Weight Watchers And Outerwall: Value Stocks Or Traps?

Weight Watchers And Outerwall: Value Stocks Or Traps?

Weight Watchers And Outerwall: Value Stocks Or Traps? by Ben Strebel, Strubel Investment Management

Dear Investors,

We are currently looking at two companies to add to the portfolio: Weight Watchers International, Inc. (NYSE:WTW) and Outerwall Inc (NASDAQ:OUTR). Both of the companies bear similarities to two of our previous successful investments, H & R Block Inc (NYSE:HRB) and GameStop Corp. (NYSE:GME).

We are still in the midst of researching both of them, but we will summarize our analysis so far. If you have any opinions on the two companies we’d love to hear them.

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Outerwall Inc (OUTR)

Outerwall Inc (NASDAQ:OUTR) is the bizarrely named parent company of Coinstar and Redbox.

If you’ve read my earlier articles on GameStop Corp. (NYSE:GME), then you may remember my continuous rants about how, despite appearing similar, Blockbuster and GameStop had radically different business models. (Blockbuster had to turn over massive amounts of merchandise at cheap prices, while GameStop turned over less merchandise at much higher prices.) This time everyone is at least correct when they accuse Redbox of being the next Blockbuster. Both have the same business model. The difference between the two this time is cost.

For anyone who has never seen a Redbox DVD rental kiosk, a picture of one is on the left. To the right is a picture of an old Blockbuster store.

Outerwall And Weight Watchers Outerwall And Weight Watchers

I hope you can tell the difference. Redbox takes about 700 of the latest, most popular titles and stocks them in a vending machine device. Redbox kiosks cost about $15,000 to install and about $6,000 more, give or take, to fill with inventory.

Blockbuster took up almost 6,000 square feet (in 2002) per store and filled it with all kinds of stuff: new popular movies and video games that turned over quickly and older less popular titles that were rarely rented.

Blockbuster’s business has essentially been split between Redbox and Netflix, Inc. (NASDAQ:NFLX) (and Hulu, Amazon.com, Inc. (NASDAQ:AMZN) and other various streaming services). Redbox takes care of making new releases available for rent, and Netflix (and others) make the older back catalogue movies available for rental.

The rest of Outerwall’s business is made up of Coinstar, which are coin cashing machines, and its new ecoATM business, which are kiosks that allow you to recycle old electronic devices like phones, mp3 players, and so forth for cash.

The Big Question?

Outerwall Inc (NASDAQ:OUTR) is profitable, almost ridiculously so. Why is the stock so cheap? Well, the big question that needs answered is, how long will it be before renting DVDs at a kiosk becomes obsolete. I have my opinion based on some research which I may share in my next newsletter. For now I’m interested in what you think. What’s your opinion of Redbox?

Weight Watchers International, Inc. (WTW)

Just like Outerwall Inc (NASDAQ:OUTR), Weight Watchers International, Inc. (NYSE:WTW) is another company that is (maybe) under threat from the internet. (What company isn’t under threat from the internet these days?) Everyone has probably heard of Weight Watchers. It’s a company geared toward helping participants lose weight through a diet and exercise plan and via in-person or online meetings.

We like the company for two main reasons: It has tremendous brand recognition; and, for the most part, the science behind its approach is sound.

Weight Watchers International, Inc. (NYSE:WTW)’s approach, unlike many diets, actually stands a chance of helping people lose weight because the science behind it is sound. Weight Watchers focuses on two main things. First, to lose weight, you must consume fewer calories than you expend (i.e., have a caloric deficit). It doesn’t matter what type of food you eat. Every food item has a certain number of calories and your body either expends those calories as energy or stores them as fat. You can lose weight eating nothing but Snickers bars and drinking Coke, as long as you consume fewer calories than you expend. Of course, a caloric-deficit-Snickers-bar-and-Coke diet is likely to lead to other health issues related to lack of proper nutrients.

Second, certain types of food have different effects on the body. For instance, it would be difficult to consume a caloric surplus and get fat eating nothing but vegetables because they are not calorie dense and they promote a feeling of fullness. (Not to mention they often require more chewing per calorie than, say, ice cream.) On the other hand, foods high in salt and carbohydrates tend to stimulate the appetite and can easily induce someone to overeat.

(If you want to know more about fitness and how the human body works, I highly recommend Fit by Dr. Lon Kilgore. Unlike most health and fitness garbage out there, everything in Kilgore’s book is supported by rigorous scientific studies.)

For the most part, Weight Watchers International, Inc. (NYSE:WTW) follows actual science and assigns point values to foods based on calories. The company manipulates the point values to encourage participants to eat more of certain foods like fruit and vegetables (which are not calorie dense and lead to feeling full) rather than high-starch and high-salt foods. So, the Weight Watchers program has the potential to be successful for anyone.

The Big Question

Weight Watchers International, Inc. (NYSE:WTW) has a great brand name and a “product” that works, so what is the problem? Well, the fear is that they are losing members to free (or lower cost) online alternatives. There are a plethora of apps and online communities that can fulfill the same function as most of the Weight Watchers program with one exception (which we view as key). None of the apps and online options can replace a real-life meeting with other people. We view the accountability factor as huge.

In fact, one of the things that strengthened our thesis on Weight Watchers is a series of articles that John Hempton (portfolio manager for Bronte Capital) wrote on Herbalife Ltd. (NYSE:HLF) (of all companies). While we disagree with John on Herbalife (for the record we never had, do not have, and do not plan on having any position in Herbalife), the stories he wrote about his visits to Herbalife “nutrition” clubs reinforced to us the value of face-to-face meetings for weight loss. John found that many people signed up for Herbalife and ran nutrition clubs not to get rich or make it a career, but as a weight loss club. I highly recommend reading John’s articles.

We can be pretty sure that the Weight Watchers system is valid and that in-person meetings have a place. The support and accountability of fellow members offered in a face-to-face setting is a huge benefit to a certain (large) subset of people. Here is a long list of comments about Weight Watchers from an online forum. For people who liked the program and had success, you can see that the element of support from other members at the meetings was the biggest factor they cited in why they liked the program.

The problem with Weight Watchers International, Inc. (NYSE:WTW) is one of execution. The management of the company appears to be in disarray with ever-changing corporate objectives. Additionally, the most crucial employees in the business, the Meeting Team Leaders, are horribly compensated. Glassdoor reports they make an average of $27k (salary plus bonuses). Many of the reviews of the company report that the employees are passionate about the company and the goal of helping others live healthier lives but are frustrated by the low pay. More than any of the C-suite executives, the team leaders make or break the brand. The changing demands on them and their low levels of pay create an environment where good performance is difficult.

With a great brand and a great product, we will likely wait on the sideline until management either gets its act together or a new management team is brought in. Similar to our investment in H & R Block Inc (NYSE:HRB), there is nothing wrong with the product or the company; it’s the overpaid buffoons at the top that are responsible for the company’s poor results.

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