CLUB - Town Sports International Holdings

[Laxputs]

This company owns about 160 gyms in NY, Boston, Phil, since 1973.

 

They pump out the fcf, and have about a 10% dividend now.

There have been reductions to the membership base recently due to competition.

They may have something of a barrier to entry for competitors in their core markets due to an economy of scale in advertising costs and the difficulty for competitors to acquire a number of locations at once in that market.

They have a lot of debt but it is very manageable at these levels and are less leveraged than during the financial crises where they still were profitable.

Bought back 15% of shares during the depressed prices of the financial crises.

Planning on closing 5% of locations.

Plans on opening up some smaller boutique studious to compete with similarly sized competitors.

 

I own shares. I may buy more as there has been a 30% drop from where I bought, they trade at their lowest price in ages, and they trade at ridiculously low multiples to FCF and OE and dividend yield.

 

The market is worried their membership decline will continue, and perhaps don't like the debt.

 

Any thoughts?

 

[Myth465]

I looked into this after G Gannon bought a large chunk. I passed the business is too unstable.

Q1 saw a massive cut to FCF or Funds Flow. I am happy I passed...

[Laxputs]

I have operating cash flow as 14.4m on the quarter and their average annual maintenance capex as around 25m (or 6.25m for the quarter). This gives .34/share on the quarter or 1.36/share on the year. 22% Owner's earnings yield.

 

FCF will be less due to capex spending on the boutique BFX studios. But their maintenance capex should be unchanged.

 

Still dirt cheap if you ask me.

[Myth465]

Its cheap but I think maintenance and growth capex are a bit blended. I think the maintenance capex is bigger because that growth is covering the drop in legacy assets.

I have not done well on FCF monsters which have high debt levels and declining revenues. It just never works out. I will continue to watch though.

[yadayada]

yeah if this had no debt, then great buy it. But debt level is way too high here.

[Guest deepValue]

yeah if this had no debt, then great buy it. But debt level is way too high here.

The company has less debt now than it had in 08/09 and generates more free cash flow. Cash flow doesn't just evaporate in this business. I don't see any real possibility of insolvency here given that it was in a worse position during the recession and managed to stay afloat.

[BG2008]

I think one of the top 3 questions that needs to be ask is "will their rent" J Curve.  Most businesses that operate in NYC fail because their 10-20 year leases expired and they can't afford to re-new.  NYSC operates in a lot of neighborhood where rent is pricey.  Just look at their locations in NYC.  If their rent doubles, the current FCF can got out the window.  I have not put in the time to analyze their lease expiration data.  But this is vitally important.  I have also been a member for a few years.  After 2008/2009, they started offering members who stopped their membership after 6 months the option to rejoin at around $40-50.  I have noticed that they have delayed cap ex somewhat as some of the locations are not as new as 2007.  They have also drastically reduced their TV programming.  Now, it's a struggle to go through that 40 min session on the elliptical machine (don't judge, I am saving my knees by not running).  I would not be a customer at $80-90/month, but at $40-50, I'm okay.   

[BG2008]

In the next five years, or the period from January 1, 2014 through December 31, 2018, we have leases for 24 club locations that are due to expire without any renewal options, two which are due to expire in 2014, and 48 club locations that are due to expire with renewal options. Renewal options include terms for rental increases based on the consumer price index, fair market rates or stated renewal terms already set in the lease agreements.

[GregS]

I have operating cash flow as 14.4m on the quarter and their average annual maintenance capex as around 25m (or 6.25m for the quarter). This gives .34/share on the quarter or 1.36/share on the year. 22% Owner's earnings yield.

 

I haven't gone into any detail on this one yet, but wouldn't seasonality dictate that their first quarter would be the best quarter for a fitness club?  Not sure you can annualize.

 

Maintenance capex is also tough to measure.  If clubs don't continue to invest they will see membership declines.  I wouldn't want to base cash flow estimates on existing capex figures unless you know whether or not a club is underinvesting.  If depreciation is higher I am suspicious (and it is, almost 2x your estimate).

[Laxputs]

Great discussion and feedback, thanks guys.

 

Here are my fairly simple thoughts:

 

I am not very concerned about their leases; they've been around for 40 years, continually managing their leases. I think gyms will necessarily exist in urban markets and therefore the biggest operator, which is this company, should be able to survive given their economies of scale in marketing.

 

I am not very concerned about their debt; they survived the 08/09 financial crises with more debt and similar revenues. They have 3$ in cash per share. They are looking to close under-performing clubs (all of which are in the suburban market which has no barrier to entry).

 

As far as FCF and owners' earnings goes, I am basing their maintenance capex on historical figures and also what management has stated it takes to maintain their operations: around 25m a year.  I understand that their fixed assets last longer that what their depreciation rate suggests.  This is central to the investment thesis here.

 

I still like the position.

 

 

[Myth465]

I have operating cash flow as 14.4m on the quarter and their average annual maintenance capex as around 25m (or 6.25m for the quarter). This gives .34/share on the quarter or 1.36/share on the year. 22% Owner's earnings yield.

 

FCF will be less due to capex spending on the boutique BFX studios. But their maintenance capex should be unchanged.

 

Still dirt cheap if you ask me.

 

Whats the yield vs. EV? - Not as attractive if you ask me.

How many years of FCF of debt do they have? How long will it take them to pay off the debt before you can access the cash?

 

 

If they have to open new gyms to replace revenue from old gyms is that maintenance or growth capex? - I would say its maintenance meaning maintenance capex is understated and OE is overstated....

 

Didnt it look cheap before the 30% drop?

Isnt Q1 / new years crowd the best quarter for gyms?

How will the home workout / yoga / online / fad fitness options effect the business?

 

 

[BG2008]

I beg to differ.  If you live in NYC, you will understand how important being able to manage lease expenses are.  Look at their gym vintages.  A lot of them are 10+ years old.  The trend in the city is that only businesses that generate high $/sqft can survive.  Equinox is well positioned, NYSC not so much.  If their lease expense structure is from 10+ years ago, you can be looking at a terminal business when these leases come up for renewal.  You need to pick up the phone and call a few brokers and ask them what kind of rent is appropriate going forward.     

 

I agree that gyms will necessarily exist in urban areas, where I differ is that "perhaps the gyms that exist will be Equinox and not NYSC" 

 

Great discussion and feedback, thanks guys.

 

Here are my fairly simple thoughts:

 

I am not very concerned about their leases; they've been around for 40 years, continually managing their leases. I think gyms will necessarily exist in urban markets and therefore the biggest operator, which is this company, should be able to survive given their economies of scale in marketing.

 

I am not very concerned about their debt; they survived the 08/09 financial crises with more debt and similar revenues. They have 3$ in cash per share. They are looking to close under-performing clubs (all of which are in the suburban market which has no barrier to entry).

 

As far as FCF and owners' earnings goes, I am basing their maintenance capex on historical figures and also what management has stated it takes to maintain their operations: around 25m a year.  I understand that their fixed assets last longer that what their depreciation rate suggests.  This is central to the investment thesis here.

 

I still like the position.

[Guest deepValue]

Whats the yield vs. EV? - Not as attractive if you ask me.

How many years of FCF of debt do they have? How long will it take them to pay off the debt before you can access the cash?

 

Look at any publicly-traded gym: they all carry lots of debt. This is usually a stable business, so its sustainable debt level is higher than companies you're used to looking at. If a given level of debt is sustainable, you might consider it permanent/not having to be repaid. This would change your valuation. Of course, not everyone is willing to ignore sustainable debt; it's a matter of personal preference/prior experience.

[Laxputs]

They have no plans to repay their debt. They use leverage to obtain higher returns on equity and as long as they can cover their interest, it makes sense for them to do so. I am comfortable with their debt levels. They are well capitalized.

 

Yes it looked cheap before the 30% drop. Yes it looks cheap now. I don't get what you are asking.

 

I'm not trying to extrapolate one quarters cash over the entire year for my investment thesis. I am looking at their annual average cash flows and on that basis it is very cheap IF earnings are understated, depreciation is overstated and OE are somewhat accurate.

 

I expect their business revenues and earnings to fluctuate over the years, that seems natural. There will be competition. There will be changes in the industry. But I believe they are positioned well to take advantage of an industry that will always be around, and that is growing.

 

"If they have to open new gyms to replace revenue from old gyms is that maintenance or growth capex? - I would say its maintenance meaning maintenance capex is understated and OE is overstated...."

 

I think this is the main question. If I have understood their maintenance capex incorrectly (they have stated it as around 4% of revenues, which is similar to other gyms, and which they have also stated is around 25M), and that they actually need some of those OE to replace old leases (which has to be maintenance capex and not growth capex), then my thesis is not valid.

 

I understand that their depreciation and maintenance capex differs so drastically because they over depreciate their fixed assets which actually last longer than the books suggest.

 

Some other points:

-Closing some suburban clubs, focusing on urban clubs where competitive advantage is greatest

-They were profitable during the financial crises and bought back 15% of the company

-They are paying a regular dividend

-Anybody could likely run the business

-Largest operator in NE and Mid Atlantic

-The industry is going to grow

-Their BFX boutique studious are not trying to prove a concept; they are implementing them because competition is already there. They should have advantages with their marketing, knowledge of the industry/operational efficiencies, offering 3 exercise programs whereas most are offering 1 or 2.

 

[yadayada]

hmm i misread, apparantly their revenue is somewhat stable. It just seems that you need a market rerating here. This idea is kinda similar to OUTR. There the market keeps disliking it, despite contradicting fundamentals. But there they will buy back shit loads of stock. Here a lot of FCF needs to go to paying off debt right?

 

Some things to consider

-leases increasing?

-what is really their next 10 year average capex? You can't charge 80$ a month with old gym equipment.

-What exactly is their moat here? In my area there are lots of gyms and price has been brought down a lot.

-what multiple does this deserve?

-2012-2013 revenue is down, and now from Q1 2013 and this quarter revenue is down again. So not a very steady eddy business.

 

Currently has a 4.5x multiple or something like that on their FCF? This could easily be wrecked by any of the above if you have no clear vision on that. And this doesnt look like it deserves more then like a 10-12x multiple even without the above issues. 

[PatientCheetah]

this is a stereotypical cigar butt business with no clear moat. It will be a decent investment if you can buy it cheap enough. The steady state FCF is probably between 30-50 mil. It has historically traded between 2-8x. The right strategy is to buy it when it is closer to 3x and dump it when it gets to 6x or higher. The multiple range is unlikely to change because the business has limited growth potential. I would take a closer look when it gets down to $4-5.

[jschembs]

this is a stereotypical cigar butt business with no clear moat. It will be a decent investment if you can buy it cheap enough. The steady state FCF is probably between 30-50 mil. It has historically traded between 2-8x. The right strategy is to buy it when it is closer to 3x and dump it when it gets to 6x or higher. The multiple range is unlikely to change because the business has limited growth potential. I would take a closer look when it gets down to $4-5.

 

Isn't the term cigar butt generally reserved for net nets with no long-term future as a business? I'm still not convinced this is a business I'd invest in, but I don't think I'd describe it as a cigar butt.

[DanielGMask]

Hello to all, I'm new to the forum though I've been following it for a while.  :)

 

My opinion about CLUB: The debt load is more than I like to see in a company but it's certainly within the standards for this industry, which by the way doesn't necessarily means it is ok!

 

I compared the financials of this one with another gyms operator I'm familiar with (a mexican company named Sportsworld - you can check the financials here: http://www.sportsworld.com.mx/inversionistas/index.php?pagcarga=anual) and debt load seems reasonable, as well as capex as a percentage of sales.

 

The issue I have is the cost of operating the locations (rent, payroll, utilities, etc... which is much higher with CLUB than with SportsWorld). The reason is simple: the ARPU is way higher at SportsWorld than at CLUB. Why? Because of the price each charges its customers. I don't think there's a moat with CLUB since their fees are on the low range of the spectrum for premium gyms, even more when talking about locations in NYC.

 

I don't like the fact that they are not able to charge $100 or more per month per user since that seems to prove there's no moat, or at least that there's no real differentiator with other similar gyms, something other operators as Sportsworld have achieved. By the way and talking about Sportsworld, I'm only using it as a comparison example since the stock price is highly overvalued.

 

Greetings to you all.

[Guest deepValue]

I don't like the fact that they are not able to charge $100 or more per month per user since that seems to prove there's no moat, or at least that there's no real differentiator with other similar gyms, something other operators as Sportsworld have achieved.

 

From the 10k:

We believe that our market leadership, experience and operating efficiencies enable us to provide the consumer with a superior product in terms of convenience, quality service and affordability. We believe that there are barriers to entry in our metropolitan areas, including restrictive zoning laws, lengthy permit processes and a shortage of appropriate real estate, which could discourage any large competitor from attempting to open a chain of clubs in these markets. However, such a competitor could enter these markets more easily through one, or a series of, acquisitions. These barriers of entry are significant in our four metropolitan regions; however, they are not as challenging in our surrounding suburban locations.

 

Town Sports has 108 clubs in the New York Metro area. It's competing with small operators that lack cost efficiency. This is a commodity product so it lacks pricing power, but it has a defensible cost advantage.

[Laxputs]

My only real concern is not leases or debt or customer attrition; I believe that will work itself out and some of it, like competition and attrition, is cyclical. And they have advantages with their cost efficiency.  Gyms will always exist, they should do fine with decent management considering the company is entrenched in these urban markets.

 

My only concern is understanding their maintenance capex correctly.  It would be interesting if anybody can analyze this more. Management has stated around 4% of sales; around 20-25m a year. Any more than that is, on average, growth spending. If this is accurate, I am excited to own a company with a 20%+ OE yield in a growing, boring, easy to understand market where the company will buy back their own shares and pay dividends.  But I want to know I understand their capex correctly.

[DanielGMask]

Town Sports has 108 clubs in the New York Metro area. It's competing with small operators that lack cost efficiency. This is a commodity product so it lacks pricing power, but it has a defensible cost advantage.

 

What do you mean by "defensible cost advantage"? If they don't have pricing power and they are not a low cost operator, at least they are not spending less than the comparison I used!

[Laxputs]

They have economies of scale. They can spread advertising costs over multiple gyms whereas a new competitor, in theory, does not have multiple locations, and has to absorb the advertising into one location. This would allow CLUB to be the low cost provider. The difficulty in acquiring multiple locations at once due to expensive leases, restrictive zoning laws, limited real estate options, etc, helps to prevent competitors from encroaching. It's not a super strong moat, imo, but they have some competitive advantages.

[Myth465]

Lax it seems like you are sold on the idea.

Good luck.

[oddballstocks]

this is a stereotypical cigar butt business with no clear moat. It will be a decent investment if you can buy it cheap enough. The steady state FCF is probably between 30-50 mil. It has historically traded between 2-8x. The right strategy is to buy it when it is closer to 3x and dump it when it gets to 6x or higher. The multiple range is unlikely to change because the business has limited growth potential. I would take a closer look when it gets down to $4-5.

 

Isn't the term cigar butt generally reserved for net nets with no long-term future as a business? I'm still not convinced this is a business I'd invest in, but I don't think I'd describe it as a cigar butt.

 

What seems missing from this whole thread is a discussion of a margin of safety.  I always think of net-nets and cigar butts as companies with no future, but there is a MoS, their giant valuation discount to their assets.

 

This investment doesn't have that, it's loaded with debt and NYC leases that are going to re-rate.  It reminds me of the phrase "100% of foreclosures were with homeowners who were in debt."

 

It's possible this gym will continue to go forward without a hitch.  But companies that carry high debt loads are always at risk of hitting a slight bump in the road that upsets things. 

 

I have an analogy for high debt companies I keep in mind.  I envision them as a pickup truck where the bed is filled sky high with precariously perched items.  The truck might be able to make it a long journey if nothing goes wrong, but all it takes is one bad pothole to wreck the balance.  Do you want to take that risk? 

 

What's the downside on this investment? 

[Myth465]

I look at debt very differently.

How long will it take me to access the FCF.

 

If its too long, then its not really FCF. I also look at maintenance different. If you have to build a new gym to maintain your userbase / case flow then its maintenance capex.

Who cares what it cost to keep a gym up to date. How much does it cost to keep cash flow from falling?

That number is higher than maintenance capex being shown...

 

There will be a point where this is a buy though.