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As Managing Director of the BNP Parabas North America, Michael Finkelman has seen the fitness industry grow since the company began lending to the industry eight years ago and he sees no slowdown in sight.

Ci: How involved with the fitness industry is BNP Parabas?

We are lenders to several fitness club companies and speak to many fitness club companies on a regular basis regarding any potential corporate finance ideas, and financing ideas in general. We have been involved since the mid-1990s.

Ci: What did BNP Parabas see to spark that early interest in the industry?

We were the initial lender to 24 Hour Nautilus, before it became 24 Hour Fitness and now Fitness Holdings Worldwide back in 1994. What we saw in the industry was a fragmented industry that was riding a demographic wave of interest in health and fitness. We were lenders to Snapple and General Nutrition, so we were aware of what was going on in that space. Then we became aware of the strength of recurring revenue of membership. Then we became comfortable with the industry as a whole, so much in fact that we began going to other lenders and financial investors touting the benefits of being involved in this industry. We haven't seen anything that has changed our minds on the industry.

Ci: How strongly positioned is the fitness industry for obtaining capital through investment or via debt?

In general, as we speak to the lending community today certain things get pointed out when you look at the fitness club industry. One of the things is that all of the companies that have been reporting such as Bally Total Fitness and TSI, which are the most recognizable names out there among the lending community, have all reported very solid operating performance over the last four to six quarters. This points to the steadiness and the resiliency of the industry, despite the economic troubles during this period of time. The other thing is that people in the investment community understand better the recurring revenue stream of the industry through the monthly dues. This is much better recognized today than it was in 1994 when we began loaning money to the fitness club industry.

Ci: When you look at the financial statements of the public companies, the recurring revenue stands out, but there have been other, growing profit centers. Does this bottom line boost help the industry's position with financial companies?

It absolutely does. We have been talking about this to perspective lenders and investors over the last few years. And if you look at the fitness club industry as lifestyle companies, these ancillary revenue streams really points out that at the end of the day it's not just people going to the club and lifting some weights or getting on a stationary bike. They are utilizing personal training nutrition, and other profit centers, and that's all captured on that ancillary revenue line. That helps to legitimize the industry because it helps to get people to think outside of the traditional image they have about fitness clubs and shows other recurring revenue streams outside of paid memberships.

Ci: Does some of this increased awareness come about as a result of the maturing process for the industry?

If you look out at the public domain there really are three companies that are out there: Bally's, Town Sports, and Sports Club. As these companies grew it caught more of the financial community's eye. Speaking from the debt side, what you see going on in the public debt side is rising default rates. And when you look at companies that are reporting results they are reporting results year after year that are sequentially down. When you look at the fitness club companies that are reporting they have all reported good results. What's happening is that it is highlighting to the investment community what a solid credit story fitness clubs can be.

Ci: Is that opening the door for other, smaller, private companies to get some financing for growth?

Absolutely. We are out there speaking to investors about the fitness club industry constantly. We have a high-yield bond analyst, John Maxwell, who specifically covers the fitness club industry as an industry sector. When John or I are out there speaking to perspective lenders there is more and more of a demand for fitness club company paper. That is based on lenders realizing what a good credit story that fitness club companies can be.

Ci: How do you qualify that “good story”?

When you look at the companies that are reporting publicly — also there are a lot of lenders out there looking at lending to companies that are private — so when you look at the industry as whole you see them reporting good results over the last couple of quarters. All lenders can tell their story about portfolios that are under some stress due to today's economy, but when you look at the fitness club companies in general they have weathered the storm.

Ci: What do you attribute to the resiliency of the fitness club industry?

When you speak to people, they seem to recognize that health club memberships are not a discretionary item. They do not give up the fitness club membership in difficult times, so the recurring revenue stream for memberships looks very strong to investors. Then you add in the ancillary revenues — these have stayed strong. One would assume that personal training, for instance, would suffer during troubled economic climate. But when you look at the companies that have reported — and again these are the bigger players — they have all reported strong private training revenues over the past couple of quarters. This is something members don't want to give up. It has become part of their lifestyle, part of the daily routine.

Ci: Looking at some of the small to mid-level players out there, what do they need to do to position themselves well for the investment community?

In today's financial market you have two groups — and this goes for every industry, not just fitness. There are the big borrowers; I would define that as people that can obtain funding at $100 million or more. Then you have smaller borrowers, which are companies with needs of $100 million or less. For companies that are able to access the bigger borrower market, there is clearly a lot of availability of capital on the debt side. For companies at $100 million or less, it is tighter. Speaking to that second group there are still debt facilities getting done, but they really have to have a strong story to tell. There are companies on the cusp of the larger group and they have an easier time, but smaller companies have to do a lot of work and be more proactive in approaching lenders and telling their story. Capital is available for the smaller, second-tier companies, but perspective borrowers must be more aggressive if they are to get it.

Ci: Has not being proactive been a problem for this industry when it comes to acquiring funds?

I think what part of the problem for the industry is that it is very fragmented. There are not a lot of big players. A lot of players growing to be bigger players, but when you look at that $100 million-plus group there are really only five or six companies that can gain access, and those five or six companies really represent a small fraction of the entire fitness club market. So you have a scenario where most of the companies can not access that market and they need to be more proactive and they need to understand that need better.

Ci: Is that fragmentation a hindrance to the growth of the industry as a whole?

It is to the extent that there is only two public companies that have issued public equity and another that has issued public debt, so you really have only three companies that are visible to a public investor. That has been the hindrance. This limits the amount of coverage you get from analysts and the amount of press given to how companies in the industry are performing, and in a sense that has limited public investor interest in this industry. One of the things PNB Parabas has been trying to do over the last few years is get out there and tell public investors that there is this industry out there that has been performing well and has great cash flow that they need to keep an eye on because it is growing and will be much more visible down the road. We tell them it is a chance to be one of the first ones to gain access. When we have sat down with perspective lenders and investors and told that story and shown them the financial results, they have told us that they are interested in it and want to know how to get into it. But it is tough when you can only point to three public companies. You have Bally's, which is still misunderstood by the investment community; TSI, which doesn't issue public stock; and SportsClub, which is a different animal altogether, with its big-box format and so few locations. So we really need to sit down with these guys and explain to them that this is only a snapshot and that there are many others in this $10 billion industry, such as 24 Hour, Lifetime Fitness, Equinox, and L.A. Fitness that need to have their story told. The investment community needs to know that there are plenty of other quality companies than the three public ones they watch.

Ci: Do you think there are other companies that are poised to make a jump to the next level?

There are a lot of companies that we are speaking to that are ready to take that next step. The big thing that is very important to this — and being associated with the industry for a very long time, I have seen this change — is the sophistication in management and infrastructure. When we started lending to the industry the infrastructure of these companies, both in management and on an IT basis, were very immature. Today we are at the point where a lot of these middle-tier companies can go public or can access this institutional money because they have the infrastructure to do that. I think over the next six to nine months we are going to see a lot more capital market activity occurring within the fitness club industry.

Ci: This growth has always been viewed with caution due to the fear of a national player dominating local clubs. Is that founded?

Not at this point. Lenders worry about overbuilding. But there is still room for everyone to grow.

Ci: You mentioned increased capital activity over the next six to nine months. What do you see as the trigger to that activity?

I think what you have are companies better able to access the market and a market that is wanting for these type of credit stories. You have a debt market — especially a bond market — that is in a bull market that is really asking for a new supply of issuers. When we go through and ask lenders what they are looking for, we can go through and put check marks against all those for fitness club borrowers. I think those really are the two factors converging at the same time.

Ci: Has the sophistication of management you mentioned earlier carrying over to a real understanding of the financial market and how to utilize it to the clubs' advantage?

For any industry as you get bigger and more mature you need the infrastructure. Over the last two years you are seeing the fitness industry moving into that stage of maturation, especially these middle-tier companies that are looking outside of their regional base.

Ci: Where do you see that leading the industry, say two years down the road?

I think you will see more public companies during that time. I also think you will see more analysts pick up the industry and recognize the growth of the industry and that it is a lifestyle industry not just health clubs. You'll also see more strategic players looking at buying into the fitness industry. When you look outside the industry right now it is hard to find many companies that are a good strategic fit. But as the fitness club companies start to really mature and as that ancillary revenue continues growing strategic buyers will start recognizing the value of the membership base. There really is a membership base out there that is unexploited, and they will enter the industry. That will be very good for the valuation of the industry as a whole.

Ci: What would be the benefit of these strategic players to the valuation of the industry?

I think as people recognize the fitness club industry as an outlet to a membership base, it is a very attractive demographic for other companies. You think of somebody like a Nike, Disney or a Club Med — which has already made a foray with a small company in France — you can see the fit. It has started to happen on the marketing side with several companies affiliating with Bally Total Fitness as the only real national player out there. I think these companies may see that owning a fitness club company may be a very attractive option for them.

The fitness club business can be looked at as a specialty fitness business or a service business. One of the things that has also hampered the fitness club industry is that it is so unique. Where do you really place it? Is it a retail concept? Well it has four walls, but it really isn't selling a product, but it is selling a service. Well then, is it a service company? Well you are selling a service but at the end of the day it is within the four walls, so not really. It is an industry that really has no home when you look to see who should be following it. That is why the more public players we get there is better coverage and more focus by the financial community. John Maxwell here is really the first person to strictly focus on the sector and look at it as an industry unto itself. But that really is us looking out a couple of years and saying this will be an industry that more people will focus on, but BNP Parabas is going to make the investment today.

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