Nutrisystem Meets Nautilus

Note: To read our other blog on NutriSystem, please click here.

One useful way to understand and value a particular business is to find comparable companies in the same industry and see how the market values these similar enterprises.

In the case of NutriSystem (NTRI), despite the fact that most analysts tend to compare the company to WeightWatchers (WTW), we believe that a better comparison would be Nautilus (NLS), the direct marketer of fitness products, including the famed BoFlex, and StairMaster. In fact, we think that given the current sharp multiple disparity between NTRI and NLS, Nautilus may in fact offer an interesting acquisition opportunity for Nutrisystem, given their similar target markets and distribution strategies.

Why specifically is NutriSystem similar to Nautilus? Quite simply both companies utilize aggressive direct marketing via infomercials, regular commercials, online advertising etc., to persuade consumers into buying products that will supposedly help them lose weight and look better. Nutrisystem sells food, while Nautilus sells fitness machines. Different products, of course, but it's the same target customer, same intent, and same marketing strategy. While we are not familiar with Nautilus’s customer metrics, we suspect, based on anecdotal evidence and personal experience, that like NutriSystem, a large majority of NLS’s customers ultimately let the products they bought gather dust. In other words, both NutriSystem and Nautilus businesses are based on one-time purchases of products that are eventually discarded.

In the case of NutriSystem, as we have mentioned in the past, the situation is actually even worse, since we suspect, as the financials indicate, that the vast majority of the people who try the product, do not consider buying it again even if they lose weight initially, because it is highly implausible to expect most people to enjoy eating freeze-dried food for any meaningful amount of time. At least in the case, of NLS, we think that most people can in fact get continued enjoyment out of the product, and mostly likely stop using it out of sheer laziness, rather than because of any indignment of the product itself, as may be the case with NutriSystem.

Incidentally, if you don’t have experience with NutriSystem’s product, you should try it and/or  read up on the Freeze-Dried Food business, the key aspect of NutriSystems diet plan, by visiting the website of Nutrisystem’s main third-party supplier of freeze-dried food: Mountain House, a division of Oregon Freeze Dry, Their website is located at: http://www.mountainhouse.com/index.cfm. After that check out these three third-party online reviews on NutriSystem:
NutriSystem Vs. Jenny Craig, NutriSystem: A Complete Review,  , NutriSystem: Diet Review.

Getting back to the valuation comparison, Nautilus (NLS), with nearly $670 million in sales, currently trades at about 12X forward earnings and about 60% of estimated sales.  Of course, one could counter that the low multiple is a function of Nautilus’s slowing growth, but that is precisely what proves our point. Not too long ago, the company was trading at over three times the current valuation, because some investors were wrongly extrapolating past growth into the future, without considering the fact that the nature of NLS’s business is that rapid growth is simply not sustainable.  What’s equally shocking is how NLS investors fell for the multiple hype, considering the history of the CML Group, the company that first marketed the highly successful, and still quite popular, NordicTrack. After a brief surge in sales and the stock, CML drifted slowly into bankruptcy as the company tried in vain to find new avenues of growth, once NordicTrack sales peaked.

Amazingly investors are making the same mistake with NTRI as they did with NLS back in 2002, and CML prior to that. Ultimately, any company that sells a product that people do not use for more than two months, and that most people never use again, cannot for basic mathematical reasons have huge growth for any sustainable period of time. Eventually the market for the product becomes saturated and sales must slow dramatically or decline. It’s only a matter of time, since there are simply not enough people around who can become new customers to replace the rapid decline of existing customers. This is particularly true if many existing customers do not have a favorable experience with the product and your ability to reach every conceivable new customer is constrained by limited time, finances, and consumer preferences (i.e. even though there are in theory a huge amount of overweight people in the US, most will never take to a regimented diet of freeze-dried food).

We think it is clear from NLS, CML and many other unmentioned examples, that under the rare circumstances, where the stock market may have been temporarily fooled into paying high multiples for these types of one-time purchases businesses, investors have subsequently lost a ton of money as the wildly optimistic estimates generated by extrapolating unsustainable current growth into the future proved to be illusory. Therefore, it is unclear to us how anyone can justify a high multiple on NutriSystem’s earnings even if one thinks they will earn $4 per share in 2007. Because what happens in 2008? At some point, their supply of new customers will be far less than their already existing customer base.  At that time, revenues and earnings will plummet. If they earn $4 in 2007 and then $3 in 2008, where should the stock trade at today?

Our advice to NTRI management: Move quickly now to take advantage of the temporary high multiple on your stock to acquire more revenue streams in related business areas, because at some point the base food business will peak, and you will need a higher base of earnings to cushion the multiple compression in the stock.

Disclosure: We have no position in NutriSystem's stock.

Note: For our last Nutrisystem's report, please click here.