Due to the impacts of COVID-19, and uncertainty surrounding a second wave, the Fitness Industry will remain pressured throughout the remainder of FY20 and potentially through much of FY21.
While most consumer retail segments were allowed to start reopening in May, as gyms and fitness facilities are still deemed a public risk, many have remained largely closed since mid-March. Some have utilized online platforms to livestream virtual fitness classes, in an attempt to keep their members engaged, which they are hoping will protect retention rates post-COVID. Many have also been selling and renting out equipment, such as bikes and weights. While many operators started reopening with limited capacity in lower-risk states, uncertainty remains about a full reopening timeline, especially as we have seen an uptick in cases near the Sunbelt. The uptick in many re-opened states has led to re-closures in the South, West, and Southwest regions of the country. On July 13, California mandated the closure of gyms across 30 counties through 3Q20, and potentially beyond. However, the reopening process remains politicized to some extent; as Florida Governor DeSantis recently said no to re-closures. On July 17, Governor DeSantis noted, “I think most people who are going to the gyms are in the low-risk groups, and I think what they are doing is making them even less at risk of the coronavirus. So, I don’t think it would make sense to close them.” Conversely, New York Governor Andrew Cuomo has insisted on keeping gyms closed, despite most of the state being in Phase 4 of reopening. As a result, many gym owners have come together to file a class action suit, insisting they have been treated unfairly and have not received any helpful guidance from Governor Cuomo’s office.
In addition to uncertainty surrounding the current and expected second-wave of COVID-19, and what the recovery timeline will look like, there are also concerns about elevated unemployment levels and a prolonged recession, which could continue to impact sales, profitability, and ultimately the balance sheet health of all fitness operators through the foreseeable future. We are also cautious about consumer comfort even after more re-openings, as many will not attend a facility until there is more resolution about the virus. Further, as authorities are currently mandating gym goers to wear masks even while they work out, we expect the post-COVID ramp-up period to remain challenged (a Florida gym owner of Fitness 1440 was arrested in late July for making masks optional).
According to a survey conducted by Piper Sandler in early April with 440 online respondents, of the respondents that had a gym membership, 6% were likely to cancel their membership. Interestingly, of the respondents that were members of a Planet Fitness gym, only 3% were likely to cancel their membership (more on value trends below). These results correspond with an update from Planet Fitness CEO Chris Rondeau on June 23, where he noted membership is still up over last year and that despite a small spike in cancellations in the first couple days of a club reopening, the member base has remained relatively steady with some locations even reporting net growth. Crunch Fitness, which operates 304 locations across the U.S, reported similar results, noting that while workout volume has been lower than last year, sale volume (number of new memberships sold) has been higher and cancellations have been relatively steady. The survey also found that 68% of respondents were likely (with 16% unsure) to keep their gym membership even if the U.S. moves into an extended recession, but health concerns fade; 54% were likely to trade down to a lower priced gym. Despite conclusions that point towards fitness being one of the distressed consumer segments to bounce back, it is important to note that the sample may not be representative, current trends may not reflect future trends, and that overall, there remains much uncertainty surrounding consumer behavior within the fitness industry. Additionally, many of the mid and higher-priced operators are expected to be more exposed to cancellations than Planet Fitness and Crunch Fitness.
Traditional Health Clubs
Even before COVID-19, traditional gyms, including LA Fitness,Planet Fitness, Town Sports International, 24 Hour Fitness (filed Chapter 11), and Gold’s Gym (filed Chapter 11) had been operating with top-heavy capital structures. As a result of an expected sharp decline in FY20 sales and EBITDA across the board, we expect leverage metrics to continue rising through the latter half of the fiscal year, and overall credit quality to remain distressed. However, there will be winners and losers in a post- COVID environment, as we do expect consumers to continue finding value in traditional gyms over the long-term.
Before COVID-19, we had reported on a trend in the traditional fitness segment where value operators such as Planet Fitness were reporting solid fundamentals and experiencing strong membership growth, at the expense of mid-priced operators such as 24 Hour Fitness and Town Sports International. This trend goes hand-in-hand with what we have seen in the broader retail space – where value and premium do well, while retailers who fail to concretely define a particular target demographic lose market share.
We believe COVID-19 has accelerated this trend within the fitness industry, and continue to expect value-focused traditional gym operators to do well, relative to peers, in a post-COVID environment. Additionally, as many of the traditional fitness segment’s temporary closures are increasingly becoming permanent, we believe this may be an opportunity for the operators with better positioned balance sheets to gain market share, and possibly come out ahead. For example, within the growing value segment, other than Planet Fitness (which commands 7x+ the market share of next closest competitor) only a couple of operators (Crunch, Fitness19, YouFit, Blink) have more than 100 locations. Overall, as many more independents are expected to fold compared to the larger operators, we expect the nation-wide chains to continue consolidating their niche markets and gaining market share.
Boutique Fitness Clubs
In the years leading up to the pandemic, boutique studios were growing significantly faster than traditional gyms. According to the International Health, Racquet, and Sportsclub Association (IHRSA), between 2013 and 2017 membership at traditional gyms grew by 15%, while membership to boutique studios grew by a substantial 121%. However, due to the impacts of the pandemic, many of the smaller operators within this space are not expected to survive. The well-funded operators with compelling brands, such as Orangetheory, may have to shutter some locations, but are ultimately expected to weather the pandemic. It is important to note that within the boutique category, high required attendance rates are key in retaining and growing the member base. Part of Orangetheory’s success stems from its attendance policy, under which members are penalized for not showing up; as a result, the Company has maintained one of the highest attendance rates within the industry. Looking forward, a key concern among boutique operators is the impact of limited capacity. Capacity constraints are expected to more adversely impact the profitability of boutique studios compared to traditional health clubs, as many members pay per class and the ratio of members to instructors will be forced to decrease.
Company Specific Updates
LA Fitness entered the pandemic with elevated leverage metrics, and given the impact of store closures on FY20 EBITDA, we expect leverage to have elevated further. The Company also operates about 40% of its gyms in California, Arizona, Texas, and Florida; this is a concern given the recent resurgence in cases and re-closures near the Sun Belt.
Overall, we expect strong ongoing operational headwinds and significant revenue disruption throughout the latter half of FY20. As of mid-July, the base case for FY20 revenues is a 45% decline. However, reports have confirmed cash burn has slowed as a result of management’s efforts to significantly scale back nonessential capital expenditures, and reduce fixed costs by furloughing and laying off employees, and working with landlords for temporary rent relief. Our sources suggest that the Company has adequate funding and investor support, including a $400.0 million revolver, and is now purportedly considering a shift to an aggressive strategy, seeking to snap up distressed gym assets and leases. We also expect the Company to take a hard look at acquiring certain 24 Hour Fitness assets.
Planet Fitness is one of the stronger operators, relative to rest of the field. Prior to COVID-19, membership growth rate was very strong at around 15%, and profitability was impressive and growing (~40% EBITDA margin). As of June 30, the Company had $510.0 million in cash, including $86.4 million in restricted cash, which gives it an adequate cushion to weather the crisis. Additionally, $1.18 billion of the Company’s senior mortgage bonds are trading above par, up from 91 cents to 97 cents on the dollar in late June. The Company’s A-2 Notes are trading around 90 cents on the dollar, up from 79 cents in late June. The Company reported encouraging performance at reopened locations, and noted that its total member base still remains higher than last year. As of August 4, the Company had reopened 1,477 of its 2,059 locations. Management noted membership levels at reopened stores has remained relatively flat. Upon reopening in early May, the Company had 15.4 million members. As of June 30, the Company had 15.2 million members, down a little over 1%. About 26% of the Company’s clubs are located in California, Texas, Florida, and New York.
Equinox had been operating with a leverage balance sheet even before COVID-19, and is now dealing with liquidity headwinds and significant operational deterioration. Similar to 24 Hour Fitness, we expect the pandemic to further increase balance sheet leverage, as the Company had to raise more debt, and FY20 EBITDA is expected to sharply decline. In early June, the Company announced plans to issue a $150.0 million first-lien B-2 Term Loan, due in 2024, in order to enhance its liquidity profile. The Company also reached an agreement with lenders to not enforce certain 2020 quarterly debt service payments. Additionally, the Company has reportedly entered into an agreement with an affiliate to raise $125.0 million in cash equity, to cover its partial guarantee of SoulCycle’s credit facility. While the new Term Loan will help enhance liquidity, the Company is expected to continue burning cash through the foreseeable future, as 70% of its Equinox clubs and 64% of its Blink clubs are concentrated in New York and California, and have not yet reopened. As of 1Q ended March 2020, the Company had $183.0 million in cash and $140.0 million drawn under its $150.0 million revolver.
Town Sports International
Town Sports International noted that the impact of temporary club closures has substantially reduced cash flow, and it faces significant debt maturities in the near term. The Company’s revolving credit facility is set to expire on August 15, 2020, and its $178.0 million term loan is due to mature on November 15, 2020. The upcoming maturities pose significant refinancing risk, as management stated it does not have adequate sources of cash to repay the amounts outstanding. The Company is currently reviewing its options, including negotiating with existing lenders, attempting to raise additional capital, or filing for bankruptcy. However, under the current environment with significant doubt about the near future, and the bankruptcies of several already in the sector, a refi will be a huge challenge. The Company indicated that in the event it files for bankruptcy, it will need to raise up to $80.0 million in DIP financing to fund costs associated with the filing, including professional fees, and to cover operating shortfalls. On July 13, the Company received a non-compliance notice from NASDAQ, for failure to file its 1Q report for the period ended March 31. The Company did receive $2.7 million in PPP funding, which we do not expect to move the needle in terms of its current liquidity troubles.
24 Hour Fitness
24 Hour Fitness filed Chapter 11 on June 15, citing the “devastating effects” of COVID-19 on its operations. On July 10, the Company was allowed to reject leases associated with 164 of its approximately 445 units. The group of 164 locations includes 133 underperforming locations which will be permanently closed, 29 clubs that were permanently closed prior to COVID, and two leases for clubs that had yet to open. On July 20, the debtors notified the court that they intend to reject a second group of 44 club leases. The Company has experienced difficulties and delays with its bankruptcy process; the hearing to approve the DIP Facility was postponed again, after gyms were forced to reclose in response to a rise in COVID cases. As of late July, uncertainty remains surrounding the outcome of the Company’s BK process, and sources have speculated that a liquidation may be one scenario.
Gold’s Gym operated nearly 700, primarily franchised locations, prior to filing Chapter 11 on May 4. As part of the bankruptcy process, the Company will permanently shutter about 30 Company-owned gyms (franchised locations will not be impacted). Subject to final approval, the Company is expected to exit the bankruptcy process with 61 Company-owned locations and more than 600 franchised locations. German-based RSG Group, a fitness and lifestyle company that operates club chains such as McFit and JOHN REED across Europe, was the winning bidder in a court approved auction held on July 13, with a final purchase of $100.0 million.
Orangetheory is one of the stronger boutique operators, relative to the rest of the boutique space. However, it is feeling pressure due to capacity constraints, which is expected to reduce profitability through the foreseeable future. The Company may have to shutter some locations, but overall, it reportedly has strong financial backing and
previous operating trends were very promising.
YouFit reportedly received between $5.0 million to $10.0 million in PPP funding, but sources note that its outlook is not certain. As it operates primarily in the South and West, there are concerns surrounding its exposure to rising cases near the Sunbelt.