Town Sports International: Follow-Up

I wanted to address some issues that have been expressed in the comment section to my article on Town Sports International Club (CLUB).

The Company’s financial position:

Town Sports reports long-term debt of $305.124 million as of year-end 2007. Not an insignificant debt load for a company of its size. However, the company interest coverage ratio is 2.26 for 2007. This coverage ratio provides the company with an important amount of leeway in regards its debt interest payments.

This financial leeway was increased by the new senior credit facility the company signed in 2007. The senior credit facility and revolver carry substantial lower rates than the notes they refinanced. Looking at the terms of the facility, at current levels the company is paying less than 8% for the loans. A competitive rate in this credit market with disruptions banks are experiencing. The fact the loans are based on a Euro-libor rate, which is falling, should help CLUB’s interest expenses decline as global rates decrease.

It is my hope that the company continues to refinance their existing bonds with these lower facilities. And as cash flow improves as the new laundry facility comes on line in the next year, and new clubs start to contribute more revenue, that the company can initiate a strategic buyback using the credit available under the facilities.

In addition, as the chart below makes clear, the company has small debt repayments in the next 5 years as it grows its base of clubs. These repayments should be easily met from cash flow from operations, as the company generated $82.9MM in cash from ops in 2007. After paying the debt due in 2008 and spending approximately $19MM in maintenance cap ex, the company has approximately $52MM for expansion from self-generated cash flow.

Chart 1: Debt Repayment by Year

Further, while technically speaking the present value of the company's lease payments should be included as debt, I believe it’s more instructive to look at its lease payments as a function of revenue. The company’s rental expense plus utility payment as a percentage of revenue has been stable in the 33% area the past three years. Looking at the PV of future rental, this ratio should be stable to declining over the next 5 years as a percentage of revenue:

Chart 2: PV of Leases

This to me is an important metric as it shows that CLUB has been disciplined in managing its acquisition and build-out, as rents is the major fixed cost for the company. If the fixed-cost driver is controlled than any cost saving from the new laundry facility, or incremental revenue for training sessions or increased membership cost can flow to the bottom line.

Finally, CLUB is also a small capitalization company ripe to be acquired. Looking at the last major acquisition in the space, Related’s buy of Equinox, is instructive. While it's hard to get exact numbers due to the private-transaction nature of that deal, it is reported that the deal was done at approximately 5X EBITDA. If we assume that CLUB should be sold at a discount due to its lower-end market focus and high debt levels, we can assume a sale at 3.5X EBITDA (a 40% discount). This would value CLUB at $14.05 per share or at 6.34X EV/EBITDA, a compelling value.

I continue to slowly add to my position in CLUB and expect over the next 2-3 years to see significant returns.

Disclosure: Author has a long position in CLUB

Comments

[Blantonw1:]

Tony

Both your original and updated analysis is spot on. Excellent work.

I would just add that the company's competitive position is as strong as I have seen in all industries as they have locked up much of the best real estate in each of their markets. It will be very difficult if not impossible for a competitor to establish a big enough presence in their markets to have a meaningful adverse effect on CLUB. Further, as a result of the clustering strategy, CLUB is the lowest cost operator in its markets. In terms of price and convenience of location (the two primary reasons why members choose CLUB facilities), there are no comparable gyms in the CLUB markets and this is unlikely to ever change.

Also, I believe CLUB could generate meaningful revenue upside from greater penetration of corporate accounts and improvements in personal training services.

The company can definitely improve upon their operations but this only represents upside. Even with sub-optimal operations, this business produce $110 million in adjusted EBITDA during 2007, which represented 10%+ growth.

2008 Apr 17 04:01 PM

[forever20062:]

stock is down to 6.15 today 6 more cents lower and it sets a new record again, bbb also says on its website it doesnt recommend nysc, i suspect that since half of the top earning workers in nysc moved down to a position that requires less status they know there company is headed in the wrong direction, they've changed what 2 ceos in the past 2 years among other higher ups

2008 Apr 23 01:20 AM