Description

Why Basic Fit? Basic-Fit (BFIT) presents the opportunity to invest in a best-in-class owner led company that has become the leading gym operator in the fitness industry in Europe by using a ‘scale economics shared’ approach to improve the customer value proposition while also ensuring the business improves with scale. This approach allows BFIT to take share in their markets while also growing the market itself by increasing fitness penetration and increasing the total addressable market (TAM) available. Should BFIT reach the club growth that management guided to at their recent CMD then revenue would grow at a >15% CAGR over the next decade with ‘mature’ owner earnings per share growing at a rate closer to 25% p.a.. Basic Fit currently trades at c.11x my estimate of this year’s mature owner earnings and I think the stock could compound at a c.25% + annual rate over the coming decade to 2030.

I. Background: BFIT is the largest fitness operator in Europe, currently operating over 1,100 gyms. The company has guided to tripling the store count over the coming decade and operating up to 3,500 gyms by 2030. BFIT are now active across six markets. Basic Fit is run by René Moos, a former professional tennis player from the Netherlands. When René’s tennis career finished he started running health clubs in the Netherlands which he turned in to a larger business before pivoting to the low-cost gym model in the 2000s when he observed what was happening in the US market where Planet Fitness, the largest low-cost gym franchise in the US, was growing the overall fitness market and taking outsized incremental market share by pioneering a low-cost value proposition to attract customers who previously hadn’t used a gym and now had access to a low-cost gym near them. René and the management at BFIT bet heavily on the low-cost gym model working in Europe, first scaling in the Benelux area and later in France and Spain. Basic-Fit was brought public in 2013 at a price of €15 per share. The largest shareholders at the time the private equity group 3i and René/ management. René owns c. €400mn of stock at current prices, or c.14% of the shares outstanding. 3i have gradually sold down their stake and now own less than 7%. 

II. Industry: Why low-cost/ value fitness is winning: The three main criteria customers care about in relation to gyms are (a) price, (b) convenience and (c) quality. Most people care about the first two, and this is why the low-cost gyms that are opening increasingly close to potential customers and which are available at a low price are winning share. Over the last 20 years, the gym industry has undergone similar shifts that other industries have seen. We see this low-cost model winning across many industries. In Europe for example, Ryanair and other low-cost carriers have been the big winners in the airline industry while low-cost German retailers like Aldi & Lidl have taken share in retail. The gym industry is proving to be no different with Europe following the path of what has already happened in the United States. Over 80% of the net new member growth in the US, the UK and Europe has been taken by low-cost fitness chains over the last 10+ years, with the vast majority of this going to the top chain(s) in those markets. 

We are now seeing an emerging ‘Premier League’ of operators emerging in different geographies who are sharing their growing economies of scale with customers by opening more gyms at low prices. These low-cost gym chains have the dual advantage of (a) higher EBITDA per gym (operating tech-enabled gyms with a lower labour requirement, lower running costs and operating leverage on their overhead/ marketing costs) as well as (b) lower initial investment requirements to open a new unit (due to standardized layout/ equipment as well as centralized planning/ purchasing for new units) which combine to produce much higher returns on capital for these scaled operators.

(Source: PureGym Investor Presentation)

While gyms historically catered for the wealthier members of society, the advent of low-cost fitness chains, first pioneered by Planet Fitness in the US has led to a massive increase in the number of potential gym members available as well as an increase in the share of the total market that low-cost gyms have taken. Low-cost gyms unlocked huge untapped latent demand, much like Ryanair did for airline travel, by offering consumers a basic, no-frills experience at a price point that was attractive. Members of scaled low-cost gyms also got access to other clubs in the network which increased the value of the customers membership.

The value fitness operators also changed the nature of the customer decision. Whereas previously customers would have to commit for a year at a time, now they could commit month to month. This turned a one-time c. €500 decision at the old mid-market gyms to a recurring €20 decision at chains like Basic-Fit which offered increased flexibility. This is a more attractive option for people with less disposable income. On top of this, gym members also choose based on convenience of the location of gyms relative to their home or workplace. The increase in the number of gyms, enabled by the low-cost model, that were close to people unlocked massive latent demand as bringing gyms closer to customers reduced the barriers to actually turning up. Most people find going to the gym regularly difficult anyway, if that gym is located far away the chances of going regularly become much smaller over time. That is why locating gyms closer to the customer has the dual benefit of increased customer satisfaction/ value and increased customer retention. 

The fitness industry has been bifurcated by the offering that low-cost fitness chains have brought to the market. Whereas previously there was little or nothing to offer to consumers at a low price point and mid/ high market gyms owned the market, the market has since been increasingly divided in to low-cost gyms who took massive share from the mid-market and high-cost gyms who are catering to members who want a more premium experience which the low-cost gyms don’t offer. The low-cost operators generally have bigger clubs with typically 2x-3x more members per club on average. For example, in Germany, the market share for the top 10 leading operators in terms of numbers of clubs was 13% in 2019, but member share was almost triple this at 38%. This gap has likely only increased as a result of COVID across BFIT’s markets as smaller operators struggled to survive during the pandemic and many were forced to shut down.  

The European gym industry as a whole should also benefit from an increase in overall penetration from the current c.10% rate across Europe to a level closer to the c.20%+ in the US and Scandinavian countries which serves to make mainland Europe, and Basic-Fit’s geographies particularly likely to benefit from an attractive industry growth tailwind over the coming decade.

III. Business: (a) Why Basic Fit are winning- Scale Economics Shared: Basic-Fit is now the #1 player in Benelux (BE, NE and LUX) and France. BFIT expect to be the largest operator in Spain by the end of this year with 100 units. BFIT is also growing the most across these markets. So why is BFIT so dominant? The simple answer is scale economics shared (SES), a concept pioneered by Sleep/ Zakaria of the Nomad Partnership.

Instead of maximizing the short-term profit of existing clubs in an area, BFIT will pro-actively decide to self-cannibalize their existing store base by opening more clubs in the same area and creating a ‘cluster’ to maximize their long-term market share and keep competition away while also increasing the value of a membership to the customer in the cluster at no extra cost. By using this ‘clustering’ strategy Basic-Fit are choosing to compete with their existing stores instead of leaving room for external competition to potentially enter. This is similar to how Domino’s Pizza operates with their fortressing strategy whereby Domino’s adds more restaurants close to their existing stores so the customer can order/ collect from a store that is closer to them resulting in faster delivery and fresher food while the company gets the benefit of higher route density, marketing efficiencies, incremental carry-out sales and increased customer satisfaction. By focusing on the long-term BFIT keeps the flywheel spinning and makes it increasingly difficult for potential competitors to offer the same value to customers at that price point.

BFIT are happy to keep adding more gyms to the cluster as long as they are still meeting their ROIC targets of at least 30% on an individual and cluster level. They get scale economies from building and servicing these clubs in the same location as well as efficiencies on marketing, cleaning crews, management time and more. BFIT can then decide to include a space for group fitness classes in only one of the three gyms which allows the minority of people who highly value these classes to access them while also enabling Basic-Fit to use their space more efficiently in the other clubs they operate within the cluster. Members that may not have had access to classes in their first BFIT gym can then access this facility in other local clubs that do. BFIT then share this scale with members as a member of the first club that was in the city can also use the second and third club at no incremental cost to their existing membership fee. A typical example might be someone who went to the gym near their workplace who can now also use the Basic-Fit gym that has just been built near their home, something which is particularly useful post-COVID.  BFIT have actually shown some evidence to investors that their cluster strategy is paying off without cannibalization using the example of two cities where the club visits per day were actually higher in the cluster clubs than the national average.

On membership pricing, it is interesting to note a comment from the FY21 results presentation this month particularly in the context of rising inflation and how BFIT are dealing with this vs competitors.

Question: ’First of all, on pricing. What do you see in the market since reopening? I have seen some other players feeling some are even slightly increasing pricing. What are you seeing in general on pricing?’ 

Answer: René Moos, CEO: ‘About the pricing increase with the competitors, we've seen that, especially in the U.S., a lot of companies increased their prices, but also more local in the Netherlands. And in France, we see some of our competitors increasing prices. This is not our goal. Our goal is not to increase prices, but our goal is to get more members into the premium membership. So that way, our yield will grow a bit but we have no plans to increase prices in the -- for this year or next year.

(b) Unit Economics:

Revenue: BFIT’s revenue model is simple with c.97% of revenue coming from membership subscriptions. The remainder comes from high-margin ancillary revenue such as add-ons etc. BFIT should increase their membership yield as there is more up-take of the premium membership option and the number of members per mature club should increase over the next decade as the clubs mature.

Club Costs:

(i) Rent- BFIT spend c. €150k per club on rent on average. I expect this to stay roughly fixed as a % of revenue over time and to rise in absolute terms c3% p.a. as rents increase annually. BFIT are a more desirable tenant when compared to independent operators in the space given their credit quality and the higher foot traffic they drive as well as their increased creditworthiness as a tenant.

(ii) Labour- BFIT spend c. €130k per club on personnel expenses on average. BFIT have slowly reduced their full-time equivalents (FTEs) by investing in labour saving technologies like cameras equipped with microphones. These cameras are included in all newly built clubs and some existing ones which allow the clubs to operate 24/7 (currently c.400 operating 24/7 in Benelux). These clubs are un-staffed, remote only for off-peak hours from 11pm at night. Over time, BFIT could potentially open up clubs without any labour at all. They would then have the option to either re-invest the labour saving in classic scale economics shared style by lowering prices or adding more clubs or they could increase their margins. I would think that BFIT would share at least some of these scale savings with their customers. This is an investment that independents and smaller chains are not making and likely will not be able to replicate and thus serves as a competitive advantage for BFIT. Most gyms typically operate with 6 or 7 FTEs which means they have much higher break-even costs when compared to BFIT who can run a club with 2.5 FTEs, a number that will likely come down further over time.

(iii) Other Costs- BFIT should see some modest operating leverage on the other cost line in their clubs over the long-term as they introduce innovations such as remote facility management to ensure efficient heating & cooling of their buildings. Short-term we may see some pressure in this area due to rising energy costs but BFIT have already fixed all utility costs until 2023.

Central Costs: As the company grows from 1,100 clubs today to 3,000 or so in 2030 the company should see material operating leverage on their central costs. Overhead costs, which should come in at c.12% of revenue in 2022 consisting of c.8% for HQ overhead and c.4% for marketing. Over time, BFIT are guiding for HQ overhead to be reduced to 4%-5% of revenue and for total overhead of c.8%-10% of revenue. Longer-term, central costs can go below 8% of revenue as BFIT continue to see increased operating leverage on their fixed cost base as they add additional clubs.

(c) Competition: It is clear that BFIT has an advantage over their independent and small chain competitors given their scale advantages such as their 30%-50% cost advantage in fitness equipment purchasing, lower labour requirements, operating leverage on OPEX as well as operational advantages from centralized planning and a standardized layout etc. Even if we look at the larger chains, BFIT are still advantaged, adding more units this year than most of their competitors have in total units. For example, Basic-Fit is more than double the size of PureGym, the #2 operator in Europe. PureGym have the vast majority of their gyms in the UK and Denmark, countries BFIT are not active in. Could the likes of PureGym be a threat if they come to mainland Europe? They could try and compete, but are less than half the size of Basic-Fit. Why would they go after BFIT when there are more attractive places to go without picking a fight with the 800-pound gorilla of Europe.  On top of this, PureGym are busy competing in their main market of the UK, one of the only markets where there are two operators who are vying to be the dominant low-cost operator. Nobody I have talked to thinks it would be rational for PureGym or others to start a fight with BFIT. We even got a signal that PureGym are looking across the Atlantic with the news that they are investing $20mn to open three sites in the much larger US market which is likely more attractive than competing with Basic-Fit. 

IV. Growth: (a) Clubs: Existing- BFIT currently have c.1,100 units. Management have a clear plan to grow to 2,000 units in existing markets by 2025. Basic-Fit are currently #1 in all of their existing markets except for Spain, where they should be #1 Spain by the end of 2022 when they plan to have 100 clubs open. Spain can be a big market for BFIT given only 12% of the country is inhabited by fitness clubs vs c.80% in Benelux and c.60% in France. Spain is one of the most fragmented markets in Europe as there is no clear leader. The largest player has less than a 5% share of the market (c.80 clubs)  

New Markets- Countries such as Germany will be a large driver of helping Basic-Fit grow to their guide of at least 3,000 clubs by 2030. Germany is the largest fitness market in mainland Europe and Basic-Fit think there is a huge opportunity here given the fragmented nature of the market. The main competitors are either franchise models or owned operators such as McFit who are struggling under the weight of a high debt load and are not growing. BFIT are opening their first clubs here in 2H22 and think there is an opportunity to grow to 600 clubs in this market.  BFIT have also reviewed eight other countries which could follow over the medium-term. These would be other countries in Europe that would be attractive to enter, BFIT would likely start with countries close to existing operations such as Portugal, Switzerland, Poland etc. 

(b) Other: BFIT have acquired clubs in the past and I wouldn’t rule this out happening again in the future given the likely distress among some operators in Europe. BFIT are also adding a direct-to-consumer fitness product, with the release of their at-home, Peloton style bike whereby consumers purchase a subscription to BFIT’s gyms + the bike for a period of time. I don’t include any potential uplift in revenue/ profit in my model for this element of the business but if it gets the uptake that management think it can then it would be an additional valuable, high-margin revenue stream.

V. Financial Model: Economic Consequences of Growth 

Should Basic-Fit achieve the planned growth outlined above successfully, it will have large positive economic consequences for shareholders. The other key element in the model that matter for getting to the core economic earnings of BFIT is to subtract the maintenance CAPEX required to maintain the clubs. Given there is a mix of mature and growth clubs in the current club portfolio the company has guided to a number of €55k per club on average for Maintenance CAPEX over the next five years. The maintenance CAPEX on new stores is minimal and BFIT have guided to maintenance CAPEX of €70k per club at maturity. (8% of revenues) 

Basic-Fit have €548mn of net debt as of FY21, or c.2.3x FY22 underlying EBITDA. BFIT have consistently negative net working capital on the balance sheet (15%-20% of FY22 revenue) which helps to drive strong operating cash conversion, averaging around 100% of underlying EBITDA. BFIT receive payments from memberships up-front and have payables related to purchases of equipment/ club openings. BFIT will maintain a minimum liquidity of €100mn. BFIT have said that as FCF sequentially improves following the re-opening of clubs, they should be able to finance club growth predominantly from internally generated cash from 2023 onwards. BFIT have guided that they will keep their ND/ EBITDA ratio between 2x-2.5x over the medium term. On capital allocation, BFIT’s main capital allocation happens at the operating level. BFIT has no intention of paying a dividend over the medium-term as they prefer to re-invest in the business instead.

VI. Valuation: When looking at the valuation, I like to look at two things: How much can I lose if my assumptions are off? And how much can I make if it all goes to plan? Given rule #1 is never lose money, I will start with the downside. BFIT currently trades at c.9x my estimate of mature EBITDA based on the 1,100 or so clubs that are currently open. This is in the same ball-park as some of the recent sector transactions involving similar businesses (on a pre IFRS-16 basis). I don’t think we are over-paying for the current business at these prices and I think we have a low chance of a material impairment of capital even if the business doesn’t grow from here given the quality and scale of BFIT’s existing club operations.

Basic-Fit has the potential to grow at a high rate for a long time while also gushing cash. If BFIT can continue to grow in-line with their club roll-out targets, at similar unit economics to their existing clubs while also seeing operating leverage from increasing economies of scale, this would result in increased EBITDA margins on a much larger revenue base. If we also assume that BFIT maintains leverage around the 2.5x ND/ EBITDA level and uses excess cash for buybacks then I believe that mature owner earnings per share can grow at a rate of c.25% p.a. over the coming decade and we can compound our capital at a similar rate without assuming any multiple expansion. On top of this, I believe if BFIT were to achieve all of this and as returns on invested capital increase, they could see multiple expansion to get somewhat closer to the valuation of their large US (franchise) peer Planet Fitness (PLNT). BFIT management also believe they can grow to much more than 3,000 clubs after 2030 given there are currently c.63,000 gyms in Europe and the market should further consolidate over time. BFIT has the potential to return a 5x - 10x+ MOIC (multiple of invested capital) over the coming decade for a c.25%- 30% IRR.

VII. Risks: The main risk to Basic-Fit are (a) return of COVID/ other virus which shuts down clubs again, (b) increased competition from other operators, particularly if other ‘premier league’ players try to compete in the same geography which could impair club economics and growth targets and (c) if management, particularly René, the CEO, or Rédouane, the COO leave.

VIII. Summary: Basic-Fit meets my criteria for investment as it is a high-quality business run by exceptional and aligned people, with a clear re-investment runway to drive growth, available at a reasonable price. We get the chance to partner with a high-quality European fitness founder with significant skin in the game who has a strong track-record of shareholder value creation (20%- 6yr CAGR). We are investing in a classic scale economics shared business model that improves the customer value proposition which drives the flywheel and enables Basic-Fit to grow and dominate their markets. Basic-Fit has a clear pathway to triple the size of the business over the coming decade by self-funding their expansion and by consolidating the fragmented European fitness market. We can invest in a business that could grow owner earnings per share at a rate of c.25% p.a. over the coming decade for 11x my estimate of this year’s mature owner earnings.

Other: I had written this up for internal purposes and thought I should upload it on VIC given the updated growth plans and guidance from the CMD in Nov 2021 as well as the commentary from the Full Year results earlier this month which meant there was some additional commentary from management which gave greater clarity over future plans as well as how the management would run the business in an inflationary environment. (resisting temptation to raise prices)

On VIC- althea had a great write-up in Nov 2020, particularly focused on the opportunity presented by COVID sell-off and which sums up the investment case very well. There has also been some very insightful commentary on that message board that pre-dates my involvement with the company.

I want to note some other good work on Basic-Fit out there:

Jonathan Abenaim/ Arlen House- presentation & business breakdown podcast

David Polansky & Tim Delaney/ Immersion Investments- letter (BFIT on pg 7)

Vadim Perelman- article & interview 

Catalyst

• Members returning to clubs, targeting average number of memberships per mature club of around 3,300 in 2022. Next update- 21 April.
• Normalization of financials post-COVID- company's IFRS financials currently look bad due to COVID club closures in 2020/21 but will improve.