University of Utah Team 1 CFA

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



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



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:



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



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



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.



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



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.

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$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:



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.



February 4, 2016

12

Appendix 1: Nu Skin Sales Leader Count by Region Source: Company filings



February 3, 2016

Appendix 2: Nu Skin Sales Leader Efficiency Source: Company filings and team calculations



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



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



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



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.



February 3, 2016

Appendix 7: Nu Skin 2016 Product Pipeline Source: Company filings

Products included on this schedule: ageLOC Me and ageLOC Youth



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%



February 3, 2016

Appendix 9: DCF Source: Team research



February 3, 2016

Appendix 10: Income Statement Source: Company filings and team calculations



February 3, 2016

Appendix 11: Balance Sheet Source: Company filings and team calculations



February 3, 2016

Appendix 12: Statement of Cash Flows Source: Team calculations



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


Current Price 31.90$


Price / Sales

2016 Total Revenues 2,376,454

Price/Sales Multiple 0.96 x

Value 2,283,772$

Shares outstanding 58,663


Current Price 31.90$




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



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



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

University of Utah Team 1 CFA

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