Summary
Life Time Fitness (LTM or the “Company”) represents an attractive long investment opportunity in the low $40s per share. The Company has a differentiated product, hard asset coverage (maybe $1bn net book value of real estate v $1.8bn cap), attractive unit economics, and compelling growth opportunities. The valuation is attractive at 7x EBITDA, 10x EBIT, and 14x P/E 2014. Earnings growth should accelerate as 2013 and 2014 club openings ramp, which should fuel a re-rating of the stock toward a fair value of $60+ per share.
Background
Life Time Fitness is a chain of 108 high-end mega-gyms. Since its founding in 1992, LTM has been led by Bahram Akradi. Previously, Akradi led US Swim & Fitness Corporation, a small fitness chain, which was later sold to Bally. Akradi is a health and fitness zealot who founded LTM to be the ultimate member-friendly gym. He is Chairman and CEO and owns c 6% of the Company
The LTM concept is akin to an upscale YMCA. Clubs are located in the suburbs and, in addition to standard fitness equipment, feature full sports facilities (e.g. squash and tennis courts, indoor and outdoor pools), catering to all family members with programs for the elderly and childcare services. Clubs offer tiered memberships which run from $50 to 160/month. Average member income is $100k+. The business is growing via box expansion (i.e. 3 new locations in 2013 and 6 new planned for 2014), regular price increases, and expansion of services per member (e.g. personal training, etc).
The gym industry has a bad reputation within the investment community given typical lack of differentiation, low barriers to entry, and absence of meaningful scale advantages. There have also been some notable failures such as Bally which reinforces this view. However, the LTM concept is extremely differentiated and difficult to replicate. Upfront capital investment of $30-50 million is unheard of within an industry where low-end competitors open clubs for c $200k. Thus, the clubs are much fancier than competing gyms, and have a much broader offering that is boosted by network effects such as the availability of many different exercise classes. While the fitness industry has traditionally been plagued by low barriers to entry, LTM has created a high barrier to entry concept which has little direct competition. There is also a first-mover advantage once a Life Time gym is established in a particular market that dissuades new entrants and potential copycats. It should also be noted that LTM has considerable expertise opening new clubs and operating them successfully which we believe is also a barrier given the high risk involved in opening such large clubs. Overall, LTM is unique in its size and track record of earnings growth.
As the company offers all memberships on a month-to-month basis with relatively low enrollment fees, the strong track record of revenue and earnings growth demonstrates high levels of customer engagement and satisfaction. For that reason, the company has been able to pass through low-single-digit dues price increases and increases in other in-center revenue per member. Bears insist that annual attrition levels in the mid 30s are high and suggestive of a weak business, but attrition has been relatively consistent over the years and has not prevented earnings growth. Clubs are managed to maximize value rather than retention, such that NPV positive price increases are taken at the expense of retention.
ROIC
LTM has attractive return characteristics, generating levered equity returns in the high-teens. See illustrative unit economics below for Diamond and Onyx tier centers where management is focusing near-term growth.
Capex: $40-50m
Membership Capacity: 10k
Utilization at Maturity: 90%
All-in Rev/Member/Month: $180-220
Inc EBITDA Margins: 45-50%
Annual D&A/club: $1.5-2.0m
LTV: 50%
Cost of Debt: 5%
Taxes: 40%
Earnings/Equity: 16-21%
Growth Opportunity
Believe the Company can grow earnings c 15 - 20% for the medium term. The Company has demonstrated its ability to raise pricing above inflation of its fixed costs and believe the company can generate c 5 - 10% earnings growth organically via price increases, increases in in-center revenue and fixed cost leverage. In terms of expansion of its footprint, the Company has plenty of white space for growth and plans to open 6 new Diamond / Onyx clubs per, which we believe translates into another c 10% growth in earnings.
Valuation
The current market valuation of LTM at $43/share represents c 7x EBITDA14, 10x EBIT14, and 14x P/E on consensus forecasts. This seems disconnected with a business with attractive fundamentals, strong growth opportunities, and net book value of real estate assets of c $1bn, especially since we believe that 2014 understates the earnings power of the Company given higher expenses and lower revenues associated with new club openings in 2014 compared with 2013. Believe fair-value of LTM is $60+ per share based on high-teens P/E 2014 and 9-10x EBITDA. One can arrive at a similar valuation using an LBO valuation analysis assuming limited club expansion and 20% sponsor returns.
Key Risks
>Fourth Quarter Results and 2014 Guidance: The Company is scheduled to release earnings this week. Do not have a view on the quarter per se; however, overall weakness in consumer spending discussed by others suggests soft economic backdrop for the Company. Further to this, the CFO of the company is retiring and his replacement has not yet been named. The changing of the guard here may lead to conservative 2014 guidance.
Mitigant: Believe the soft consumer backdrop and issues around CFO transition are already understood by the market and to some extent incorporated in the current stock price.
>Execution. Team must continue to manage complex club openings and current portfolio.
Mitigant: Company has demonstrated a successful track record over the last 20 years.
>Gym Competition. New competition focused on LTM markets and customers could suppress returns.
Mitigant: Thus far the Company has not faced significant direct competition using similar concepts in its own markets.
>New Fitness Concepts. Emergence of smaller fitness concepts (such as CrossFit) or disruptive technologies (such as Fitmob), which matches independent fitness trainers and athletes could steal mindshare from customers and depress club performance.
Mitigant: The size of the LTM gyms allows for flexibility to change equipment and classes to adapt to changes in fitness trends.
>Cyclical. Gym memberships discretionary purchases, which could be paired back in an economic downturn. Earnings could suffer a material pull-back given the high fixed cost nature of LTM’s business.
Mitigant: LTM managed the last recession rather well notwithstanding elevated attrition in 2008 and 2009.
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.