Putting the Pieces in Place: Looser credit opportunities are stimulating market activity in the health club industry, which could result in consolidation.
When the recession hit in late 2008, Life Time Fitness, like so many club companies in the industry, curtailed its plans for expansion. Whereas Life Time had planned to open 10 to 12 clubs per year, the Chanhassen, MN-based company slowed that growth to about three new opens per year.
Now in the third quarter of 2011, Life Time is primed to accelerate its growth with more capital and less debt. In the second quarter, Life Time retired $70 million of mortgage debt and increased its credit facility from $470 million to $660 million, extending its term to June 2016. The company now has bank commitments totaling nearly $900 million.
“This speaks volumes about the strength of our balance sheet and cash flow,” Life Time CEO Bahram Akradi said in a second quarter financial call with analysts.
The company plans to grow its number of clubs through both new builds and conversions, although Akradi wouldn’t offer specifics, only saying, “We’re all over it.”
Life Time is just one company eyeing expansion. Other companies that are private have made overtures, according to various industry sources, over the past few months. The major players either have the cash or are more able to get the credit to grow their companies. The result could mean industry consolidation, likely driven by only those major players.
Several companies, like Life Time, have adjusted their credit facilities. Last year, JP Morgan launched a $675 million loan to refinance debt at 24 Hour Fitness, San Ramon, CA. The refinancing, according to an Internet report, will eliminate significant debt maturities this year and next.
Also last year, Equinox, New York, increased its debt facility from $400 million to $425 million. Earlier this year, Town Sports International (TSI), New York, refinanced its $350 million debt that includes a seven-year loan facility that matures in 2018.
(After this story went to press, TSI, during a second quarter earnings call with analysts, reported its best results since fourth quarter 2008. Also after this story went to press, Equinox announced it had acquired The Sports Club Co.)
All of this is good news for the industry, says Mark Mastrov, co-founder and chairman of New Evolution Ventures, Lafayette, CA, which operates Crunch, New York.
“The banks have opened up and started to refinance some of these bigger companies out there,” Mastrov says, “which means there’s a trickle-down effect for the regional players and the mom-and-pops to go out and get refinancing.”
It also means companies armed with new financing are better equipped to grow, and, perhaps, to wheel and deal.
Although no major club deals had been announced as of press time, two deals were close to realization. In April, LA Fitness, Irvine, CA, was reportedly in talks to acquire Urban Active, Lexington, KY, but the deal fell through. LA Fitness had received a $300 million acquisition loan from GE Capital prior to almost acquiring Urban Active. Sources say that LA Fitness may still use the loan for another acquisition.
The biggest speculated deal in the industry, prior to press time, involved rumors that Gold’s Gym International, Irving, TX, was acquiring Bally Total Fitness, Chicago. Despite having knowledge of the negotiations, several industry observers nevertheless doubted that the deal would come off and questioned Gold’s motive for acquiring Bally. After this story went to press, a source said that Gold’s and Bally officials were meeting to discuss due diligence. Neither company would comment about the deal possibility.
One possible merger may be under the radar now but could intensify in the weeks ahead. 24 Hour Fitness is eyeing Lifestyle Family Fitness, St. Petersburg, FL, sources say. When asked about the rumor, 24 Hour said in a statement that it does not comment on market rumors or speculation about mergers and acquisitions.
A lot of factors are creating the market activity in the industry now as opposed to two or three years ago. First and foremost is the improving debt market, says Rick Caro, president of Management Vision, New York.
Another reason, Caro and others in the industry say, revolves around the timetable of private equity firms. After about five to seven years of investment in a company, private equity firms will seek a return on their investment through a sale or an acquisition. Forstmann Little and Co., for example, invested in 24 Hour six years ago when it bought the company for $1.6 billion.
A third reason, Caro says, is that potential sellers in the industry now realize that they did not have a realistic exit strategy.
“Prospective buyers were not willing to pay the prices of 2007 and early 2008,” Caro says. “Sellers were not willing to accept lower offers. Hence, few deals got done. [Potential sellers] are now willing to seriously explore deals where they would not have done so in late 2008 to 2010.”
One of those sellers could be JP Morgan, which, along with Anchorage Advisors LLC, acquired Bally’s equity from bankruptcy in 2009.
“If they can find a buyer that can come in and recapitalize what they lost, they’re probably going to put a transaction together at some point,” Mastrov says of JP Morgan. “But it’s a deep-pocketed bank that could hold onto [Bally] for a long time if they want to.”
Gold’s should have the wherewithal to make an acquisition. The company is privately owned by TRT Holdings Inc., whose portfolio includes Omni Hotels. TRT is owned by Robert Rowling, whose reported net worth is $4.2 billion, putting him 69th on the Forbes 400 list.
Partnership Capital Growth, San Francisco, is a boutique investment bank that has worked with several clubs, including Gold’s Gym, Equinox and Anytime Fitness, Hastings, MN. Over the past 12 to 18 months, 24 Hour, LA Fitness and Life Time Fitness have all improved their ability to complete transactions, says Brian Smith, director of Partnership Capital Growth.
Eric Schiller, vice president of Partnership Capital Growth, adds: “A lot of entrepreneurs have been looking at timing of the market and when is the time to exit. I think that the market now is starting to heat up, and we will see some exits in the next 12 to 24 months.”
Although no major health club deals have been consummated so far this year, most industry observers agree that the fitness industry is heading toward consolidation.
“I think there’s some consolidation going on in the industry for two reasons,” Mastrov says. “One is that some of these club groups are having to come to market and sell. [And], people with good balance sheets are capable of doing larger deals. It’s pretty obvious that LA Fitness has a very strong balance sheet and they can do whatever they want to do. They’re by far the strongest financial company in the industry, in my opinion. If you look at Gold’s, you have a very wealthy individual who owns that business, and he has the firepower to pull off a transaction like acquiring Bally.”
But to what extent of consolidation is the industry heading? The 2008 documentary film “Food, Inc.” outlined the growing consolidation in the food industry, where only five or fewer corporations control the majority of that industry. Observers in the club industry say the fitness business will not experience the same result because this industry still has too many clubs for just a handful of club companies to control.
“The biggest chain, outside the YMCAs, has 400 [clubs],” Mastrov says. “Even if the top five guys got to 1,000 each—which would be a miracle—it would only be 5,000 of 35,000 clubs. It’s just not an industry that consolidates that easily, and it’s not an industry that I see getting to that kind of a point any time soon.”
Smith echoes Mastrov’s opinion that consolidation may not be realistic right now because only four operators have the scale and ability to buy a lot of assets to force consolidation in the marketplace.
“With that, you need a robust credit market. In the last 36 months, we have not seen that,” Smith says. “And so their ability to take on leverage to pursue acquisition has not been there.”
Smith adds that 24 Hour, LA Fitness and Life Time, while having the most capital to work with, are being disciplined in what they are willing to pay. Because there are a lot of opportunities in the marketplace, companies are not willing to pay seven to eight times EBITDA (earnings before interest, taxes, depreciation and amortization), which makes it more difficult for private equity firms that want to exit to do so, Smith says.
Schiller adds that larger strategic companies are deploying capital with a 25 percent-plus expected return on their investment, which means they need to exceed a 25 percent return when they buy a club. Purchasing an existing club requires rebranding, which requires cash, and spending cash on rebranding diminishes the returns more than building a new club in an existing brand.
“I think that’s why we haven’t been seeing a lot of consolidation to date,” Schiller says.
That has not stopped some companies from considering acquisitions, but they are looking to do so at the lowest price because multiples are down and because it is still difficult for many companies to raise capital and borrow money, Mastrov says.
“I think a lot of people are looking to shop a little bit,” Mastrov says. “If there’s an opportunity out there, people will look. You’re going to need some serious cash firepower to buy some of these big brands, and there’s not a lot of money out there on the sidelines waiting to jump into the industry. That’s why you’re seeing more consolidation among players who might have capital like LA Fitness or Gold’s Gym.”
Whether or not those two companies close on a transaction remains to be seen.