Upload
chase-lindsey
View
302
Download
0
Embed Size (px)
Citation preview
Important disclosures appear at the back of this report
Team 1
Initiation of Coverage This report is published for educational purposes
only by students competing in the
CFA Society of Salt Lake Investment Research
Challenge
Ticker: NUS (NYSE) Recommendation: HOLD
Price: $31.90 Price Target: $34.04 (6.7% Upside)
Diluted Earnings/Share
Mar. Jun. Sept. Dec. Year P/E Ratio
2013A $0.90 $1.22 $1.80 $2.03 $5.95 19.49x
2014A 0.90 0.32 1.12 0.77 3.11 12.48x
2015A/E* 0.60 0.75 0.28 0.71* 2.34 13.95x
Highlights
We initiate coverage on Nu Skin Enterprises, Inc. (NUS) with a HOLD
recommendation based on a one-year price target of $34.04, representing a
6.7% upside from its February 3, 2016 closing price of $31.90. We base our
recommendation primarily on the following:
Chinese Market Offers Great Promise, but Potential Peril: As a large
market with an emerging middle class, China is fertile ground for selling
personal care products. Nu Skin, with its direct selling model that is able
to capitalize on the country’s large population and premium personal care
offerings, appears like a perfect fit for the market, but problems exist.
Direct selling practices have been under fire by Chinese regulators and
state media in recent years, making it difficult for the Company to build
and maintain a sales force.
Effective Business Model, but Questions Remain: Nu Skin’s direct
selling model is certainly effective, allowing the Company to easily move
product downline to Sales Leaders and generate revenue. The model does,
however, have drawbacks. The Company’s high attrition rates among
Sales Leaders and the model’s similarity to a pyramid scheme—at least at
first blush—raise questions about the long-term viability of the model.
Efficient Salesforce Brings Sustainable
Competitive Advantage: When measured against
peers in the direct selling industry, Nu Skin has a
highly efficient sales force, with its Sales Leaders
generating twice as much revenue, on average, each
month compared to their counterparts in competitors’
salesforces. Under the VRIO framework, this should
give Nu Skin a sustainable competitive advantage as
the salesforce is valuable, rare, imperfectly imitable,
and the Company is organizationally positioned to
capitalize upon it. If Nu Skin is able to maintain this
efficiency while also expanding its salesforce, the Company could realize
significant advantages over its competitors in the long-term.
February 3, 2016
Sector: Consumer Staples
Industry: Household
Products
Figure 1:
NUS Stock Performance,
January 2015 – January 2016
Source: Capital IQ
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 4, 2016
3
Figure I: Nu Skin Operating
Revenue by Region (2014)
Source: Bloomberg
Business Description
Nu Skin Enterprises, Inc. (“the Company”) develops and sells personal care cosmetics and
nutritional supplements through a person-to-person direct selling model. The Company was founded
in Provo, Utah in 1984 and has since expanded operations to 54 countries.
Nu Skin went public in 1996, trading under the ticker NUS on the New York Stock Exchange.
During 1998, the Company acquired Pharmanex, a firm specializing in nutritional supplements. This
acquisition diversified the Company’s product offerings and added several patents it would later use
to develop new products.
Nu Skin strives to innovate continuously within its competitive space and remain a leader in terms
of the science behind its products. It supports these efforts through in-house research and
development, collaborative research agreements, licensing, and acquisitions.
Direct Selling Business Model Nu Skin sells products in two main ways, direct-to-customer and direct selling. In direct-to-customer
sales, the product is sold straight to a consumer, often through the Company’s website. These
consumers are called Actives. In direct selling, Sales Leaders purchase product from Nu Skin and
act as a salesforce to re-sell the product. The Company believes that Actives primarily buy for
personal use and do not pursue direct selling opportunities. It claims that “substantially all” of its
revenues come from Sales Leaders and their associated networks, so the business model analysis
focuses primarily on this type of sales.
The Company recruits Sales Leaders with the promise of a “business opportunity” in which the Sales
Leader is an entrepreneur who independently operates his or her own business selling Nu Skin
products. New Sales Leaders purchase a starter kit to get their businesses started and are encouraged
to enroll in automatic product shipments to keep product in stock for sale. This assists the Company
because it ensures that inventory will move and provide revenue on a regular basis.
Sales Leaders are encouraged to build a network of other Sales Leaders who will work beneath them,
creating a team. Sales Leaders who are successful at creating this network may qualify for
commission pay on top of the retail mark-up they are entitled to keep. Sales under a Sales Leader
are included in the Sales Leader’s personal group sales volume (PGSV), which ties to their
compensation plan, as shown below.
The business model differs in Mainland China. Chinese regulations require that most sales occur in
a retail store, preferably owned by the company. These Sales Leaders are considered employees of
the company, rather than independent contractors. After establishing a retail store, some members
of the sales force can apply for special licenses that allow selling away from the retail store, as long
as the sales occur within the same province in which the retail store is located. The amount of
licenses is determined by government regulatory agencies tasked with regulating fair business
practices.
Source: Nu Skin Sales Compensation Plan Nov. 2015
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 3, 2016
4
Sales Leader Compensation Model
Nu Skin distributors earn money in two ways:
1) Retail markups on product sales
2) Commissions from product sales, both personal and from distributors in downstream network
The vast majority of Nu Skin distributors—approximately 94% in the United States—earn only
retail markups. Each individual distributor is allowed to set his or her own prices, but the Company
gives a suggested price for each individual product, usually providing a 25% markup over wholesale.
Since Nu Skin does not set pricing beyond the wholesale level, the Company does not provide
estimates for the average retail markup.
The Company’s commission structure is based on the sales of a distributor and his or her downstream
network of distributors. In all markets except Mainland China, commissions are paid based on the
Company’s global sales compensation plan. Under this plan, the distributor earns points based on
each personal sale and the sales of all downstream distributors and commission percentages are
based on the number of points earned in a sales period. In Mainland China, commissions are earned
at pre-established rates with no regard to sales volume or downstream sales as there are no sales
networks. Additionally, some Sales Leaders who work at Nu Skin retail locations in China draw a
salary and service fees. These payments are reevaluated and set on a quarterly basis. An example of
compensation structure is provided below. Compensation is also distributed by distributor type,
shown to the right.
In 2014, Nu Skin paid out commission payments of just over $128 million in the United States and
totaling about $1 billion worldwide. Of this, the vast majority went to what the Company terms as
Active Distributors. Active Distributors make up 38.25% of total distributors, of which 15.57%
received a monthly commission on average. This means that only approximately 5.95% of all
distributors earned commissions in 2014. This reflects how difficult it is for a new distributor to
work toward a commission as a very large network is required to accumulate enough points to
qualify. This makes Nu Skin a less appealing option for those interested in direct marketing as most
of the pay is concentrated at levels that new recruits are unlikely to reach. It also contributes to high
attrition rates: over 50% of new recruits leave within one year and 99.4% leave within five years.
Products Nu Skin manufacturers and distributes anti-aging personal care products under two primary product
brands: Nu Skin and Pharmanex. Both brands have recently sold products under the ageLOC anti-
aging brand. The Nu Skin brand represents 60.8% of revenues, Pharmanex represents 38.9%, and
other revenue accounts for the remaining 0.3% as shown in Figure II.
Nu Skin
The Nu Skin brand consists of premium-quality anti-aging and supplemental personal care products.
The primary categories within this product line are skin-care systems and targeted treatment
products. These products include the ageLOC Galvanic Spa, a machine that sends weak electric
pulses into the face to condition the skin, and the Tru Face line, consisting of facial creams designed
to reduce visible lines and wrinkles. ageLOC products accounted for 28% of total revenues and
46% of Nu Skin product category sales in 2014. The division also sells a line of therapeutic essential
oils under the Epoch brand as well as other cosmetic, personal care, and hair care products.
Figure II: Nu Skin
Operating Revenue by
Segment (2014)
Source: Bloomberg
Source: Nu Skin Sales Compensation Plan
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 3, 2016
5
Research and
Development Expense as
Percentage of Revenue
(2014)
NUS 0.74%
EL 1.65%
AVP 0.71%
USNA 0.59%
Pharmanex
The Pharmanex portfolio consists of nutrition and weight management products. This includes
LifePak and ageLOC R2 nutritional supplements and the ageLOC TR90 weight management
supplement. The LifePak line consists of a variety of health-promoting vitamins in small packages
intended for daily use. ageLOC R2 is similar in concept, but it is meant to prevent aging. LifePak
and ageLOC R2 accounted for 22% and 23%, respectively, of Pharmanex revenue in 2014 and a
combined 9% of total company revenue.
Product Cycle
The Company releases products on an annual basis, using a two-year process to introduce the
products worldwide. New products are released in certain geographic regions in the first year, then
introduced in the remaining regions the following year. This process is shown in Appendix 7.
The product launch process begins with a product preview that displays product to Sales Leaders to
build interest. Next, the Company rolls out a limited-time offer, during which qualifying Sales
Leaders in the launch region can purchase the product first. Finally, the product is launched, making
it available to all Sales Leaders and Actives in the region.
Product Development
The Company develops products through internal R&D and joint research projects. The Company
maintains facilities in the United States and China and collaborates with researchers in the United
States and in Asia. Expenses for research and development in 2014 totaled $18.9 million. The
Company also occasionally enters licensing or supply arrangements in exchange for royalty
payments on product sales. The Company may also invest in acquisitions to acquire technologies,
including Pharmanex in 1998, LifeGen Technologies, LLC in 2011, and Nox Technologies, Inc. in
2012. Expenses for royalties and amortization for technology-related acquisitions were
approximately $10.4 million in 2014.
Future Products
Throughout 2016 and 2017, the Company will introduce two new products, ageLOC Me and
ageLOC Youth. This rollout will follow the previously outlined product cycle depicted in Appendix
7. ageLOC Me is a lotion dispenser with which consumers can formulate lotions specifically for
their skin type. Consumers load pods containing different serums and moisturizers based on their
needs and the product dispenses them in the proper proportion. ageLOC Youth is a supplement
capsule designed to target signs of aging based on gene expression.
Beyond these two products, the Company is developing two new products called Epsilon and
ageLOC Kappa. Details are scarce, but Epsilon is said pair with the ageLOC Galvanic Spa and
Kappa relates to ageLOC Youth. Epsilon will arrive in 2017 while Kappa is forecasted for 2018 or
2019.
Sourcing
For markets other than Mainland China, nearly all Nu Skin personal care products and Pharmanex
nutritional supplements are sourced from third-party suppliers and manufacturers. In Mainland
China, the Company operates manufacturing facilities that produce a majority of personal care
products and nutritional supplements sold in Mainland China.
The Company sources its ageLOC Galvanic Spa systems from single vendors who own or control
the product formulations, ingredients, or other intellectual property rights associated with those
products. In 2014, one supplier manufactured more than 10% of Nu Skin personal care products.
Customers Nu Skin’s primary customers are its Sales Leaders. This is beneficial for the Company in a number
of ways. First, it provides the firm with more predictability over revenues and necessary inventory
since many Sales Leaders enroll in consistent automatic ordering plans to ensure they meet the
Company’s $2,000 monthly purchasing requirement. Second, it allows Nu Skin to focus its efforts
on growing and retaining its sales force, the most important factor in its business model.
In some respects, since Sales Leaders are the key customer for Nu Skin, the Company’s various
products are secondary to the experience sold to new recruits to persuade them to join the sales force.
The Company works hard on this “product,” vowing to offer the most competitive commission
structure in the direct sales industry. To this end, the Company incentivizes Sales Leaders with
international conferences and vacations to celebrate sales milestones and continuously introduces
new products to generate enthusiasm and stimulate new sales.
Figure III:
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 3, 2016
6
Industry Overview and Competitive Positioning Nu Skin competes in the direct selling industry, which is made up of companies which actively
recruit independent sellers to market their products. This can include door-to-door sales, party
hosting, product demonstrations, and other forms of sales outside of a conventional retail location.
The Company also competes in the personal care industry. Companies in this space produce hair
care, skin care, cosmetics, and fragrances, among other products.
Size and Growth
The direct selling industry accounted for revenues of about $40 billion in the U.S. in 2014, according
to IBISWorld. The industry is expected to grow at a slow 0.2% rate annually through 2020. The
majority of companies within this industry operate in international markets, with some generating
large amounts of their income outside of the United States. According to IBISWorld, 37.4% of direct
selling companies in the United States distribute wellness and personal care products.
The personal care industry is large, with revenues of $264 billion globally in 2014. The industry is
mature, with an expected growth rate of 4.5% through the end of the decade. It is global in scope,
with the industry’s largest players competing in all major developed markets and increasingly
moving into developing markets.
Industry Structure
The direct selling industry is highly fragmented. The industry has a C4 of 35.0% and a Herfindahl-
Hirschman Index (HHI) of 425.9. The personal care industry is similarly constituted. The industry
C4 is 33.5% with an HHI of 340.2. The recent trend toward highly specialized and high-end products
has contributed to this fragmentation as numerous firms enter the market to meet this demand which
legacy personal care companies did not.
Industry Demand Drivers Per Capita Disposable Income
When individuals have greater discretionary income, revenues of direct selling companies tend to
increase, while decreases in income have the opposite effect. This is a result of the non-essential
goods that dominate the industry.
Economic Recession
When unemployment rises, many individuals enter the direct selling industry due to low startup
costs and the opportunity to make money while setting their own schedules. Despite the increase in
distributors, stagnant or negative employment growth can harm revenues, as shown to the left. This
is due to product purchases and per capita disposable income. As shown to the left, unemployment
has decreased in all key markets for direct sellers outside of China. This trend may steer potential
direct sellers away from the industry toward more gainful employment.
Premium Products in Emerging Markets
As middle classes have formed in emerging markets, demand for premium products has increased
dramatically. No longer content with basic personal care and cosmetic items, consumers in these
markets are now looking for more specialized products, such as anti-aging creams, supplements,
and high-end makeups. These trends have been of particular importance in the BRIC nations. Nu
Skin has a presence in these nations and may be able to capitalize if it can attract Sales Leaders.
New Product Innovation
Personal care products and cosmetics are typically purchased on a fairly constant basis. With no
increase in utility for increased purchasing, consumers are content to buy at more or less the same
volume at all times. Products with higher quality, better results, or catering to a new need are vital
to driving demand, causing consumers to spend more through higher-priced upsells or adding new
products to their existing regimens. The Company adapted to this trend well, introducing LifePak
as a continuous consumption product.
Increased Health Consciousness In the face of increased scrutiny of ingredients in personal care and cosmetics products and
heightened awareness of potential side effects, demand has shifted away from traditional products
toward “healthier” options. Products claiming to be all-natural or organic have benefitted from this
shift, with natural product revenues growing at over three times the rate of traditional products—
30% compared to 8%—in recent years, according to IBISWorld. None of Nu Skin’s current product
lines explicitly target the organic product segment, so it may miss out on an opportunity for growth.
Source: IBISWorld
Source: World Bank
Figure IV: Direct Seller
Revenue vs. Employment
Growth
Figure IV: Unemployment Data
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 3, 2016
7
Regulation and Scrutiny of Direct Selling Industry Direct selling is subject to high regulation levels that have changed over the last ten years to prevent
the practice of fraudulent or deceptive business practices, including “pyramid schemes” which
follow a similar business model to direct selling companies.
Within the United States, the Federal Trade Commission (FTC) polices unfair trade practices, but
has no bright-line test for identifying a pyramid scheme, causing ambiguity over anti-pyramid
scheme laws. The FTC has historically differentiated direct selling companies from pyramid
schemes by determining whether the main focus of the organization is the sale of a product or simply
an investment opportunity. If a product is central, the business is considered direct selling and legally
permitted. If not, the business can be deemed a pyramid scheme and shut down.
Direct selling and anti-pyramid regulations in China prohibit the payment of multi-level
compensation. A company seeking to sell directly to customers must obtain a series of approvals
from various provincial and national regulatory authorities such as the State Ministry of Commerce
(MOFCOM), the national governmental authority overseeing direct selling.
In January 2014, the Chinese government announced it would investigate the business practices,
products, and business model of Nu Skin. The investigation was initiated after various media and
research outlets, specifically Citron Research, reported the company was practicing a multi-level
marketing business in the country despite regulations banning MLM sales. As a result of these
actions and adverse publicity, the Company experienced a 60% decline in Sales Leaders and Actives
in the Mainland China region between 2013 and 2014 due to a voluntary suspension of business
meetings and new Sales Leader applications. In May 2014, the Company resumed business meetings
and application acceptances.
Government regulation also targets the products sold by the direct selling industry. Many issues
have stemmed from the mislabeling of products or claims that have not been scientifically
substantiated. The Food and Drug Administration (FDA) issued warning letters to a variety of
different companies alleging noncompliance of their products. In the past, dietary supplements were
not regulated by the FDA, but the agency proposed increased regulations regarding dietary
supplements in 2011.
Major Competitors Avon Products (NYSE:AVP)
Avon Products is a manufacturer and marketer of beauty, personal care, and home products. Similar
to Nu Skin, the firm uses a direct selling model for its products. In recent years, the company allowed
its product mix to stagnate and did not adapt to new industry trends quickly. As a result, Avon
hemorrhaged sales personnel and has seen sales steadily decline, posting revenue dips every quarter
since Q3 2011. Over the same period, the company has lost 90% of its value. The company’s North
American business has now been taken private by Cerberus Capital Management in hopes that an
aggressive cost-cutting and modernization plan can lure its sales force back and restore growth. As
of February 2015, Avon estimated that its active salesforce was approximately six million associates,
but this includes one-time buyers in addition to those who actively market the products.
USANA Health Sciences (NYSE:USNA)
USANA Health Sciences is a developer, manufacturer, and direct marketer of personal care and
nutritional supplement products. The company focuses on supplements, positioning its products as
a way to “reduce the risk of chronic degenerative disease.” The firm reports an active direct
salesforce of 349,000 associates worldwide as of January 2015.
The Estée Lauder Companies (NYSE:EL)
The Estée Lauder Companies manufacture and market a wide variety of personal care products,
specializing in skin care, hair care, cosmetics, and fragrances. The company offers products under a
diverse array of brands spanning the premium segment of the market. The company sells its products
in a variety of department stores, specialty retailers and salons, and the internet, among other outlets
Competitive Arena Commission and Reward Structures
To attract individuals to join, direct sales companies must offer a compelling opportunity to earn
both compensation and, in most cases, luxurious rewards packages. It is important that firms remain
generous in this arena to stimulate growth. Based on the Company’s own filings about its
commission and rewards structure, Nu Skin pays out about $1 billion in commissions annually and
offers “Success Trips” to its top Sales Leaders to celebrate their accomplishments. This is positive,
Figure V: Sales Leaders in China
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 3, 2016
8
but questions about the distribution of commissions, as outlined previously, make the programs less
appealing.
Financial Analysis
Income Statement
Revenue Nu Skin generates revenue by selling product to its Sales Leaders for distribution. Simply put,
revenue is a product of the number of Sales Leaders and the revenue generated per Sales Leader.
Revenue per Sales Leader does vary slightly period to period but the largest factor affecting top line
growth is the variation in the number of Sales Leaders. We drove revenues by making assumptions
about the change in Sales Leaders in each geographic region as well as changing monthly revenue
per Sales Leader.
Projecting Sales Leaders was a function of historical data, correlations, and our own assumptions
based on our research. The research was especially important when determining growth in the
Mainland China region. Given that the region’s sales leader growth has been so volatile in recent
years, it was difficult to find historical or causal data to support the events, so we appraised China
from a standpoint of potential risk to growth from outside forces, such as regulation or bad press.
Similarly, projecting the revenue per Sales Leader was a function of historical data combined with
our assumptions about the future. We believe that the Company’s new products will drive growth at
a 2% rate annually in each of its regions over our horizon. With pricing details unavailable, we were
forced to assume growth without knowing the degree of each product’s effect on revenue. Thus, 2%
seemed a reasonable rate: neither stunningly conservative nor overly optimistic.
Balance Sheet and Financing
Inventory
Inventory consists primarily of merchandise purchased for resale and is stated at the lower of
standard cost or market. The Company uses first-in, first-out method (FIFO). Inventory accounted
for 12.1%, 18.7%, and 21% of total assets in 2012, 2013, and 2014, respectively. The company
was concerned about some of its third-party manufacturers being able to keep up with demand of
its planned product launches in 2014 and subsequent years, thus the high growth of inventory. We
anticipate inventory to continue to increase to 22.2%, 23.5%, and 24.8% of total assets in 2015,
2016, and 2017, respectively. We anticipate this increase because costs of goods sold has
historically been 70% of revenue and revenue is expected to grow 5% annually for the next 5 years
while holding the same operating margins of 11.5%.
Plant, Property and Equipment
Net plant, property, and equipment accounted for 20.4%, 21.8%, and 28.8% of total assets in 2012,
2013, and 2014, respectively. The 7% increase from 2013 to 2014 was attributable to construction
of the Company’s greater China regional headquarters as well as the renovation and expansion of
its Provo, Utah, headquarters. The Company invested more than $100 million on the renovation
and building of both projects. The 300,000 square foot facility provides expanded research and
development space, more office space, and a better auditorium for group meetings. While
expensive, these investments are important for the Company as it tries to project prestige and
legitimacy, especially to counter poor press in China.
Debt
The Company currently has $66.7 million as their current portion of long-term debt with $186.2
million in long-term debt. The Company historically has had EBIT/Interest Expense of 65.5x,
184.7x, and 61.8x in 2012, 2013, and 2014, respectively. The company has shown that it can pay
off its debt and doesn’t have plans to take out any new extensive borrowings.
Cash Flows
Operations
Cash flows from operations were $311.0 million, 530.2 million, and -$56.5 million, in 2012, 2013,
and 2014, respectively. Over the same years, these cash flows were 14.6%, 16.7%, and -2.2% of
annual revenues, respectively. Both the increase and decrease were largely attributable to
corresponding increases and decreases in net income. In 2013, net income advanced by nearly 64%,
while net income fell by 48% in 2014. The degree of the decline in overall operating cash flows in
2014 was greater because of excess inventory levels.
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 3, 2016
9
Our model shows cash flows from operations remaining relatively steady after a $37 million decline
between 2015 and 2016, driven mainly by inventory declines and increases in accrued expenses.
While never returning to its 2013 peak, we believe the Company will post strong cash flows from
its operations over the next five years.
Investing
The Company’s cash flows from investing are consistently negative, with large investments in
capital expenditures and no divestments. The Company’s cash flows were -$104.9 million, -$193.7
million, and -$91.7 million in 2012, 2013, and 2014, respectively. These large amounts of capital
expenditure coincided with the previously mentioned construction in China and Utah.
Our model shows capital expenditures calculated as a percentage of projected revenues. This keeps
them in line with historical trends, but does not account for potential large developments. The
Company does not currently have plans to undertake major capital expenditures and we have little
reason to believe that it will do so in the investment horizon.
Potential Cash Crunch
Based on our model, the Company, in its current state of operations, may encounter a cash crunch
in 2018. We do not forecast that this will have a major effect on the operations of the Company as
it will be able to tap into its revolver to make up the shortfall.
Investment Summary
We recommend a HOLD on Nu Skin Enterprises with a one-year price target of $34.04, representing
an upside of 6.72%. Despite the slight upside potential, we feel that the Company is too exposed to
unique risk factors that could severely harm the Company’s future cash flows. The Chinese market
is volatile in the face of government regulation and state media attacks of the Company’s business
model, as seen by the 60% drop in Sales Leaders and the corresponding regional revenue decline
from the People’s Daily exposé in 2014. Additionally, the Company’s products are precipitously
positioned on the borderline of regulated medical devices and unregulated personal care products.
The Company can be held liable by government watchdogs for misleading or unsubstantiated
claims—as it has been in the past—either it or its Sales Leaders make about products, which could
lead to a product’s removal from the market.
Decision Points
Since we recommend a hold due to uncertainty, we have determined scenarios that would push our
decision toward either a buy or a sell.
In order to recommend a buy on Nu Skin Enterprises, the following must occur:
If growth in Chinese Sales Leaders reaches 7% in 2016
New products prove successful in limited-time offer phase and indicate potential for revenue
growth beyond expectations
The Company introduces a new product line or brand that attracts additional Sales Leaders
In order to recommend a sell on Nu Skin Enterprises, the following must occur:
Governmental action or poor press, especially in China, hinders growth in that market similar to
2014
The Company loses, or appears likely to lose, its securities fraud lawsuit and pays out high
damages
The FTC opens an investigation into claims made by Sales Leaders in regards to products.
Valuation Valuation Methods
We determined our target price using two valuation methods: a hybrid discounted cash flow analysis
and a peer group multiple analysis, which itself involved three different methods. These two
scenarios create a base case of Nu Skin’s operations that was then adjusted for situational risk
probabilities to determine a final target price.
Hybrid DCF
The hybrid DCF analysis incorporates both a perpetual growth rate method and an exit multiple
method, weighted equally to arrive at a target price. Both methods use the free cash flows from the
projected financial statements and can be found in Appendix 9.
Figure VI: Weighted Valuation
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 3, 2016
10
The perpetual growth rate method grows 2019 cash flows in perpetuity using the Company’s WACC
less the discount rate, 8.6% and 2.0%, respectively, for a final discounting rate of 6.6%. This resulted
in a terminal value of $2.02 billion. To contrast, the exit multiple method uses a median enterprise
value to EBITDA multiple of the comp set (Appendix 14) in conjunction with the 2019 EBIT to
determine a terminal value of $2.59 billion. These terminal value figures were averaged, discounted
back to 2016 levels, and added to the 2016 present value of all free cash flows in the period to
determine an enterprise value of $2.19 billion. The enterprise value is then stripped of cash and debt
is added back to determine the implied market value of equity, divided by the expected diluted
number of shares outstanding, 58.7 million, resulting in a target price of $38.39.
Peer Group Multiple Analysis
For the purposes of this multiples analysis, we compared Nu Skin to its publicly traded peers in the
direct selling industry, including Avon, Herbalife, and USANA. While the Company does compete
with more traditional personal care companies, like Revlon and Estée Lauder, the fundamental
difference in the firms’ business models makes them incompatible for comparison. Direct sellers
trade at significantly lower multiples and it would skew the valuation to include non-direct sellers
when computing an appropriate multiple to use.
We use enterprise value to EBITDA, forward price to earnings ratio, and price to revenue to estimate
the Company’s value. In the first case, we use the Company’s projected 2016 EBITDA and the
multiple to come to an implied value of equity, then divide by the number of shares outstanding. In
the second case, we use our projected 2016 earnings per share and multiply by the Company’s
historical P/E multiple to determine a price. In the final case, we use the projected 2016 revenue
numbers and the multiple to come to an equity value, which is then divided by the number of shares
outstanding.
Scenario-Adjustment The Company is exposed to various scenarios that dramatically affect the valuation of the company
overall. These scenarios have independent probabilities and can therefore occur both individually
and simultaneously in various combinations. Individual scenarios and combinations of scenarios
are valued into the target price of the Company by determining the effect of each scenario on Sales
Leader growth by region as well as potential effects on margins then taking the difference between
the valuation if various scenario combinations occur and the base case valuation and weighting
these differences by the probability of those combinations happening. This adjustment results in a
$3.60 decline in target price to account for the risk of these scenarios occurring. Scenarios and the
assumptions associated with them are given in Appendix 15. Scenario combinations, their
probabilities, values, and effect on target share price are shown as well.
This histogram shows the distribution of all outcomes of the simulations in terms of target price
range, showing a stronger pull towards downside cases. This suggests a stronger inclination towards
a sell rating despite the upside potential listed in the base case since a majority of scenario
combinations lead to decreased stock value. The price range distribution chart supports the thesis
that if Scenarios 1,2,4, or 5 were to occur, the stock recommendation would be changed to a sell. If
Scenario 3 occurred, the recommendation on the stock would be changed to a buy.
This valuation analysis also acts as a risk analysis, taking various downside scenarios into account.
The scenario-adjusted target price is $34.04
Investment Risks
Macro Risks Interest Rate Risk
Interest rates are likely to rise as central banks navigate their way through the recovery from the
global economic downturn. The Company has variable rate debt, exposing it to interest rate risk.
Currency Fluctuation Hurts Profitability
Nu Skin is highly exposed to fluctuations in currency value. During 2014, about 91% of its revenue
came from markets outside the United States and all business is denominated in local currency. The
Company does not hedge its positions, so any strengthening of the dollar hurts its financial results.
The dollar has been strengthening in recent years, negatively affecting the Company’s revenues by
approximately 3% annually between 2012 and 2014. If this trend continues, or even intensifies, Nu
Skin’s revenue growth would be severely harmed.
0
2
4
6
$10to
$15
$15to
$20
$20to
$25
$25to
$30
$30to
$35
$35to
$40
$40to
$45
Price Range Distribution
Scenario 1 Scenario 2 Scenario 3
Scenario 4 Scenario 5
Source: Team Estimates
(Expanded in Appendix 15)
Source: Team Estimates
Figure VII: Scenario
Distribution
Figure VIII:
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 3, 2016
11
Industry Risks
Internet-Based Competitors
Direct marketers generally rely on their sales forces to generate nearly all of their revenues. While
there are distinct benefits provided by face-to-face contact with the consumer and the ability to
demonstrate products, personal care and cosmetic firms with a greater internet presence will likely
reduce these advantages as consumers become more comfortable with online shopping.
Firm-Specific Risks Legal Action
The Company is currently the defendant in a class action lawsuit brought forward by Andrews &
Springer LLC for possible securities fraud and breaches of fiduciary duty, alleging that the Company
misled investors about the growth potential of the Chinese market. The case was filed on June 30,
2014, as a consolidation of seven cases filed between January and March of 2014. The Company
filed a motion to dismiss the consolidated complaint on August 29, 2014, but was denied a dismissal
on February 18, 2015. The case is still in progress with no information on the amount in damages,
but average damages for these types of lawsuits in the previous five years was about $40 million.
Sales Leader Liability
The Company is also subject to scrutiny over the actions of individual Sales Leaders in countries
where regulators assert the Company is responsible for the conduct of its Sales Leaders. These
countries, such as Japan, may also require the Company have internal controls that ensure Sales
Leaders comply with local regulations. In June 2013, the Company changed the distributor sign-up
process in Japan and expanded trainings to distributors to address concerns brought forth by the
Japanese government. Similar actions could be undertaken by governments in other markets.
Disclosures:
Ownership and material conflicts of interest:
The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company.
The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this report.
Receipt of compensation:
Compensation of the author(s) of this report is not based on investment banking revenue.
Position as a officer or director:
The author(s), or a member of their household, does not serves as an officer, director or advisory board member of the subject company.
Market making:
The author(s) does not act as a market maker in the subject company’s securities.
Ratings guide:
Banks rate companies as either a BUY, HOLD or SELL. A BUY rating is given when the security is expected to deliver absolute returns of 15% or greater over the next twelve month period, and recommends that investors take a position above the security’s weight in the S&P 500, or any other
relevant index. A SELL rating is given when the security is expected to deliver negative returns over the next twelve months, while a HOLD rating
implies flat returns over the next twelve months.
Investment Research Challenge and Global Investment Research Challenge Acknowledgement:
CFA Society of Salt Lake Investment Research Challenge as part of the CFA Institute Global Investment Research Challenge is based on the Investment Research Challenge originally developed by the New York Society of Security Analysts.
Disclaimer:
The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended
to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a
solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with CFA
Society of Salt Lake, CFA Institute or the Global Investment Research Challenge with regard to this company’s stock.
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 4, 2016
12
Appendix 1: Nu Skin Sales Leader Count by Region Source: Company filings
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 3, 2016
Appendix 2: Nu Skin Sales Leader Efficiency Source: Company filings and team calculations
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 3, 2016
Appendix 3: Nu Skin SWOT Analysis Source: Team Research
Strength
• Strong cash holdings
• Low marketing costs
• Low level of product returns
• Strong product innovation
•High margin products
Weakness
• Stronger dollar reducing revenues
•High sales force turnover rate/decreasing sales force
•Expensive products
•Reliance on China
Opportunity•Aging population
•Acquisition of personal care companies
• Strong financials can be used to expand
Threat
•Regulation over MLM tactics
•Rigorous competition
•Adverse publicity
• FDA scrutiny
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 3, 2016
Appendix 4: Direct Selling Industry Porter’s Five Forces Analysis Source: IBISWorld, Nu Skin Company Filings
Threat of New Entrants:
In the direct selling industry, the threat of new entrants is low due to the difficulty of acquiring a customer or distributor network. Brand loyalty is one
of the keys to success in the industry and a new entrant will need to develop a strong relationship with its customers in order to capture market share. Another difficulty that a new entrant will face is reaching top line growth while selling a commoditized product, as many direct sellers do. New entrants
will also face competition from online retailers offering competitive pricing. Increased regulation of multi-level marketing firms can also deter the
entrance of new companies into the industry due to fear of litigation.
Threat of Substitutes The threat of substitution within the multi-level marketing industry is medium. There are a variety of different business models that allow for
competitive compensation of employees, thus creating strong substitutes for network marketing. The emergence of online platforms has allowed many individuals to sell products and receive compensation with virtually no start-up costs.
Bargaining power of suppliers:
The industry has a relatively low threat from the bargaining of suppliers since many of the products this industry markets are commoditized, allowing many different suppliers to serve the same company. Though low for the industry, the bargaining power of suppliers is high in regards to Nu Skin as it
has only a handful of suppliers that produce its products. The ageLOC Galvanic Spa system and Tru Face Essence products, for example, are provided
by suppliers who own the product formulations and intellectual property rights. This means that one supplier has complete control over two Nu Skin products. The lack of alternative suppliers means that their bargaining power is relatively high as it applies to Nu Skin, but not the overall industry.
Bargaining power of buyers: The bargaining power of buyers is medium for the direct selling industry. Many direct selling companies require their distributors to order and maintain a quota of inventory. This means that the company will sell their products regardless of consumer taste. Brand loyalty has also locked in many
distributors and customers from choosing other brands, allowing for the companies to set the prices more stringently. However, since the market is
saturated with many direct selling companies, buyers have the power to switch from one company to another. This leads to buyers having some negotiating power with the company.
Rivalry among existing competitors:
Rivalry among existing competitors is rated at a high risk. This is drawn from the conclusion that although the industry provides a variety of different products, many direct sellers compete to sell in similar product categories, like beauty and personal care. Major industry players, including Herbalife,
Avon, and Mary Kay, compete vigorously for distributors since they drive nearly all sales for the companies. Many direct sellers are also entering in
emerging markets where many of them will have to compete to gain direct sellers. Overall the rivalry between companies in similar sectors exhibit a
high risk.
Threat of New Entrants
Threat of New Substitute
Buying Power of Suppliers
Buying Power of Buyers
Rivalry Among Competitors
0
1
2
3
4
5
4
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 3, 2016
Appendix 5: Nu Skin Executive Team Source: Capital IQ
Founders
Blake M. Roney Founder
Steven J. Lund Chairman of the Board
Sandie N. Tillotson Founder
Regional Management
Scott Schwerdt President of Americas
Greg Darlington VP of Marketing
Matt Hall VP of Sales
Nick Johnson GM - Latin America
Executive
Truman Hunt CEO
Joseph Y. Chang CSO
Scott E. Schwerdt President - Nu Skin Americas
Rich Wood CFO
D. Mathew Dorny VP
Ryan Napierski President - Global Sales
Board of Directors
Steven J. Lund Executive Chairman of the Board
Truman Hunt President and CEO
Neil H. Offen Former CEO of Direct Selling Association
Daniel W. Campbell Managing General Partner, EsNet
Andrew Lipman Partner, Bingham McCutchen
Edwina Woodbury President and CEO of Chapel Hill Press
Thomas R. Pisano Recently retired CEO of a military sales corporation
Nevin N. Andersen Retired executive
Regional Presidents
Andrew Fan President - Greater China Region
Melisa Quijano President - Asia Pacific Region
Mikael Linder President - Europe, Middle East, and Africa Region
Scott Schwerdt President - Americas Region
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 3, 2016
Appendix 6: Nu Skin Insider Holdings, % of Outstanding Shares Source: Bloomberg
Company insiders significantly reduced their holdings in NUS in early 2015 as the Company muddled through tough times following
the huge reduction of Sales Leaders in China.
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 3, 2016
Appendix 7: Nu Skin 2016 Product Pipeline Source: Company filings
Products included on this schedule: ageLOC Me and ageLOC Youth
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 3, 2016
Appendix 8: Nu Skin WACC Source: Team calculations
Nu Skin WACC
Cost of Debt
Interest Rate 2.3%
Tax Rate 37%
Weight of Debt 22.7%
Weighted Cost of Debt 0.3%
Cost of Equity
Risk Free Rate 1.94%
Expected Market Return 9.93%
Beta 1.1
Weight of Equity 77.3%
Weighted Cost of Equity 8.3%
Weight Average Cost of Capital 8.6%
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 3, 2016
Appendix 9: DCF Source: Team research
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 3, 2016
Appendix 10: Income Statement Source: Company filings and team calculations
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 3, 2016
Appendix 11: Balance Sheet Source: Company filings and team calculations
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 3, 2016
Appendix 12: Statement of Cash Flows Source: Team calculations
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 3, 2016
Appendix 13: Multiples Valuation Source: Team calculations
EV/EBITDA
2016 EBITDA 332,899
EV/EBITDA Multiple 7.01 x
Value 2,334,734$
Less: Net Debt (354,862)$
Less: Pension & Operating Lease Obligations -$
Plus: Inventory 357,656$
Total Equity 2,337,529$
Shares Outstanding 58,663
Value per share 39.85$
Current Price 31.9
Premium (Discount) to Market 24.91%
NTM Forward P/E
2016 Diluted EPS $2.51
P/E Multiple 12.73 x
Value per share 31.92$
Current Price 31.90$
Premium (Discount) to Market 0.06%
Price / Sales
2016 Total Revenues 2,376,454
Price/Sales Multiple 0.96 x
Value 2,283,772$
Shares outstanding 58,663
Value per share 38.93$
Current Price 31.90$
Premium (Discount) to Market 22.04%
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 4, 2016
25
Appendix 14: Multiples Valuation Comp Set Source: Capital IQ
Nu Skin Comp Set
As-Of Date: Jan-30-2016
Company Name Type Market
Capitalization
Latest
LTM Total
Revenue
LTM
EBITDA
P/Diluted EPS
Before Extra
LTM - Latest
NTM Forward
P/E (Capital IQ)
TEV/EBITDA
LTM - Latest
NTM
TEV/Forward
EBITDA
(Capital IQ)
Revlon, Inc. (NYSE:REV) Personal Care 1,559.1 1,893 310.5 44.0x - 10.4x -
The Estée Lauder Companies Inc. (NYSE:EL) Personal Care 31,477.5 10,984 2,098.7 27.9x 26.09x 15.5x 14.48x
Avon Products Inc. (NYSE:AVP) Personal Care Direct Sales 1,476.2 7,626 642.0 NM 15.30x 5.0x 6.71x
USANA Health Sciences Inc. (NYSE:USNA) Personal Care Direct Sales 1,620.5 914 148.6 18.1x 15.18x 9.7x 8.44x
Herbalife Ltd. (NYSE:HLF) Personal Care Direct Sales 4,276.0 4,504 699.6 11.0x 9.90x 7.3x 7.00x
Nu Skin Enterprises Inc. (NYSE:NUS) Personal Care Direct Sales 1,811.4 2,284 342.4 13.2x 10.12x 5.1x 5.00x
Summary Statistics Market
Capitalization
Latest
LTM Total
Revenue
LTM
EBITDA
P/Diluted EPS
Before Extra
LTM - Latest
NTM Forward
P/E (Capital IQ)
TEV/EBITDA
LTM - Latest
NTM
TEV/Forward
EBITDA
(Capital IQ)
High 31,477.5 10,984.0 2,098.7 44.00x 26.09x 15.50x 14.48x
Low 1,476.2 914.0 148.6 11.00x 9.90x 5.00x 6.71x
Mean 8,081.9 5,184.2 779.9 25.25x 16.62x 9.58x 9.16x
Median 1,620.5 4,504.0 642.0 23.00x 15.24x 9.70x 7.72x
25th Percentile 1,559.1 1,893.0 310.5 16.33x 13.86x 7.30x 6.93x
75th Percentile 4,276.0 7,626.0 699.6 31.93x 18.00x 10.40x 9.95x
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 4, 2016
26
Appendix 15: Scenario Analysis and Effects Source: Team calculations
Five scenarios were chosen to account for both risk
and possible opportunities within the model:
additional Chinese investigatory action, legal
settlement, bad public relations, and FTC action
against false product claims, and the introduction of
a new product line.
Chinese investigatory action is assigned a 5%
probability, taking the 2014 investigation that found
no wrongdoing into consideration. If this scenario
were to occur, general & administration expenses
are expected to increase while Sales Leader
numbers would experience significant decline in the
Mainland China region.
Probability of a legal settlement occurring within
the investment horizon is 25%, due to the pending
lawsuit against the company. Legal settlements for
securities fraud averaged $34 million per case in
2014, according to research done by NERA
Economic Consulting and 97% of these cases were
listed as pending.
Bad public relations refer to negative coverage of
the Company that leads to Sales Leaders losing faith
in the multi-level marketing model. This scenario
would affect growth within the Asian regions the
most within the two years following any release, as
proven by the mass exodus of Sales Leaders within
the Mainland China region in 2014. Due to repeated
inquiries into the practices of the company as well
as an ethically questionable model, probability of
this scenario occurring is 15%.
FTC action against false product claims would
generate decline in Sales Leaders in all regions in
the years immediately following action. It would
also effect the gross profit margin of the Company
as it will most likely have to shut down business for
a period of time. The Company has had the FTC
investigate product claims in 1994, 1997, 1998 and
with 2014 investigations on product claims in
China, the probability of the FTC investigating
these claims is given a 20% value.
Typically, after an FTC investigation, the company
looks to develop new product lines such as the
acquisition of Pharmanex. Because of this, the
probability of a new product line being developed is
the same as the probability of the Company being
investigated for false claims. New product lines
result in an increase in Sales Leaders across all
regions.1
1 Assumptions are added onto base case (i.e., overall assumption on growth is Base Case Assumption + Scenario Assumption
CFA Society of Salt Lake Investment
Research Challenge Student Research
February 4, 2016
27
Appendix 15 (Cont’d): Scenario Analysis and Effects Source: Team calculations
1) Each value in Scenario columns correlates to Scenario #. Commas denote a combination of multiple scenarios.
2) Value pertains to the price of the company if each combination of scenarios were to occur.
3) Value Change refers to weighted change in value by calculating (Value – Base Case Valuation)*Probability.
*Counts the frequency of the values outputted in any scenario combination containing the specified scenario within the specified range.
0
1
2
3
4
5
6
$10 to $15 $15 to $20 $20 to $25 $25 to $30 $30 to $35 $35 to $40 $40 to $45
Price Range Distribution
Scenario 1 Scenario 2 Scenario 3 Scenario 4 Scenario 5