Everybody knows that obesity is a huge problem in America, but it's devilishly hard to make money here on a sustained basis. The sales of various diet drugs and devices have largely disappointed their developers, and even those companies that have steered clear of the FDA process (supplements and "nutritional products") have struggled to make the money that investors expected. That puts Weight Watchers (NYSE:WTW) in a curious place - although Wall Street has gotten a lot more rational about this name (and the stock has badly underperformed this year as a result), it's still not necessarily a compelling stock today, even though it may be the best-positioned company in the market.

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Less Bad Is Good Enough for the Third Quarter
Weight Watchers didn't have a great third quarter by objective measures, but the company did perform better than expected and Wall Street is first and foremost a relative expectations machine. Revenue was up less than 1% as reported, but up nearly 3% in constant currency terms. Revenue from meeting fees declined almost 3% on an almost almost 4% drop in meeting paid weeks, while in-meeting product revenues declined 11%. Online remains a strong source of growth, however, as revenue jumped 22% this quarter. Due in part to the strong online revenue growth, Weight Watcher's revenue mix shifted in a more positive direction, and the company's gross margin saw an improvement of nearly 150 basis points (BPs). Operating income was down 5%, however, in part on higher marketing expenditures.

Cycles Produce Hope and Uncertainty
Weight Watchers certainly didn't report great attendance numbers this quarter. North American attendance fell more than 9%, while attendance in the United Kingdom fell almost 18%. Continental Europe was a bright spot, with nearly 5% attendance growth, but it's a smaller part of the overall operation. At least insofar as North American attendance is concerned, the declines seem at least partly attributable to the company going through the tail end of a program cycle. The company has talked about a "major program innovation" coming soon, but details are scarce at this point - likely because rivals like Nutrisystem (Nasdaq:NTRI) and Nestle (OTC:NSRGY) would certainly love to know what's coming.

Unfortunately, this is just how it is with Weight Watchers - its attendance revenue is cyclical and the company has to keep up its marketing efforts and identify new spokespersons to carry the brand forward. On a better note, online continues to grow and holds the hope of being more stable/sustainable. Likewise, the company's increasing focus on business-to-business (B2B) opportunities could offer more sustainable growth in the future as businesses look to cut employee health costs.

Drugs Likely Won't Change Much
Although there has been ample hype for the new weight loss drugs from Vivus (Nasdaq:VVUS) and Arena (Nasdaq:ARNA), I am increasingly skeptical that they are going to change much of anything in the weight loss market. Although Vivus's Qsymia is effective, the side effects are not trivial and the early prescription data hasn't really provided upside surprises. When Arena's Lorqess launches (likely in early 2013), I expect it will likewise disappoint the bulls.

This is hardly a new trend in the obesity market. There's a good reason that there aren't any blockbuster obesity drugs on the market today and why most Big Pharma players have largely quit trying. Moreover, Allergan (NYSE:AGN) recently announced that it would likely divest its Lap-Band business. Even though Allergan has supported this product with strong marketing (and Allergan is pretty good at marketing) and the device produces solid placebo-adjusted weight loss, it just isn't selling as well as Allergan hoped. Now it's not as though Weight Watchers is immune to this; plenty of people join Weight Watchers and quit relatively quickly once they realize it's not a cheap quick-fix to lose weight. Rather, I simply think that these alternative approaches aren't really a substantial threat to Weight Watchers anymore at this point.

The Bottom Line
It's very challenging to model the weight loss industry, but I've tried and I believe Weight Watchers might have about 5% share. While that certainly sounds like a lot of untapped potential for the company, I would caution investors about getting too optimistic that Weight Watchers will capture that quickly or easily. There are a lot of things about Weight Watchers' financials that give me pause, including the company's large debt load and negative net worth. Curiously, however, sell-side analysts have become significantly less aggressive with their growth assumptions, and expectations may at last be pretty rational here. Nevertheless, the company's large debt load wipes away a lot of the cash flow-based fair value for the stock, and I still do not believe Weight Watchers is a compellingly cheap stock today.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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