heinz, which kept a perpetual, royalty-free right to use the brand for products from frozen breakfasts to pizza. Through September this year, Weight Watchers posted revenue of $478 million and is set to collect perhaps $600 million for the full year. That's 40% or so of what the brand generates overall.

What the market seems to be missing entirely is the company's weak capital structure. Liabilities, including $481 million in long-term debt left from the buyout of Heinz, outstrip assets. That leaves Weight Watchers with a net worth of negative $194 million, plus a hefty financing tab at rates of up to 13%. Interest costs and preferred-stock dividends this year are on track to near $60 million, or 10% of revenue.

The IPO did nothing to help lower those costs: Instead of paying off some of the debt, Artal and a few minority partners are taking all of the deal's $455 million in estimated proceeds. This means that Artal, which will continue to hold more than 76% of Weight Watchers' equity, has gotten its original investment back several times over. In other words, it's now playing with money put up by public investors in the IPO. Will that necessarily stop Weight Watchers from continuing to thrive? No, but to me it suggests that the easy money has already been made.

Public companies to compare Weight Watchers with are scarce, but you can get a rough indication of values by looking at what Weight Watchers paid for a major U.S. franchisee last January: $83.3 million, or 1.4 times revenue and 6.8 times cash flow. At $32 a share, Weight Watchers trades at 5.6 times my estimate of this year's revenue and 40 times the $80 million to $85 million in net earnings it may post.

Cash flow? Through September of this year, Weight Watchers reported $120 million in cash from operations, a huge leap over the $50 million reported a year earlier. Weight Watchers' prospectus doesn't offer the details you need to understand how that happened. Nor did Thomas Kiritsis, its chief financial officer, answer my inquiries. But guessing--generously--that operations will provide $160 million in cash this year, the stock would be trading at 21 times cash flow. At that, chances are it is the sellers who will be pigging out this holiday season. By Robert Barker

The Good Business Issue
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