CHICAGO — An ongoing Securities and Exchange Commission investigation, hundreds of millions of dollars in debt and a wave of missed financial reporting deadlines are swirling around Bally Total Fitness as the health club operator actively seeks a buyer for its nearly 390 health clubs. While walking the show floor at the International Health Racquet and Sportsclub Association convention (IHRSA), CEO and Chairman Paul Toback declined to speculate on the strategic sales process, but according to a SEC filing, Bally authorized its advisors, JP Morgan and the Blackstone Group, to take the next step in selling Bally by setting up strategic discussions with interested parties.
Bally is widely circulating its pitch book, a comprehensive report detailing the market conditions, Bally's debt, historical financials, and breakdowns of financials at the club or regional level, said Consultant Rick Caro of Management Vision. According to the New York Post, Bally handed out these books in early March and the first round bids were due in mid-April. Once these bidders advance to the next round, they gain access to a data room and most likely will visit a smattering of Bally clubs nationwide. As is the case with many large companies up for sale, the next step is for Bally's advisors to organize an auction to get the best price for the company, Caro said.
Many private equity firms, other health clubs and real estate investment trusts are interested in scooping up Bally, according to the March 21 article in the Post. At the IHRSA show in Las Vegas, however, the name of one potential buyer spread like wildfire through the show floor — Virgin Active, which has 700,000 members worldwide and owns 25 clubs in the United Kingdom, 77 clubs in South Africa and 12 clubs in Europe. Several Bally employees dropped by the Virgin Health Care booth at the IHRSA show to verify the rumor that the Virgin Group, owned by British billionaire Sir Richard Branson, is eyeing a takeover of Bally as a way to grow its health club business in the United States. Unnamed sources in the Post article said executives at Virgin Active were reviewing a pitch book created by JP Morgan Chase & Co. and the Blackstone Group, Bally's advisors.
Bally shares soared to a four-year high when the Post article stated Bally could be sold for $1.2 billion or $12 a share and Virgin Active was among the list of the potential buyers. Acquiring Bally could be a fast way for Virgin Active to quadruple its number of clubs, said Consultant Michael Scott Scudder of Fitness Focus.
“If (Richard) Branson does want to expand Virgin into the United States, a billion dollars would be a cheap entry point,” Scudder said. “Bally has four million members, and they could buy a lot of branding at a relatively cheap price.”
Lori Levine, a Virgin spokeswoman, said she was not aware of any discussions between Virgin and Bally about a possible sale, but that didn't preclude the company from taking a close look at Bally down the road.
“We have very successful health clubs in England and South Africa, and it wouldn't be far fetched for us to do something in America,” she said. “We haven't been approached by Bally, but that doesn't mean we won't have some interest in them in the future.”
While Bally operates mid-priced clubs, Virgin Active runs high-end clubs overseas, and the two companies wouldn't be a good fit, said Caro, who has visited Virgin's clubs in England. The Virgin clubs have a strong emphasis on children's programming, trendy cafés and strong relationships with insurance companies. Health club members can earn points toward Virgin products and services or pay lower health insurance premiums simply by working out.
A more likely scenario would be for Virgin to open up their own clubs in the United States rather than rebranding Bally's existing operations, Caro said.
“Virgin has a unique brand and the image of being very cutting edge and service-oriented, and it would be hard to translate other clubs' size and shape into their culture,” he said. “It may be better for them to create their own green fields as they go forward.”
Caro predicted that a financial firm will be the most likely buyer of Bally.
“They are experts in restructuring and financial engineering,” he said. “There may not be a lot of synergy for Bally as a whole with any other club company. If Bally were to split up in pieces and sell off clubs in small markets or regions, it could be a strategic buyer in the club industry, but if they intend to sell the company as a whole, the most likely party would be a financial firm.”
Bally's buyer should try to restrict debt, invest fresh equity, create an attractive pricing model and consolidate the number of regions served by the health-club chain, Caro said. The new owner will most likely take a close look at how the company is being run, he said.
“They could make sweeping changes from the outset as a sign to the public markets and the outside world that life at Bally will be different going forward,” he said. “There's nothing to say that a financial firm won't take this company private and run it in a way that information will not be available on a quarterly basis. They could also have a smaller board of directors and select people who are already well known to the financial firm.”
In addition to hanging a “for sale” sign on the company, Bally Total Fitness is also working on filing delayed financial reports. The March 16 deadline for filing Bally's 2005 annual report slipped by, and the fitness operator plans to file the 10-K a month late. Bally delayed the filing of its audited financials for 2004 and restated financials for prior years, which led to difficulties in updating legacy systems and testing and managing the company's internal controls, according to a report from the company.
Once the company files the 2005 annual report, Bally will award a $200,000 bonus to Toback and a $100,000 bonus to Carl Landeck on top of the $1.535 million in 2005 bonuses the company has already awarded its top executives. Toback earned a $700,000 bonus for 2005 compared to $400,000 for 2004 (see chart on page 32). When setting the amount of the bonuses for the fiscal year 2005, Bally's compensation committee selected company-wide earnings before interest, taxes, depreciation and amortization (EBITDA) as the financial performance goal as well as the executives' personal performance goals.
Granting Bally executives exorbitant bonuses in the wake of delaying its 2005 annual report is a slap in the face of Bally's shareholders, Scudder said.
“It's an absolute abomination that at a point in time when they're trying to sell the company, they would take $1.535 million out of Bally when there are no earnings,” he said. “Bally still has a negative cash flow, and it appears they paid out the bonuses before they got to the bottom line.”
While the bonuses were ill timed, Caro isn't sure Toback didn't deserve the bonus.
“In our industry, that sounds like a lot of money, but Bally is a billion-dollar company,” he said. “It may be that the board is satisfied with the work that has been done up to this point, and they see it as an accumulation award.”
By the Numbers: Executive Compensation at Bally
|Name||Title||2004 Bonus||2005 Bonus|
|Paul A. Toback||Chairman, President and CEO||$400,000||$700,000*|
|Carl J. Landeck||Senior Vice President, CFO||***||$100,000**|
|Marc D. Bassewitz||Senior VP, Secretary and General Counsel||***||$225,000|
|William G. Fanelli||Senior VP, Planning and Development||$175,000****||$90,000|
|Harold Morgan||Senior Vice President, Chief Administrative Officer||$175,000||$195,000|
|John H. Wildman||Senior Vice President, Chief Operating Officer||$175,000||$225,000|
|*Paul Toback will earn an additional bonus of $200,000 upon filing of the Annual Report on Form 10-K for the year ended December 31, 2005.|
|**Carl Landeck joined Bally in April 2005 and will be eligible to receive an additional bonus of $100,000 upon filing of the annual report for the year ended Dec. 31, 2005.|
|***Carl Landeck and Mark Bassewitz were not employed by Bally in 2004 and therefore didn't receive bonuses during that time.|
|****William Fanelli served as the senior vice president and acting chief financial officer in 2004.|