A possible bankrupty filing looms large over Bally Total Fitness, causing speculation about the company's future.

At the 11th Annual International Health, Racquet and Sportsclub Association (IHRSA) Financial Panel on March 29 in San Francisco, the first three presenters painted a mostly positive picture of the state of the club industry.

However, the fourth and final speaker, independent research expert Ron Rich, presented a case study about one of the dark clouds in the industry — Bally Total Fitness, which announced in mid-March that it may file for Chapter 11 bankruptcy.

“The picture potentially is looking uglier,” Rich said about Bally during his presentation.

Bally has about $827 million in outstanding debt, and the debt has more than doubled in recent years, Bally Chief Executive Barry Elson and Bally interim Chairman Don Kornstein disclosed in a conference call with analysts on March 15. Bally also informed the U.S. Securities and Exchange Commission (SEC) that it was unable to file its annual report for 2006, which was due March 16.

“Our intent is to implement a substantive fix, not just perpetuate the status quo,” Kornstein said in the conference call. “However, if we are unable to obtain accommodations from our creditors, Bally may be forced to take other significant actions, which could include a restructuring.”

Bally hasn't had a profitable year since 2001. The company expects to post a loss from continuing operations in 2006, with membership revenue falling 3 percent, or more than $25 million less than 2005. That year, Bally, which has also been struggling to attract new members, put itself on the block but was unable to find a buyer. In August, Bally dismissed CEO Paul Toback, and top Bally shareholders Pardus Capital Management and Liberation Investment Group stepped up to play a bigger role with the company.

Membership collections have continued to fall through the first 11 weeks of this year, a trend Elson said on the conference call would continue through 2008. He added that to ease the company's financial woes, Bally would lay off staff, renegotiate rents and close underperforming clubs.

Sharon Zackfia, a Wall Street research analyst with William Blair & Co., said during the IHRSA financial panel that she covered stocks such as Life Time Fitness and Town Sports International, but she did not cover Bally's stock because “it's just not a growth stock.”

At the close of activity on March 30 on the New York Stock Exchange, Bally's stock was at 61 cents, not far from the 52-week low of 52 cents the stock was worth on March 16, the day after the teleconference in which the stock plummeted 62 percent. The stock has been reduced nearly 95 percent in the last year.

On March 30, Bally filed an SEC Form 8-K in which the company said its shares may be delisted from the New York Stock Exchange if the company does not submit an acceptable business plan that indicates how it will regain compliance within 18 months. Trading in Bally's shares has actually been suspended since March 16 because the stock was set to open at or below $1.05, the minimum bid on the NYSE. If Bally shares are delisted, the company said it would make arrangements to be quoted on the OTC Bulletin Board or a similar quotation system.

Michael Scott Scudder, owner of MSS FitBiz Connection, an online-based club consulting and training company, has been predicting for months that Bally will file for Chapter 11 bankruptcy. That could happen by the end of May, he says.

“To me, it was an inevitability,” Scudder says. “I don't think it's a question of, ‘Will they?’ as much as, ‘When will they?’ Do I think that the name Bally will disappear? Absolutely. Now it's not a marketable entity. I believe it would be foolish of them to try to remarket Bally Total Fitness. I think they'll take it private. They'll eliminate the Bally name. They'll reorganize the company. They'll get the bondholders behind them.”

Rick Caro, president of Management Vision and moderator of the IHRSA financial panel, says Bally needs to find cash, figure out a business operating model and redo the capital structure. Bally's shortcomings, however, will not greatly affect the club industry, Caro says.

“Wall Street and the financial community really do understand that the club industry is a strong, successful industry and that Bally happens to be an aberration,” Caro says. “They have a different business model, which they've had for years. They have a number of facilities in different markets, which give it some presence. But in no way is it a sign that it is the only or the best company in many of those markets anymore — if it was the market leader before. What has happened is more competition has come in. The share of the market that Bally had at one point has been diminished, or in some cases is really not that significant.”

Mike Grondahl, owner of Planet Fitness, would not confirm speculation that he had been trying to buy some Bally clubs, but when asked if he would be more hesitant to buy Bally clubs if the company was headed for bankruptcy, Grondahl said, “No.”

As for the club industry as a whole, Grondahl says Bally's possible filing for bankruptcy is no different than any other large company in another business faced with the same dilemma. He adds that consumers will remain confident with the club industry.

“Other than closing their doors and people getting burned out of paid in-full memberships, they've already done so much damage to the industry, I don't think they can do any more damage,” Grondahl says of Bally. “Their problem is they just don't have an efficient operating model. They have plenty of revenue. There's no reason they should be in trouble. If we were running the clubs, they wouldn't be in trouble.”

Craig Pepin-Donat shares Grondahl's view about Bally's operating model and sales approach. In his new book, “The Big Fat Health and Fitness Lie: Enrich Your Life and Improve Your Health Without Getting Ripped Off in the Process,” Pepin-Donat, who has been in the club industry for 26 years, says the problem Bally had with its original business model was that it was designed more like a finance company than a fitness company. The model was based on selling long-term (usually three-year)contractual memberships and financing those at high interest rates and with few options for getting out of the contract.

“Bally should have done the right thing long ago and gone to a month-to-month, pay-as-you-go, stop-when-you-want concept that many quality clubs have gone to,” Pepin-Donat says. “When you have that kind of ongoing negative press, somebody at the higher levels of the organization at some point has to step up and realize how it's negatively impacting the company and do the right thing — make the change. But when you're a publicly traded company and beholden to your shareholders, you are going to continue to do whatever you need to do to bring the greatest amount of shareholder value in the short term. The short-term decisions that they've made have clearly affected them on a long-term basis, and now they're paying the price. They've made their own bed. Now they've got to sleep in it.”

Despite the bleak outlook, Bally officials say they remain optimistic about the company. Bally has invested $15 million in new equipment and has upgraded the interior of many clubs with such items as plasma TVs.

“Since taking on our respective leadership roles late last August, we've obviously learned a great deal about Bally's history, past management approaches, how it goes to market and the value drivers for the business,” Elson said in the Bally teleconference. “We've also come to understand that many of the substantive and seemingly intractable issues that our company is wrestling with today are the legacy of decisions made over the course of many years, and they will not be resolved overnight, despite the significant progress we have made on many fronts since last fall.”

“That being said,” Elson continued, “we remain fundamentally optimistic about the long-term prospects for turning the company's performance around once its underlined capital structure problems are resolved. After all, we are a billion-dollar company. Our operations generate positive cash flow. And we still are the best-known fitness brand in a sector that has been growing at a reasonable rate in recent years.”

Rich predicts that Bally will continue to exist “in one form or another,” adding that “a billion-dollar business does not disappear overnight.” Rich also predicts that Bally will be restructured as a smaller company that will need to decide on its market position, increase its yield among membership and improve its information systems.

As for Bally's chances that it will file for bankruptcy, Rich says that it's anybody's guess.

“There's going to be a lot of negotiation in the near term between and among bond holders, equity holders and management,” Rich says. “I really would doubt that anyone wants to see this business in bankruptcy.”

Rich concludes, “Whether Bally is restructured inside or outside of court, it beats me. But it will be interesting to watch.”

For Bally news that occurred after this issue went to press, visit www.fitnessbusinesspro.com.