Amid rumors last month that Planet Fitness was close to a deal with a private equity firm, CEO Mike Grondahl pointed out that his company has been close to “the finish line” before when it comes to these types of transactions.
Indeed, in 2010, Planet Fitness, Newington, NH, proposed a minority sale with Goode Partners, New York, until that deal fell through. This time around, Grondahl tells Club Industry that he feels good about his company’s possible purchaser, the name of which he did not disclose. One source says that the company is a consumer-oriented private equity firm.
Should the Planet Fitness deal become finalized, it would be the second transaction between a franchised company and a private equity firm this year. Curves International, Waco, TX, completed a deal with private equity firm North Castle Partners, Greenwich, CT, in August. Terms of that deal were not disclosed.
With markets opening during the past year, private equity firms are becoming more interested in the fitness industry. Industry insiders say that the industry’s recession-resilient reputation, increased mergers and acquisitions in the industry, plus an impending capital gains tax deadline have led to more activity as 2012 heads down the home stretch.
History of Investments
Private equity firms are no stranger to fitness club companies. LA Fitness, Irvine, CA, which has made three major acquisitions in the past 12 months (including its acquisition of all 36 Urban Active clubs last month), is backed by three private equity firms: Seidler Equity Partners, Marina del Ray, CA (since 1998); CIVC Partners, Chicago (since 2001); and Madison Dearborn Partners, Chicago (since 2007).
North Castle Partners owned Equinox, New York, from 2000 until 2006, when it sold Equinox to The Related Companies for $505 million. North Castle currently owns World Health Club, which has 25 clubs in Calgary and Edmonton, Alberta, Canada.
In 2004, TRT Holdings, Dallas, acquired Gold’s Gym International from Brockway Moran and Partners, a private equity firm that had purchased Gold’s in 2001. At the time of the sale to TRT Holdings, most Gold’s Gyms were franchises, but Brockway Moran had expanded the number of corporate clubs. TRT Holdings continues to build corporate-owned Gold’s Gyms, including low-price Gold’s Gym Express clubs.
Besides Gold’s Gym, Curves and possibly Planet Fitness, other franchised companies have attracted interest from private equity firms. In 2008, Summit Partners, Boston, made a minority equity investment in Snap Fitness, Chanhassen, MN. Also that year, Lake Capital, Chicago, announced a partnership with RetroFitness, Colts Neck, NJ.
“I think the franchises are an interesting story,” says Rick Caro, president of consulting company Management Vision, New York. “If the model can be proven to be successful, then obviously we’ll have more transactions.”
However, investor interest in the industry actually was higher in the 1990s when the industry had fewer players and was less fragmented, according to Kurt Roth, director at Robert W. Baird & Co., Milwaukee. Back then, the growth expectations for the industry were in the double digits, and people predicted the industry would explode.
“There were all sorts of uncharted territories,” Roth says. “The sky was the limit. Now you’ve seen it go through a business cycle and kind of a wash out, and come out on the other side.”
Interest waned during the recession, especially as a few club companies gave the industry a black eye, and the industry became more crowded with clubs, particularly with mid-price-point clubs seeing less demand, Roth says. But as the industry has matured, interest is picking up again, and investors are much more focused on the category leaders.
“We are seeing people looking at the fitness category pretty hard,” Roth says. “Everyone respects the success of Equinox and LA Fitness, so a couple of winners have been identified, but then there is a real concern about who are the other strong players. Who else is worth backing?”
The 24 Hour Effect
The owners of 24 Hour Fitness, San Ramon, CA, are hoping that its investment is worthy of backing. 24 Hour is the biggest player in the industry currently on the market. Earlier this year, its parent company, Forstmann Little, New York, put the company on the market. Reports indicate 24 Hour could fetch about $2 billion in a sale. The sale announcement about Forstmann and 24 Hour may have ignited more activity in the industry, says Mark Mastrov, co-founder of New Evolution Ventures (NeV), Lafayette, CA, and the founder of 24 Hour.
“When 24 Hour is looking for a buyer, and they think that their value is north of $2 billion, that’s going to attract a lot of very large institutions who can afford to write that size of a check,” says Mastrov, who sold 24 Hour to Forstmann Little in 2005 for $1.6 billion. “So a lot of other companies are saying, ‘I have interest in selling, too, so maybe we should get in the market and all be out there around the same time because there’s going to be a lot of high interest right now.’”
Despite a report in The New York Times this summer that LA Fitness and Life Time Fitness, Chanhassen, MN, might be interested in buying 24 Hour, both companies later said they were not interested. Brian Smith, partner at Partnership Capital Growth, San Francisco, says the potential buyer would likely be a large private equity firm. Smith did not rule out LA Fitness, based on its private equity support, but said another possibility could be Richard Branson’s company, which owns Virgin Active Health Clubs outside the United States.
“The price tag on 24 Hour Fitness will preclude the majority of any real strategic buyers,” Smith says.
Mastrov predicts a 24 Hour sale by the end of the year or early next year.
“How long will it take for somebody to close and will they get the price they’re looking for is the question,” Mastrov says. “If they get the price they’re looking for and somebody shows up at that price, I would think that they should be able to complete a transaction in the next 90 to 120 days.”
The impending sale of 24 Hour might not be the only reason for a seemingly higher interest in club sales and purchases. Some of that interest can be chalked up to taxes. The George W. Bush tax cuts are set to expire on Dec. 31. Long-term capital gains rates will increase from 15 percent to 20 percent, and as a result of the 2010 health-care law, an additional 3.8 percent for high-income earners will be added, according to a Bloomberg report last month. For that reason, financial advisers are encouraging their clients to sell their businesses now.
Mastrov says the capital gains rates could reach 25 percent. If a 3 percent tax increase on the ballot passes on Nov. 6 in California, that, too, will become a burden to businesses in that state. (Update: Proposition 30 was approved in California.)
“You’re trying to avoid that additional 10 percent tax,” Mastrov says. “If you’ve got $1 billion of equity in your company, another 10 percent is $100 million in tax.”
Companies have a lot of capital in funds that they are looking to deploy, adds Mastrov, whose own NeV fund partnered with private equity firm Vision Capital in 2011. Crunch, New York, is co-owned by NeV and another private equity firm, Angelo Gordon and Co., which originally bought Crunch from Bally Total Fitness, Chicago, with Marc Tascher in 2005.
“Whether it’s a hedge fund, whether it’s a private investment group, a lot of folks have a lot of capital, and they’re trying to find good, safe places to put it to work with pretty strong return dynamics,” Mastrov says. “Our industry is one of those that has shown consistent return on capital, it’s shown good growth on its cash flow and it’s performed well in the downturned economy.”
Bryan O’Rourke, CEO of Integerus, Covington, LA, concurs with Mastrov, saying there is a lot of “dry powder” on the sidelines from private equity firms waiting to deploy. The fiscal cliff the U.S. government faces at the end of the year, when the terms of the Budget Control Act of 2011 are scheduled to go into effect, is a significant factor in deals considered by private equity firms, which are expanding their investment choices, O’Rourke adds.
“Some are buying venture capital portfolio companies, making riskier investments and even expanding into the hedge fund world,” O’Rourke says. “While many of these firms do not view the impending fiscal cliff with as much fear, some do.”
Added to the deadline pressure felt by some companies, venture capitalists may lose their carried interest treatment at the end of 2012, which would result in revenues shifting from capital gains to ordinary income rates, O’Rourke says. Carried interest is the share of profits that a general partner of an investment fund receives from his or her ownership interest in the fund’s assets, according to the Private Equity Growth Capital Council.
“Hence the money on the sidelines wants to get deployed before year-end if a grandfather provision, which is a likely negotiated conclusion around new tax law, would result,” O’Rourke says.
If owners of some club companies do not make a sale by the end of year, they might increase the sale prices on the total worth of their clubs to compensate for the higher capital gains tax, Caro says.
“I know a number of clubs that would like to have a transaction before the end of this year or they’ll raise their prices for the same story starting Jan. 1 of next year because they don’t want Uncle Sam to benefit disproportionally for the value that they think they’ve created,” Caro says. “Especially if it’s a family-owned club and they want to get a favorable tax treatment, then they’re obviously going to be encouraged to try and create a transaction before the end of this year.”
However, some owners who have had their clubs for a long time would be happy to sell after the new year even if a transaction cannot be completed by Dec. 31, Caro says.
“There will be private equity dollars available in 2013,” Caro adds.
In addition to franchised companies, the private equity activity in the industry this year also has included niche fitness concepts, such as TRX, Zumba, The Bar Method and, possibly, CrossFit.
In April, TRX, San Francisco, announced that Castanea Partners, Newton, MA, had purchased a minority interest in the suspension trainer manufacturer. Terms of that deal were not disclosed, but Castanea Partners said it typically invests between $15 million and $75 million of equity in companies with specifically targeted industries. Partnership Capital Growth represented TRX in the transaction.
A month earlier, Zumba Fitness, Hallandale, FL, received a minority investment from The Raine Group and Insight Venture Partners. The Raine Group plans to grow Zumba further internationally, particularly in Asia and the Middle East, with the help of WME Entertainment.
In August, Mainsail Partners announced an equity investment in The Bar Method, which has more than 60 barre-based exercise studios and produces home-exercise DVDs.
The deal that has not been consummated but is generating a great deal of discussion in the CrossFit community involves Bryan Kelly of Anthos Capital, a private investment firm. Kelly and Anthos Capital have entered into an agreement to purchase the ownership interest in CrossFit for $20 million from Lauren Glassman, who is embroiled in divorce proceedings with her husband, CrossFit founder Greg Glassman. Cross- Fit filed a tortious interference lawsuit last month in California against Anthos Capital.
Private equity money in the fitness industry is going to niche concepts and franchised companies and not to traditional club operators, Smith says, because of the heavy capital required for reinvestment in traditional clubs.
“You can’t put a lot of leverage on the business,” Smith says. “If you do that, you can’t grow.”
Michael Scott Scudder, managing partner of The Fitness Industry Group, Taos, NM, agrees that one of the reasons niche markets are a focus for private equity firms over traditional clubs is because of bifurcation—the growing divide between low-price clubs and high-end clubs, with an eroding middle market.
“I think [private equity firms] see the writing on the wall with bifurcation and are hustling to get into certain niches in the industry to be able to dominate a sector in selected markets,” Scudder says.
The Private Equity Exit
Steve Tharrett, president of Club Industry Consulting, Highland Village, TX, says small and mid-sized club operators seeking an exit strategy will most likely have to partner with private equity firms to provide the capital—along with the resultant debt—to implement growth strategies.
“Whether it is a select few smaller and mid-size [clubs] who have an attractive value proposition to take to a larger market, or larger [clubs] seeking consolidation strategies or exit, private equity firms will be important,” Tharrett says.
A private equity firm might especially be important to Planet Fitness, which has shown growth in the past few years. In 2011, it had total net revenue of $136.4 million compared to total net revenue of $92.3 million at the end of 2010, according to its Franchise Disclosure Document (FDD). Net income attributable to members of Planet Fitness Holdings LLC was $26.9 million in 2011 compared to $17.7 million in 2010.
Planet Fitness reported in its FDD that it had 520 clubs at the end of 2011, a jump from 390 at the end of 2010 and 312 at the end of 2009. Of the 520 clubs in 2011, 453 were franchised clubs.
“I am hoping for the good of the industry that they do consummate the transaction,” Caro says, “and they succeed terrifically as a result with the fresh resources and grow in faster and better ways than before.”
For club owners who have not yet looked into private equity investment, it is probably too late to get a deal done by the end of this year, both Caro and Mastrov say. However, Mastrov adds, raising capital is once again a viable option for club owners, one that they should consider.