2011 Was A Year of Improvement In Fitness Club Financials But Still Premature For Rejoicing

2010 saw some leveling off with some clubs getting attrition back under control. Where expense management was a serious thrust, clubs were able to maintain their EBITDA margins and stem the tide. Still, there was limited predictability on new joiners, leading to alternative marketing techniques. Few club sales occurred, except those at distressed levels. Most of the new clubs were developed by the very large club companies or were part of franchises or specialty studios.

Based on the IHRSA Industry Trends data, revenues were increasing slightly as were the total of net memberships. Non-dues revenue (ancillary revenue) was increasing at a rising clip, as more owners were trying to realize more revenue per existing member. This was due to a combination of greater penetration of the membership, more fee-based alternatives and greater renewal of program participants. The EBITDA margins are now holding steady, slightly increasing over 2010 but a lot less than the 2007-2008 levels.

The big-picture story for the industry was the continual climb of the overall health club memberships in the U.S. A year ago, there was a 10.8% increase to over 50 million members. In 2011, it grew another 2.4% to 51.4 million. This helped validate the previous year’s surge and helped confirm that the industry is on an upward trend line. Interestingly, the number of health club facilities has leveled off. We all recognize that some independent clubs and smaller facilities have closed, but these have been offset by take-overs and new builds.

The biggest challenge this club industry has faced over the recent 3-4 years has been in the debt markets. The large club companies borrow on the basis of cash flow. The level of leverage as a multiple of cash flow reached a high in 2007-2008 and has not returned to that level. Private equity firms, who are already invested in this industry or are interesting in doing so, are waiting for the return of those leverage levels. So, few deals and less growth has been a result. Sometimes, the availability of such funds has dried up and a quiet period ensues.

The debt challenge has also effected medium-sized and smaller club companies who borrow based on their assets. In these cases, banks have been changing their lending criteria – even for those with previous track records. Their loan-to-value ratios have decreased and become more conservative. Some of their other criteria have been changing. The role of the SBA has also been in flux. These local banks and big bank money centers have been very difficult on start-up companies, which has limited the number of unwanted and perhaps, undercapitalized competitors from entering the market.

There were no IPOs (Initial Public Offerings) in the U.S. and none likely in the future. No U.S. club company bought or developed a major set of clubs internationally. At one point, there was speculation that Virgin Active would enter the U.S. market by either new builds or acquisition. Instead, they just sold a majority interest to a private equity firm, CVC Partners, in the U.K.

On the positive side, there is evidence that medium-sized club companies keep adding 1-2 clubs a year in their same geographical areas. Many of the franchise companies have seen growth (i.e. 24/7 all-access clubs and the HV/LP – high-volume, low-priced clubs), while the women’s-only segment has seen more downsizing.

Given the economy and the realities of funding challenges, many non-profits have seen slower growth in new builds and major renovations. Few communities are successful in getting bonds passed to build new public parks and recreational facilities. Few military bases are building or expanding each year. Few new hospital wellness centers are being created. JCCs and YMCAs are dealing with challenging fund-raising environments. The major exception is university-based fitness centers, which are growing in rapid numbers tied to major increases in student fees over a projected 10-year period. Often, these facilities are costing $30-$60 million, even at smaller universities. They currently focus on serving students, faculty and staff.

There seems to be constant legislative pressure at the state level on clubs, especially involving such issues as increasing sales taxes, membership renewal regulations and the licensing of personal training.

The club industry has had an uneven story at the large-club level, as some investors have had significant success while others have been burned. There may be some exits in the near future, with some consolidation still a possibility.

There still seems to be lots of capital in private equity’s hands that is chasing a very limited number of good deals. The club industry has lots of intriguing aspects (e.g. recurring revenue, attractive club unit economics, good free cashflow, alignment with impressive demographics). Many financial institutions have not appreciated the value of strong industry operational expertise. There are some new business models evolving in the industry, and technology will play a greater role in their success in the future. Some of the lessons learned included not overpaying when buying a club company, changing management right away if doing so at all, not overleveraging the capital structure, accepting that this industry is not recession proof and not simply classifying it as a membership business when it is a sales, customer service and a product differentiator business. Many noted that the industry is still weak in data capture. They project significant mergers and acquisition activity in the next 18 months.

Posting date: 04/28/2012

Source: Rick Caro