Experts from the financial community examine the industry's potential and discuss why they invested in health clubs.
"On Wall Street today, durable goods were down and high-tech stocks took another beating. But both the Dow and Nasdaq closed at record highs as heavy trading in commercial fitness facility stocks pushed all of them to their highest levels ever."
While it isn't likely that we'll be hearing business reports like this on CNN in the near future, the financial community has indeed taken greater notice of the commercial fitness facility industry. Last year, Brentwood Associates, a Los Angeles-based investment firm, formed a company to consolidate local chains into a national operation. Brockway Moran & Partners joined forces with a Gold's Gym licensee to acquire Gold's Gym Enterprises, the Venice, CA-based licensing company. Ongoing investment in Town Sports International has allowed the chain to grow to almost 100 units. And Fitness Holdings has used funds invested in it to become arguably the largest health club chain in the world.
How much the investments in these companies reflect the financial community's confidence in the entire fitness industry is difficult to determine. Certainly, investors and analysts see potential for growth with specific fitness providers. And they do point to favorable changes in demographics that could favor the industry as a whole. But for the most part, what has been attracting investors to fitness companies has been the vitality of the individual firms more than the industry itself.
For example, analysts who are bullish about Bally Total Fitness point to its potential to better leverage more revenue from existing members with, for instance, pro shop sales. Seth Weber, an analyst at Merrill Lynch, singled out Bally's heavy investment in its back office operation as one of the company's unique strengths to continue its growth.
Said another analyst who pointed to the strength of Bally's management team, while also giving a nod to demographic changes that could benefit the entire industry as well, "The best days for Bally are ahead of it."
Anaylsts do agree that there is good potential for the entire commercial fitness industry to grow. Paul Roukis, senior equity analyst at Sidoti & Company L.L.C., commented that an increasing appreciation of the benefits of fitness, especially by insurance providers, may fuel greater membership growth. Plus, an aging population should create more demand for fitness services.
Analysts maintain that the market has few serious risk factors. For example, because health club memberships are generally low-cost items, it's not expected that a weakened economy would have a major impact on the business.
But two concerns were targeted. Roukis said that there are some indications that the number of new facilities being developed is outpacing the demand for them. He also noted that the industry must develop better trained management. "As this industry becomes more professional, it's going to take more people with a different skill set to manage it."
Invested in 24 Hour Fitness/part of Fitness Holdings Worldwide McCown DeLeeuw could see the consolidation coming. As the firm prepared to invest in the fitness industry, the fragmentation was impossible to ignore. At the time, approximately 12,000 clubs-mostly small, single operations-were in business across United States. And Bally Total Fitness, with its hundred of locations, loomed larger than them all.
McCown DeLeeuw believed that the industry needed more multi-club ownership, backed by the power of a brand that people recognize and respect. According to David King, managing partner with McCown DeLeeuw, clubs with brand names can outgrow industry standards. "They can outperform single clubs," he says. And they enjoy economies of scale that single clubs can't achieve.
Not only did fragmentation and economics favor multi-club ownership, an evolution in consumer perspectives indicated an increasing demand for fitness services, according to King. Aging baby boomers were looking at their health, and they were going to demand high value from health clubs. Only the clubs that could meet this demand could expect business from boomers.
With all of this in mind, McCown DeLeeuw went shopping. "We looked at the industry and did a lot of tire kicking," King says. The firm found what it wanted in the closing days of 1994: 24 Hour Fitness, a club chain that possessed the meaningful brand that McCown DeLeeuw desired.
Describing 24 Hour Fitness as one of the industry's "dominant players," King notes that the chain's management team knew how to build on its strengths and deal with its weaknesses. That latter skill especially left an impression. For example, to improve upon lost membership-arguably the industry's biggest challenge-24 Hour Fitness hired a Berkeley engineer who developed a system that helped measure retention. "They had focused on the problem and put processes into effect to deal with the issue," King says.
Although 24 Hour Fitness's management team gained McCown DeLeeuw's confidence, the firm still had worries about the industry. During the early days, McCown DeLeeuw wondered if the mounting interest in health and fitness was a long-term trend or a short-lived fad. Also, the industry's own reputation gave McCown DeLeeuw pause. "This is an industry beset by its aggressive selling practices," King notes.
Many of the risks that once raised questions with McCown DeLeeuw no longer apply today. Aggressive selling has cooled, King claims. And interest in exercise, particularly among the boomers, has not waned. Still, challenges do exist. King points out that it's difficult for a growing chain to create information (i.e., computer) systems that tie locations together. That's because clubs which are acquired never anticipated that they would become part of a larger entity, so they don't have the appropriate hardware in place. Therefore, in a fragmented industry, the system capacity isn't immediately available to run a large chain.
King describes management building as another challenge-that is, turning fitness enthusiasts into sophisticated managers who understand everything from service needs to balance sheets. He also notes that financing remains a problem, as the meaningful bank loans necessary to grow aren't readily available.
Despite this, McCown DeLeeuw has grown its investment considerably. Today, 24 Hour Fitness is part of Fitness Holdings Worldwide, a worldwide chain with approximately 350 clubs. This global company includes Sats, a large chain in Northern Europe, and California Fitness, an Asian chain.
And the company hasn't stopped yet. King expects his firm to make even more investments in the industry; in fact, he expects other investors to target this market as well. "We've seen a number come in the last couple of years," he says, "and I suspect we'll see more and more.
Show Me the Money
For more information on why commercial fitness is becoming an attractive investment opportunity, don't miss this special panel discussion at the IHRSA 2000 International Convention and Trade Show-Why The Financial Community is Bullish on the Club Industry.
Moderated by Rick Caro, chairman of Spectrum Clubs, the panel discussion will feature leading investors and financial analysts, including David Wong, managing director, Brentwood Associates; David King, managing director, McCown DeLeeuw; Michael Finkleman, managing director, BNP Credit Markets; and Paul Roukis, senior equity analyst, Sidoti & Co L.L.C.
The panel discussion will reveal:
* What has made the club industry attractive to private equity and large banking markets;
* What experts think are the key drivers for the industry over the next five years;
* The difference between the public and private markets;
* How real the consolidation market is and how it impacts you, and;
* The challenge of accessing the public and private equity and debt market.
Why The Financial Community is Bullish on the Club Industry, Session C38, will be held on Thursday, March 23, from 1:45 to 3 p.m.