Since the return of club membership growth in 2010, the fitness industry has been anticipating a return to pre-recession levels of mergers and acquisitions and equity capital markets activity. While we will not see a year like 2007 again anytime soon, the industry is progressing through a recovery phase, and corporate buyers and sellers now have the opportunity to take advantage of this situation, if they are fully prepared.
Headlined by Harbinger Capital Partners’ acquisition of Bally Total Fitness for nearly $1.1 billion and Madison Dearborn’s $600 million investment in LA Fitness, 2007 saw peak-level deal activity with 16 announced transactions. From 2004 to 2006, the industry averaged nine M&A or equity financing deals each year, and many of these were platform deals such as Related Companies’ acquisition of Equinox, Forstmann Little & Co.’s acquisition of 24 Hour Fitness and Falconhead Capital’s acquisition of Extreme Fitness. In 2008 to 2010, by way of contrast, the industry averaged between six to seven deals each year, and the vast majority of these were small and/or distressed. In a sign of increasing momentum, there were 12 announced deals in 2011 and nine announced deals through year-to-date July 2012. Much of the recent deal activity has been driven by LA Fitness, which has acquired more than 200 club locations since November 2011 in two separate transactions.
Going forward, Baird believes M&A prospects are strong for the fitness industry as 2013 and 2014 are expected to show improved economic growth as the recovery gathers steam and significant political uncertainty comes off the table. In addition, the sector will continue to benefit from strong secular trends around consumer interest in healthier lifestyles. Factors driving increased transaction activity include the need for private equity-backed firms to create liquidity events for their investors, high-growth entrepreneur-owned businesses seeking partnerships with and growth capital from sophisticated institutional investors and a general return in confidence of the broader health of the segment.
Supported by 3 percent growth in membership and higher revenue per member, the $25 billion North American fitness club industry saw a 6 percent revenue increase in 2011, according to research recently published by the International Health, Racquet and Sportsclub Association. For 2012 and 2013, Baird sees further industry growth based on the following factors:
- Many club operators experienced solid first quarter 2012 results (the most important quarter of the year). Further, steady improvement in employment trends should lead to better than expected results for full-year 2012.
- More customized member programming and services, like the Ultimate Fitness Experience at Town Sports International, are allowing operators to better capture and retain members while also increasing revenue per member.
- New unit growth is expected to pick up in 2013. After several years of limited club expansion, several larger box operators are accelerating the pace of new unit growth as their balance sheets have been deleveraged, free cash flow trends have improved and consumer demand is returning.
- Smaller footprint, franchised chains that thrive in secondary markets, such as Snap Fitness and Anytime Fitness, are continuing to see strong growth.
In the $4 billion fitness equipment sector, manufacturers have experienced two years of positive trends off of the tough levels of 2009, and business continues to gain momentum in 2012. Most manufacturers are benefiting as club owners need to replenish their equipment and as their margins improve due to higher sales and operating efficiencies. Keep an eye on certain manufacturers that invested in their businesses during the downturn, such as Life Fitness and Johnson Health Tech (Matrix, Livestrong). We see these industry participants coming through the current recovery phase much healthier and with greater market share than when they entered the downturn.
Importantly, a few new distribution and business models that meet consumer demands for efficacy, convenience and customization are expanding rapidly and creating a tectonic shift in the industry. Companies such as Beachbody (P90X, Insanity), CrossFit and Zumba have revolutionized the way consumers exercise and experience fitness content. These transformative brands provide group- or independent-based fitness content in an engaging format. Consumers can access much of this content on-demand at home or experience it in a gym or small studio setting.
Valuations in the fitness industry will vary depending on the historical and projected growth and profitability of any given business. Those club operators, content providers and equipment manufacturers that continue to stay focused on solutions that provide real results in helping people to achieve a healthy lifestyle will rise to the top in terms of creating brand equity and franchise value. Premier industry participants will have several things in common, including raving consumer enthusiasts, differentiated customer acquisition and retention capabilities, scalable operations, sustainable barriers to entry and numerous growth opportunities.
For those not currently in the market, Baird is advising sellers to wait until next year before launching a process. Market activity between Labor Day and Christmas will be busy this year, as many sellers attempt to finalize a deal prior to year-end due to the coming expiration of the Bush tax cuts and a rise in the capital gains rate. A busy deal market is a disadvantage to sellers, and those that are able to delay should wait until 2013 to launch a process.
Buyers and sellers should take action now to effectively participate in the next cycle of deal activity. Sellers should be ready but not overly anxious to come to market if they can afford to wait. Although the markets are inherently unpredictable and timing difficult, those who can demonstrate multiple years of improving top and bottom lines with a clear forward growth plan will drastically improve their valuations. Buyers should move now during the recovery phase to acquire strategic targets as the coming 12 to18 months will likely see increased competition for deals and higher valuations.
Kurt M. Roth is a senior member of the consumer investment banking team at Robert W. Baird and Co. Roth has 15 years of M&A and equity financing transaction experience and focuses on the wellness, nutrition and fitness sectors. Contact him at [email protected] or 312-609-4689.