Description

1. Business model

SmartFit is LatAm's largest fitness group, with more than 1,000 clubs (80/20 owned/franchised) across 13 countries (55% in Brazil, 20% in Mexico) and almost 3 million members. 

SmartFit offers a no-frills, great value for money proposition, focusing on core services (cardio and strength) with no swimming pools, courts or restaurants. Clubs are relatively small (1,200 sqm) and monthly fees range from US$15 to $25. This price point compares with mid-market gyms from US$25 to US$70 and high-end gyms starting from US$70. SmartFit’s clubs are located in metropolitan areas and cities with more than 100k citizens with high per capita income. 

Like its European counterpart BasicFit, Smartfit adheres to a cluster strategy. Clustering is the process of entering a local market with a large number of stores designed to immediately build out high density. Density matters because as more members join, the value proposition becomes better. Although the clustering approach cannibalizes the existing store base first, it increases the value proposition to consumers over time, resulting in share gains. Clustering confers two main advantages. 

1) Convenience to customers by reducing travel times and offering multi-location access. 

2) Increases the barriers to entry by winning on convenience and having a large store network at the local level. For a new entrant to compete, it would need to build out the infrastructure ahead of demand formation and also make sure it has a large enough scale to make decent returns. 

Clustering in summary makes sense because at the cost of some level of cannibalization it makes it effectively impossible for others to compete while the incumbent shares the scale advantages and remains profitable with lower level of members per gym vs the level of members that less efficient and smaller competitors need. 

SmartFit expands its value proposition through an app that offers nutrition, streaming and also improves the inside-gym experience with training.

In addition to the high-value/low-price model, SmartFit also owns 25 high-end clubs under the Bio Ritmo brand in Brazil and a training streaming platform with online and offline programs called Queima Diaria. However, 95% of value in the business comes from owned operated SmartFit clubs.

The unit economics of a low cost gym are as follows:

• Initial capital is employed in construction (2/3) and fitness equipment (1/3). Asset life of initial outfit is around 15 years and around 7 years for fitness equipment (on a blended basis PPE asset life of 11 years)

• 6 months to open a club (2 months permits + 4 months construction) and 24-36 months to reach maturity.

• Operating costs are essentially fixed and mainly consist of salaries, rent and other expenses such as cleaning, utilities, etc. 

On a four wall club basis, post-tax returns are 20% (gross PPE) and 40% (average net PPE). Considering corporate, selling and general costs can reach 15% of revenues, post-tax returns on a company level are around 15% (gross PPE) and 25% (average net PPE)

BasicFit in Europe and Gym Group in UK have very similar returns both on a club and company basis.

Fitness industry

Low-cost fitness is a winning model in every market where it’s been rolled out and has increased and accelerated gym penetration. Some data. 

• 2010-2019 US low-cost model market share moved from 5% to 25% and fitness penetration increased from 16 to 21%. Planet Fitness captured 86% of net new growth from 2010-19

•  2010-2019 UK low-cost model share from 4% to 38% and penetration from 7 to 17%

• In France BasicFit captured 87% of net new growth from 2015-19

Why is the low-cost model winning?

• Offers better value proposition for customers -  Focus on delivering the things that fitness members always look for (convenience, quality & low prices)

• Disrupts the middle market - Middle market operators lose on most dimensions as their value proposition has become obsolete. Fixed costs prevent middle market players from pivoting to a low cost model. 

• Growing global awareness of health & fitness needs -  The percentage of population educated and aware of the benefits of exercising is increasing

LatAm fitness club penetration is still very low vs developed world (developed world 10-20% vs Brazil 5%, Mexico 3%, Colombia 2%, Chile 3%, etc). The main reasons probably have to do with: 1) poor gym experience and expensive membership costs  amid the absence of a low-cost/high value format), 2) low awareness fitness health benefits and 3) income levels.

We have seen Planet Fitness, Gym Group and BasicFit expanding their respective TAMs. Actually, about half of BasicFit members are new gym joiners.

Low-cost fitness groups tend to consolidate their markets (Planet Fitness 22% US market share, BasicFit 20% France and Benelux market share, Gym Group + Pure Gym 20% UK market share). SmartFit, with a 13% market share has room to keep gaining market share and consolidate its leadership position.

Covid has highly impacted fitness clubs across the world. The low traffic killed less-efficient competition in a mostly fixed cost business. Industry players in LatAm estimate that up to 30% of gyms in the region closed permanently during the pandemic. SmartFit raised BRL 2.5 bn in IPO July 2021 to fund organic growth while its two key competitors, SelFit and BlueFit couldn’t complete their respective IPO, further reinforcing SmartFit’s competitive position.

Quick recap

• SmartFit is LatAm’s largest fitness group by a wide margin, has strong unit economics that will eventually lead to c.25% ROCE on a company level

• The low-cost model has expanded fitness membership penetration in US and Europe and the vast majority of the expansion has been kept by the market leaders (Planet Fitness and BasicFit)

• SmartFit has already expanded and lead the LatAm’s fitness market but has still a lot of room to grow considering low penetration levels

2. Competitive Advantages

Scale advantage

SmartFit is the 4th largest fitness group in the world by number of members and is 8x larger than its closest competitor in LatAm, Bodytech. In Brazil, SmartFit has 15% market share and around 8x more clubs than BlueFit and SelFit, their main competitors.

Both global and local scale matter. It materializes in:

• Lower initial capex - Allows more bargaining power in equipment (~1/3 of store capex, acquired with up to 30% discount to market prices)

•  Lower rental costs - Landlords will offer better terms because of higher foot traffic, becoming the tenant of choice for landlords. Market leaders will drive higher foot traffic, rarely closes their stores, and always pay on time. So landlords pick SmartFit over any mid-market or independent operator, allowing SmartFit to build sites in the most attractive locations. This higher visibility in combination with national advertising - which no other gym chain can afford - and the unmatched value proposition, results in SmartFit ultimately filling its clubs with 3,300 members faster and at a lower cost than the average gym. 

• Leverage the app, marketing/advertising costs through the entire membership base

• High automatization and low employee base per club - SmartFit has 9,000 employees and 1,100 clubs (8 employees per club). We know that BasicFit is probably the world leader in terms of automation and employee headcount. They have 7,000 employees and 1,015 clubs (7 per club). However, on a club basis, they have around 1.5 employees per club. SmartFit has 8 employees per club, which indicates they are also efficient in that sense.

Constantly sharing economies of scale with members makes the business durable. Scale begets scale. by becoming more efficient both in capex and opex and passing those savings in the form of lower prices and more convenience, further reinforcing the value proposition. This effectively widens the gap with competition making the business more sustainable. As the first mover, once SmartFit got the network and the scale in a local market it proved very hard for others to compete or even enter the market. Network is valuable for members and actually 50% of SmartFit members pay for the more expensive "Black" plan to be able to go to any of its ~1,000 gyms in LatAm. 

3. Growth

There are currently around 21 million gym members in LatAm, implying a 3% penetration rate. As the low cost model increases its presence, and income levels and health awareness rise,  that penetration rate should catch up with the developed world, which is at 10-20%. Brazil has the highest fitness penetration rate and is still at 5%. Even if it doubled by 2030 it would still lie at the low end.

SmartFit has less than 3 million members which implies a 13% market share in LatAm. We have seen fitness group leaders (Planet Fitness, BasicFit) consolidating the industry and gaining market share reaching 20% plus share.

SmartFit plans to add more than 200 clubs per year (above historical rate of 170-190) from a ~1,100 base. They should be able to at least sit at 2.5x the number of clubs by 2030 (CAGR 11% or average 170 new clubs per year until 2030). This seems to be very doable. Just as a reference, BasicFit, in a more mature market, plans for 3x their fitness club base by 2030 with the same base.

By the end of 2022 60% of clubs will reach maturity. As the club network matures they will grow members per club at 3% CAGR, reaching almost 8 million members. Assuming the same market share it will imply a total market of 53 mm or 7% penetration rate. They will keep gaining share so the implied penetration rate should be lower, between 5-6%

This coupled with 4% annual increase in average membership price, equates with a top line 2022-30 CAGR of around 18%. On an EBITDA company level, due to club maturation, margins should go up from 21% to 35% implying a 2022-30 CAGR of 25%.

4. Capital allocation

SmartFit IPOd in July 2021, raising BRL 2.5 bn at BRL 25 per share (BRL 14.5 bn valuation), mainly to fund organic expansion. They will accelerate to 220+ clubs by 2023, higher than the 195 delivered in 2019 (10% through franchises). With the capital raised and internal cash flow, it can fund all the growth.

SmartFit has a franchise call option to buy back most of the franchisees in Brazil (154 out of 159) after 3 years from the opening, at ~6x predetermined EBITDA multiples. Outside of Brazil, SmartFit operates mostly with master franchisees and does not have this optionality.

As for M&A, SmartFit has opportunistically acquired gym clubs in the past to start operations in new regions/countries or to get premium real estate locations from competitors.

5. Management team and shareholder structure

Edgard Corona (Founder and CEO)

-          He studied chemical engineering in the 1970s

-          Different entrepreneurial ventures before going into the fitness industry

-          In the 1990s, he sustained a skiing injury that would land him in physical therapy. During his time in recovery, he would develop an understanding of how gyms worked, what they could offer the public, and how they could be improved

-          After focusing on a viable business model, he started Academia Bio Ritmo in 1996

-          Smart Fit was established in 2009, when the company opened its first gym in São Paulo. It all started when Edgard Corona noticed how North American gyms that charged an average of US$20 per month were growing much more than those charging US$70.

Management team

Shareholder structure

-          Corona family 15%

-          Patria 42% (Invested in 2010 and 2019)

-          GIC 9% (Invested in 2015)

-          CPPIB 12% (Invested in 2019)

-          Free float 22%

Risks

-          Competition

o   The gym industry has low barriers to entry, mainly related to capital, and we could face a potential increase of competition from local and global players.

•   BlueFit

·         Low-cost/high value model

·         102 clubs in Brazil and 200k members

·         Bluefit was founded in April 2015, with its first unit in Santo André operating under the brand “Health Place”. In 6 years, the chain expanded reaching 102 clubs in operation on June 30, 2021, with presence in 14 Brazilian states.

·         The chain operates its own clubs and franchises (60/40)

·         Owned by a PE. They tried to IPO in 2021 but could not close it.

• SelFit

·         Low-cost/high value model

·         75 clubs in Brazil and 190k members

·         Owned by HIG tried to IPO in 2021 but could not close it

• BodyTech

·         Mid segment

·         170 clubs in Colombia (75), Chile (52) and Peru (22) and 350k members

·         Planning to enter the low-cost segment

o   Marketplace corporate platforms (GymPass):

• Gympass is a global wellness benefits platform that allows corporate employees to get access to gyms, studios, boot camps, fitness classes, etc.

•  It was founded based on a double insight: 1) gyms rarely operate at full capacity due to challenges in maximizing equipment utilization rates and 2) customers face little flexibility in membership plans due to the hyperlocal business model of traditional gyms.

• It works as a three-sided marketplace connecting corporates, employees and fitness clubs.

• Instead of following a B2C model in which individual gym-goers would be both users and payers, Gympass decided to sell to large corporations, which would then offer membership plans to their employee base.

• Different segment than SmartFit's core, with higher prices, but could be appealing to part of its public

• SmartFit has TotalPass to compete in that segment.

o   Workout streaming platforms

• Different value proposition

• SmartFit also has Queima Diária (largest platform in LatAm) to compete in this segment

-          FX equipment

o   20% of capex is USD denominated (2/3 of purchased equipment) and weaker FX rates in LatAm could lower return on investments if not passed through

-          Marginal ROIC

o   Its roll-out strategy relies on consistent unit returns, which may not be a reality in marginal openings. The cluster strategy could generate higher-than-expected cannibalization, which would lead to downside risk to our numbers. That said, units are small, the main reason for churn is overcrowding at peak hours, and new units have ramped up as expected.

-          Expected maintenance capex

o   At 8% of revenues may not be enough to keep stores fresh and up to date with market trends (although it is at the high end of the market’s range).

Valuation

-    At BRL 15 per share the model offers 90% plus upside (I might share the model if you find it troublesome to work through it… but it is an easy call! Come on guys!)

-          Key assumptions

o   Club additions: 170 per year from 2022 to 2030

o   Members per mature site: ~3,550

o   Average monthly ticket: Annual increase of 3.5%

o   Mature club EBITDA margin: 51%

o   Capex per new club: 3.5% annual increase

Key Investment Highlights

-          LatAm will keep increasing its membership penetration rate to close the wide gap with developed markets (3% vs 15-20%)

-          Low cost/high value segment will lead the vast majority of the increase in penetration rate as it has been the case in US, UK and Europe

-          SmartFit will lead that segment thanks to its current scale advantage, club network and operational skills

Catalyst

KPI

-          Clubs opened per year

-          Metrics of mature clubs

- Relative scale vs other players