Fitch Ratings-New York/Chicago-09 April 2020: High fixed-cost rent and debt service obligations significantly increase the risk of a liquidity crisis stemming from the coronavirus pandemic for US and European fitness operators, despite the companies’ ability to cut operating expenses following property closures, according to Fitch Ratings. Therefore, we view maintaining adequate near-term liquidity to withstand cash burn as a primary credit consideration for the fitness industry.
We estimate operators can cut labor, marketing, royalty and utility expenses to offset loss cash flow due to business interruption caused by the coronavirus pandemic. Beginning mid-March, fitness concepts closed clubs and furloughed property-level staff due to social distancing regulations and business closure mandates. However, rent and interest payment obligations largely remain intact. Membership billings across the pricing spectrum have been frozen with an uncertain timeline for clubs to reopen. To increase liquidity, operators including Town Sports and Planet Fitness have drawn on revolving credit facilities.
European gym operators are similarly affected by gym closures amid the coronavirus outbreak. Pure Gym (B-/Negative) is reducing cash burn and supporting its liquidity position by negotiating rent holidays with landlords. The company is also benefiting from government support measures such as 80% funding for staff costs, a 12 month business rates holiday and deferral of taxes.
We do not anticipate mass membership cancellations for budget concepts in the near term due to the lower membership price point, which averages $10-$20/month, and administrative challenges of cancellations. However, some degree of membership attrition due to the anticipated economic challenges for consumers’ is anticipated. Attrition should be less severe than experienced by higher priced gyms, given membership dues represent a higher percentage of customers’ discretionary income for the latter. A faster recovery is expected for budget operators compared with other segments as some customers may trade down the pricing spectrum.
The boutique fitness segment is most exposed to coronavirus-related revenue declines in 2020, given the high price point of often $100/month or greater. We expect revenue recovery for boutique operators to be slower than budget gyms due to the high price point amid broader economic weakness. Pay-per-class models offered by the boutique segment do not have the stability of contractual membership programs that help retain customers upon re-opening of studios. All operators could be affected by potential apprehension of consumers to return to crowded classes and re-opening regulations, such as occupancy restrictions.
The prevailing issues affecting the mid-priced fitness segment will be exacerbated by the coronavirus disruption. This segment has experienced lower capex investment by clubs and higher membership attrition due to competition from both budget and boutique price points.
Fitness operators typically hold only a few months of liquidity on hand, inclusive of revolver capacity. Therefore, the zero revenue environment resulting from the coronavirus pandemic significantly increases the risk of default. For our recovery analysis, Fitch generally assumes operators will be reorganized as a going concern in the event of a bankruptcy filing, with some degree of store closures and margin compression from membership attrition. Enterprise value (EV)/EBITDA multiples range from 4.5x-5.5x depending on a variety of factors, such as price point, geographic diversification, membership trends/brand strength, and franchise fee generation, if applicable. Fitch does not typically assume liquidation of the fitness equipment, a majority of operators’ assets, as most locations are cash flow positive and equipment is often tailored to a specific brand.
For example, in 2009, Bally’s Total Fitness was reorganized for the second time at 3.5x EV/EBITDA as part of its second Chapter 11 filing. Idiosyncratic factors, including high attrition due to membership model changes and increasing competition from budget models at the time, resulted in a low valuation. Bally’s poor club quality was a disadvantage. Weak cash flow generation, caused by an onerous capital structure and declining membership fees, limited club reinvestment to about 3% of revenue. Bally’s rejected 70 leases, or 17.5% of its total leases, during the reorganization but continued to shrink its footprint by selling locations.