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  • Writer's pictureGreystone Capital

Planet Fitness (PLNT) – impressive but too expensive

Been doing some work in the health and wellness industry recently, a space that I know very well as a consumer of the products, wearer of the apparel, and gym-goer for nearly two decades.

There are plenty of attractive business models and niche businesses within the space that I like a lot – specialty supplements, specialty fitness classes, even equipment manufacturers such as Nautilus (NSR) and Life Fitness who build long lasting products with sticky relationships and decent switching moats.

As a side note, I’d love to get my hands on a piece of Orange Theory Fitness, which is growing like a weed, boasts solid unit economics, and will have reached 1,000 worldwide locations by the end of the year. OT just took a nice chunk of private capital to continue to expand, so there’s likely no IPO on the horizon, but that business is rolling on all cylinders, having found the secret sauce of great demographics, limited competition, technology integration and personal accountability. Another post for another time.

I’ve been a gym user for some time now, with experience at  places like Golds Gym, Planet Fitness, LA Fitness, the YMCA, 24-hour fitness, and SNAP. The fitness club space is competitive, commoditized, and any advantages that clubs boast usually come down to price, geography, and limited network effects (you want to work out where your friends/colleagues/familiar faces are) Other easily replicable things such as cleanliness, size, equipment and class selection help push members toward one place or another, but hardly cause any particular club to stand out.

There are only a few publicly traded gym stocks, consisting of Planet Fitness and Town Sports International (after Lifetime Fitness was acquired by TPG and Leonard and Green Partners), and I wanted to do a quick dive into Planet Fitness given that share are up 89% over the past 52 weeks, and 45% YTD. Something must be working. I don’t spend a ton of time looking at mid-caps, but this was worth a few hours of my time. Of note, I have no special insights to add to existing PLNT analysis.

First, a simple 7-year DCF. This baby is expensive using a 6.6% discount rate (Gurufocus uses 5.7%) and a conservative 8.5% growth rate for free cash flow heading 7 years out (3-year FCF growth rate is 19%, the lowest growth rate during the past five years has been 8.5%).

PLNT DCF

PLNT’s goal is to grow, grow, grow, and I’d say the will be able to achieve a free cash flow growth rate in the neighborhood of 8-10% moving forward with the additional opening of new gyms, increased membership at existing locations, further equipment sales, and positive operating leverage down the road. Franchisees still seem to be willing to buy new licenses and open new stores, with growth showing no signs of slowing down.

Gym count has absolutely exploded over the past few years, leaving me to wonder about sustainability, cannibalization and over-expansion. Does the world really need 4,000+ Planet Fitness locations (management’s target store count)?

2016

  1. Stores at the start of the year:  1,066

  2. Stores at the end of the year:  1,255

  3. Net change:  +189

2017

  1. Stores at the start of the year:  1,255

  2. Stores at the end of the year:  1,456

  3. Net change:  +201

In studying the KPIs of franchise businesses (I own shares in The Joint Corp. – JYNT), I found that most successful franchise concepts share some similar growth, margin and brand characteristics. I usually try to look for:

  1. Fast growing concept with a really strong brand

  2. $300k – 500k in gross sales per location

  3. At least 10% net margins

  4. 1,000 locations – sort of a ‘turning point’ in the franchise world

  5. Growth in SSS at mid-single digits to double digits

  6. Aligned owner/operator

Planet Fitness hits on a lot of these categories, sporting over 1,600 locations in 50 states and around the world, 18% net margins, around $500,000 average revenue per store. In addition, CEO Chris Rondeau (who started as a front desk employee) and PLNT founder own the majority of stock (albeit in a sh*tty share structure) and a brand that has become well known as the gym for ‘non-gym’ people.

Planet Fitness now boasts a membership count of 12 million members worldwide! In other words, PLNT is interested in signing up every human being on earth.

Mugatu

It’s no secret by now that the company is catering to the non-typical, ‘non-health obsessed’ gym user who is either:

  1. Young

  2. Doesn’t already belong to a gym

  3. Has no idea what they are doing/self-conscious

As I’m sure most have seen the commercials, Planet Fitness layers their marketing materials with ads making fun of bodybuilders, promoting ‘judgement free’ workout zones, and offering perks like free pizza Mondays and bagel Saturdays. In addition, the gyms have no frills whatsoever, eliminating things such as workout classes, personal training, expensive specialty equipment, rock climbing walls and cafeterias/snack bars. This, as well as low-employee count per store and a lean franchise/equipment sales model has allowed PLNT to earn high pre-tax returns on tangible capital over the past three years.

Pre-tax ROTC:

2016: 20%

2017: 32% (excluding one-time tax benefit adjustment of $281mm)

2018 (LQA): 26.5%

Their approach has worked, and Planet Fitness has been able to successfully differentiate themselves in an otherwise competitive environment in the following ways:

Brand: marketing blitz, 8-10% of revenues are spent on the national marketing campaign, PLNT is known as the judgment free zone, even going as far as calling themselves ‘not a gym’, have gotten people to believe that at any gym other than PLNT, you’re constantly judged and made to feel bad. Most people have heard about the siren that goes off if you yell during sets, or drop weights and make a lot of noise.

Price: low cost memberships, affordable for everyone, small cost relative to the benefit you get from joining a gym (or saying you’ve joined a gym), almost not worth cancelling at $10/month, they make it very difficult to cancel, sticky members. I have heard of people joining both Planet Fitness and their main gym, because a PLNT location closer to them at least offers top notch cardio equipment – the cost of membership doesn’t dissuade you from doing so.

Size/scale: spreading fixed costs over larger base of gyms and franchise fees, 1,601 corporate owned and franchise locations in 50 states and some countries, 12.1 million members.

Capital light via the franchise/equipment model: sell development rights to franchisees, $10k per location, an upfront payment for a bundle of locations, develop over the next 5 years, collect franchise fees and equipment sale fees as new stores open (equipment fee revenue is now 30% of total revenues). Area development pipeline, with over 1,000 already signed agreements with current franchisees, half will be open in the next three years.

It would be interesting for investors to ask themselves the following: If you had $5 billion, could you compete with Planet Fitness? It would be very difficult without access to long-term patient capital able to cope with years of loss-making.

  1. Can’t lower pricing much to compete on membership fees – especially if you want to differentiate your gym with classes/equipment/trainers/amenities etc.

  2. Have to achieve scale – takes decades to build out the base PLNT has

  3. Spend tons on marketing to build the brand – not guaranteed to work, PLNT has found their niche ‘angle’

  4. You still wouldn’t capture the first time or recreational gym user

At a $5B Enterprise Value, investors are receiving a whopping TTM FCF yield of 1.7% (TTM FCF of $86mm), and buying a business trading at 58x free cash flow, with no capital being returned to shareholders in dividends or buybacks (ok given growth mode and high return on signing up new franchisees/opening new gyms). No thank you.

Again, nothing too insightful to add about PLNT. I believe it’s too expensive at these levels.

Risks involved:

  1. Share structure – how aligned is mgmt with shareholders

  2. Business model dependent on new store openings

  3. Equipment sales contributed 44% of revenues for 2017. This segment is dependent on new stores opening. Does the world really need 4,000 Planet Fitness locations (management’s target)?

  4. Debt load

  5. Levered at 3.0x debt/EBITDA

Disclosure: I do not own any PLNT shares. I’ll take a hard look if shares ever reach the $15-20 level, though.

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