Club Industry Financials In 2006
By Rick Caro
The financial headlines for the health club industry had many major stories in 2005. It was a time of blockbuster deals. 24 Hour Fitness was sold for $1.6 billion to Forstmann Little (who also owns IMG, the largest worldwide sports marketing firm). Then, Fitness First (with more clubs than any one other company in the world) was sold for $1.5 billion to BC Partners, a large UK private equity firm.
Real estate companies bought stakes in the club industry in that same year. Equinox Fitness was sold to a major real estate development company (The Related Company) for a huge multiple. Soon, Millennium Partners (another similar real estate developer) bought five Sports Club/LA clubs and the Reebok Sports Club in New York City. Finally, Sport & Health (a regional cluster of clubs around the Washington, DC region) was purchased by a former CEO along with some local real estate investors.
For the first time, a major club company sold off a cluster of clubs. Bally Total Fitness, desperate for cash, sold its Crunch Fitness division of about 25 clubs to Angelo Gordon, a private equity firm and hedge fund. However, this deal did not close until 2006. A major challenge involved how the new company would be able to use and adapt the Bally membership, billing and accounting systems for its use. This has proven to be a substantial problem for the purchaser.
2006 HEADLINES
The biggest news in 2006 was that Town Sports International (TSI) went public and at a difficult time for new public companies. It went public around $13 per share and has performed consistently. It has shown improving profitable results and has performed on its growth plan. Its stock has traded in the low $20s.
Another private equity firm has entered the club industry as California Family Fitness was purchased by the Bunker Hill Associates. The club industry continues to draw regular interest from the private equity market, but often only 1-2 such firms enter this industry in any given year. The obvious challenge is identifying an appropriate platform of existing clubs with a readiness for quick growth and with a proven model.
LifeTime Fitness has been a proven winner in the public company arena, as it has created eight new clubs a year of 110,000 square feet costing $25-$30 million. It has delivered on its projections and continues to be rewarded with an increasing stock price of over $50.
BALLY’S STATUS
The concern for the industry has been the fate of Bally Total Fitness. It has suffered a continuing decline over recent years and even encountered losing years. It is confronted by a huge debt stranglehold with no immediate solution in sight. It saw a battle of stockholders with two hedge funds gaining Board seats. This led to the removal of Paul Toback, CEO. With the outsiders becoming insiders, all hoped for improvement in the outcome of Bally. Unfortunately, no stock offering was realistic. Some senior debt was replaced. But, subordinated debt of $300 million due in October, 2007 has not yet been dealt with properly. And, the basic business model has failed to be a current or future success story. All of the metrics show a worsening situation before any significant improvement can be determined. It is likely that Bally will consider a reorganization, probably through bankruptcy court oversight. This may lead to disposal of losing clubs, revision of leases, reduction in overall staff, some cutback in offerings (e.g., group exercise classes) not critical to their story, reduction in debt loads, revision in stock ownership and major changes in its basic business model. In all likelihood, new leadership will come in with new strategies. And fresh money will have to be found to bring the clubs up to an adequate physical plant level, given the lack of proper capital re-investment over a period of years, as well as to have adequate resources to allow the clubs to compete properly in the resulting marketplaces.
2007 will see some more private equity investment in regional clusters and some news of changes in some existing major club groups. But, no IPO (initial public offering) is likely.
OVERALL ECONOMIC TRENDS
The U.S. economy was stable in 2006 and up slightly over 2005. The IHRSA Index, which tracks a sample of clubs quarterly, found that same “store” (club) sales were slightly better than the same period in 2005, but net memberships were flat. The non-dues revenue categories continued to provide impressive results. The real concern is that EBITDA margins were decreasing. With the topline net growing, this indicates that clubs may need to do a better job on cost cutting. The debt markets were still strong, although lending rates were increasing upwards.
OVERALL CENTER TRENDS
Many of the trends noted in 2005 continued in 2006. The trend toward increasing the size of facilities, especially among the larger chains, is prevalent again. The cost of construction continues to rise. With capital expenditure reinvestment still an annual requirement to both maintain the functionality and desirability of the clubs, owners and GMs will be pressed to plan for regular cap ex spending and balance needs that are often greater than available resources.
2005 saw an anomaly for the club industry: no membership growth. For over 20 years since tracking has been doing, there had been continuing growth in the total number of total health club memberships in the U.S. In fact, it had been on a steady and impressive path. However, there was no growth from 2004 to 2005 as the total number remained at 41.3 million members. The good news for 2006 was that the growth trend was re-established as the total reached 42.7 million (+3.4%). While not a major percentage increase, it does indicate that it is an industry that is on an upward path. There is much confusion as to whether the number of new clubs is outdistancing the growth in membership. When one accounts for the limited size and number of members in tiny 30-minute express clubs or limited-staffed, 24-hour clubs, the trends are in more of an expected relationship to each other.
Once again, there was substantial talk of consolidation (i.e., existing clubs being bought by other existing clubs) in the club industry. However, minimal activity occurred. With the Top 10 club companies owning less than 5 percent of the total U.S. facilities, the club industry is viewed as one of the most fragmented. In any given year, 1-2% of the total industry may change hands. This is not a sign of consolidation. However, the UK has seen the exact opposite trend as it has become highly consolidated. There has not been any international club company investing in the U.S. market yet.
Small regional companies continue to show growth, generally by creating new additional sites rather than by acquisition. However, many of these regional/local companies are still too small in revenue, EBITDA levels and number of units to attract the sophisticated private equity firms.
There continues to be an infatuation with franchised clubs, as more companies are being created in both the 30-minute express space as well as the limited-staffed, 24-hour access area. Many are priced at affordable levels. In addition, the low-service, low-priced clubs are continuing to proliferate.
Real estate leases are still attractive but less so in major metropolitan markets as rents have increased substantially. There continues to be a challenge for the first-time club developer with no track record to gain proper financing and ideal real estate locations.
OTHER RELATED TRENDS
This past year saw the real estate development segment gain a stake in the club industry with various deals. However, other analogous industries (e.g., hotels, resorts, leisure/entertainment companies, etc.) have not made major investments in clubs. The diet center industry is approximately three times the size of the health club industry. Yet, its basic business model is not successful in terms of long-term customer results without an exercise component. The magic diet pills have either not gotten required FDA approval or are expensive and need prescriptions or have undesirable side effects.
The non-profit, unfair competition issues remain. Once again, it has been a year without any breakthrough news with respect to government’s influence in creating regular exercisers or any significant commitment from HMOs or insurance companies to financially provide real incentives. Fewer new hospital-based wellness centers are being erected.
2007 looks to be a similar year to 2006. There may be some club deals, but none of great import. Unless a real recession occurs (which is not projected), clubs will have no external pressures. The club industry will still be faced with the need to improve its member acquisition processes and techniques, always to update its program and service offerings, develop more user-friendly systems and create a better bottom line. Guarded optimism seems to be the theme.
Rick Caro is President of Management Vision, Inc., a club consulting company focusing in the areas of market analyses, valuations, member surveys, finances, feasibility studies, expert witness testimony, club sales/purchases and operational analyses. Management Vision, Inc. can be reached at (800) 778-4411.
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