Description

Short -- Life Time Group Holdings (LTH US)

Life Time is a highly levered recent IPO that has a business model that is fundamentally impaired post-Covid. Life Time, despite structurally lower membership numbers and continued free cash flow burn on existing clubs, is continuing to take on more leverage and build new clubs. Fitness businesses are, by their nature, fad -driven businesses and the current trends have moved away from Life Time. So far, as a new public company, Life Time has disappointed investors with lowered membership and EBITDA guidance. We believe there is a lot more downside to go. Despite these troubling trends, Life Time is still trading at 14x CY EBITDA. Life Time has a 10% short interest and can be borrowed at GC.

Company Overview

Life Time operates 153 premium health and fitness clubs around the United States and Canada. Life Time is a high-end fitness offering with average monthly revenue per member at ~$180. Life Time clubs are built in affluent suburban locations and average ~100,000 square feet (vs 5,000-10,000 square feet for Planet Fitness). The cost of new clubs is in the $50-$60m range and have historically needed 10,000 to 11,000 members to earn the appropriate level of return.

VAR Completed

We conducted >10 VAR calls with industry consultants, former employees and executives at competitors. We have also analyzed credit card data and website visitation data.

Thesis

1. Life Time’s members are not coming back after Covid – this calls into question the entire business model

Life Time lost 40% of its members over the course of 2020 due to Covid, or close to 350,000 total members. The company came to the public markets late in 2021 promising the street a compelling Covid re-opening story with fast membership growth, high incremental margins, new club openings and robust revenue growth over the next few years. In the last four quarters, with virtually all of the clubs open, Life Time only added net 67,000 new members TOTAL, or only 20% of the members it lost in 2020. In our conversations with Industry consultants, we learned that this trend is not an industry wide issue, but seemingly more idiosyncratic to higher end gyms like Life Time Fitness and Equinox. Value gyms and boutiques are back to pre-pandemic levels with many above ’19 levels. For example, Planet Fitness is close to 100% of ’19 membership levels with many clubs above ’19 levels. Life Time is still materially below this (see below)

Fitness trends have gone the opposite way of Life Time -> smaller scale boxes, cheaper prices, digital offerings, at home workouts, etc.

In a troubling strategy, Management realizes the members are not coming back, so in an attempt to still make the math work, the company is raising dues 10-20+% across the portfolio. For example, many clubs’ dues were raised earlier this year from $179/m to $219/m. The problem with this strategy is that 30% of current members don’t ever come to the club and management is still trying to attract back those who dropped during Covid, so this pricing strategy makes it that much more likely the membership numbers will not rebound. In addition, ~35% of pre-pandemic revenue came from on-site extras like personal training, spas and cafes. With total membership at a structurally lower number, this revenue stream will be permanently lower. Our conversations with fitness experts and Life Time formers confirms this fact - at 100,000 square feet and 300-350 employees per club, Life Time clubs cannot be running at 70-80% of pre-pandemic membership levels in order to generate the 20% margins that is promised by management. The math just doesn’t work.

2. Life Time is HIGHLY levered and relies on robust capital markets to maintain and grow its business

Life Time’s net debt/EBITDA is 6.6x on ’22 EBITDA and does NOT include $1.8bn in operating leases. The company has been burning FCF, even prior to Covid, as it is investing hundreds of millions of dollars a year into new and existing clubs. If we give them the benefit of the doubt and define FCF as operating cash flow less maintenance capex (which is disclosed), the company is still burning FCF.

So how is Life Time is funding its business? It is funding it by selling real estate in sale leaseback transactions over the last few years. If and when the capital markets close down, Life Time will not be able to fund its rapid expansion and could run into debt problems on its term loan due in 2024 and both tranches of notes due in 2026.

3. Highly susceptible to a weakening consumer and competition from much cheaper alternatives

Life Time is attempting to charge $220+ per month compared to lower cost gyms like Planet Fitness that charges $25 for its highest level. Life Time, like other gyms, traditionally sees 3-4% attrition a month. In order to maintain flat membership levels, it needs to replace almost half of its members per year. ~80% of Life Time locations are within a 5 mile radius of a Planet Fitness and over 90% are within 5 miles of Orange Theory:

Home and outdoor fitness solutions are widespread after Covid and offer MUCH cheaper alternatives to Life Time. Any consumer weakness is going to hurt Life Time pretty dramatically given the highly discretionary nature of the offering and the plethora of cheaper alternatives.

4. Despite much lower membership numbers and weak mature club economics, Life Time is continuing to take on debt and build new clubs and other facilities in highly competitive areas

Life Time’s current clubs are operating at 75-80% membership levels compared to pre-covid numbers and there is no reason to believe these numbers are going dramatically improving anytime soon. In fact, in the last earnings call, Life Time guided to FLAT membership net adds for the second half of 2022. In order to continue to show the street topline growth, management is guiding to building an additional 10-12 clubs per year at a cost of $50m-$60m per club. The industry consultants we spoke with believe management is doing this purely in an attempt to boost headline membership levels and revenue growth, despite the fact that the returns do not justify such spend. In addition to continuing to build out traditional health clubs, Life Time is entering the luxury condo business with a recently announced new property just outside of Las Vegas.

Conclusion

The history of the fitness club business is filled with fads and bankruptcies. Life Time is on the wrong side of current fitness trends. Given the size of the investments made by Life Time, the math does not work at structurally lower membership levels. Over the next 6-12 months, we believe Life Time will report disappointing membership numbers which will reverberate through the income and cash flow statements and lead to liquidity issues.

Valuation

Life Time will continue to disappoint investors and EBITDA will not reach its expected 20% margins, leading to continued lowering of consensus expectations. We are 10-12% below consensus for next year. Using a fitness industry historical average multiple of 8x, we are getting to >40% downside in the stock in our base case.

Catalyst

Earnings Disappointments