I dagsläget består min aktivt förvaltade portfölj av bara tre innehav; Strayer Education, Emeco Holdings samt det relativt nyförvärvade Town Sport International (CLUB). Jag tyckte caset för min investering i CLUB var väldigt bra och sammanställde analysen i en ansökan till Value Investor Club. Tyvärr blev jag inte antagen, caset är dock väldigt bra och jag ville därför publicera det på bloggen.
Aktiepriset har stigit något sedan jag investerade, min GAV är 5,99 USD men min första investering i bolaget gjordes till en kurs som var något högre än den nuvarande. Analysen presenteras på engelska för att underlätta för eventuella kommentarer från våra amerikanska vänner på andra sidan pölen.
Town Sport International
I believe enterprising investors have been handed a major opportunity in Town Sport International (CLUB – Share price at the time of writing 6,05 USD). Town Sport International is a major operator of gyms in primary New York and Boston. The company have not been handled gently by the market, with the stock price down 59% YTD. The price action have been primarily driven by worries of new competitive threats, the risk that the company’s debt represent and the market’s general dislike for any company that doesn’t grow. The investment in Town Sport International hinges on three central parts:
A) The business problem plaguing Town Sport International is more short-term in nature and the company’s all-important moat is still in place. Furthermore, the company will be a long-term benefiter of the increased interest of health and wellness in America. The company’s ability to generate large amounts of free cash flow is still intact. In 2009 the company managed to generate free cash flow of 27 MUSD with 486 000 members compared to today’s member count of approximately 488 000.
B) The market values CLUB as a disaster waiting to happen/already happened with EV/EBIT of 4,48 and FCF yield of 23,7% (using a five year annual average). Today, the company’s Enterprise Value consist primarily of debt, as the market value of the company’s equity is around a third of the market value of the company’s debt. This amount of leverage means that there is a possibility of a huge and fast upward correction.
C) There is a catalyst in place. An event driven value Hedge Fond, HG Vore Special situations, have established a position with 16% of the company’s outstanding shares. HG Vora Capital have urged management to unlock some of the value of the company by actions such as buy-back, special dividends or a sale of the complete company. The largest owner, Farallon Capital Institutional (16,7% of the outstanding shares), has also urged the board to consider a sale of the whole company in order to unlock value. Furthermore, the company have entered an agreement to sell a building they own to the tune of 85 MUSD, which will increase cash at hand to 162 MUSD, comparing to market value of the company’s equity of 147 MUSD.
Town Sport International’s competitive advantage hinges on having a dense network of gyms in a geographical market such as New York and Boston. We believe that the strongest factor in deciding with gym to frequent, is the proximity of the gym to either (and preferably both) your home or job. Therefore, a gym chain with more locations than its competitors will be preferred by customers, which in turn will lead to scale advantages in areas such as marketing. There are also other positive effects of having a large network; increased value of membership for those with gyms close enough to both home and office, opportunity for more efficient staffing and scale advantages in areas such as G&A.
It’s clear that the market worries about the competitive threat that smaller boutique gym pose. As they are smaller, they are less expensive to start and it is easier to find suitable locations. Management notes that during the last two years over 120 of these smaller boutique gyms have open in Manhattan, which have put pressure on the company’s ability to recruit new members. However, there is no obstacle (baring the possibility of finding the right locations) for CLUB to start either their own competing boutique gym (which they are in the process of doing) or even buying up the competition in order to strengthen their network and utilize their scale advantages.
Furthermore, to further emphasize the difference in how I view the business compared to the market (free fall) is that the company generated free cash flow of almost 27 MUSD with 486 000 members in 2009. According to the latest Q-10 the company currently has 488 000 members. The company has also announced plans to close the lowest performing 5% of their clubs, in order to decrease operating costs. Management believes that their active clubs will be able to take over most of the affected members, which would increase free cash flow. The clubs targeted for closing will primarily be gyms outside the company’s core markets (NYC and Boston).
If one believe, as we do, that the business problems the company are facing are more short-term in nature and that the company’s competitive advantages are still in place, the company is available for a bargain price. The last five years the company has generated just over 174 MUSD in free cash flow (translating to an annual free cash flow of 34,8 MUSD). The company has distributed around 80 MUSD to its owner primarily by a special dividend, cash at hand has increased to 62 MUSD and the company has paid down 32 MUSD on their long-term debt.
There are however some strings attached to the cash at hand. The scheduled repayment of the company’s long-term debt represent no danger as it is quite far away in the future. However, the company could be forced to make extra payments on its long-term debt if the company has “excess cash flow” due to convents on their long-term debt. Please see the latest filing from HG Vora for more details. The company has unfortunately failed to respond to my questions regarding this matter.
Cash: 77 MUSD
Long-term debt: 311 MUSD
Market value of Equity: 147 MUSD
Total Enterprise Value of 381 MUSD
Average five-year Annual EBITA: 85 MUSD
Average five-year Annual FCF: 34,8 MUSD
FCF yield: 27,3%
The investment case
The company currently has 77 MUSD in cash, which it has accumulated under the last 5 years. The management has a rather ambitious plan to invest the cash in several initiatives to revitalize the company and get it back to growth. Furthermore, the company will also receive 85 MUSD in September for the sale of its building at 1 51 East 86th Street, New York, given it a total cash at hand of 162 MUSD, or put in another way; a cash balance equal to 110% of the market value of the company’s equity.
HG Vora Capital Management (with 16% of the outstanding shares) has taken the lead in trying to unlock the value in the company by either distributing cash to the shareholders, or by the sale of the whole company (see SC 13D 21th of August for details). Farallon Capital Institutional (owning 16,7% of the outstanding shares) filed SC 13D/A on the 26th of August basically saying that they have been in contact with the board urging them to engage a financial advisor and preparing for a sale of the company.
In my eyes, CLUB offers an excellent example of a low risk bet. If HG Vora and Farallon succeeds in securing a take-over offer, the price of the stock will increase dramatically. Giving the company’s stable cash flow and its competitive advantages I believe it will be traded for a significantly higher multiple than the stock trades for today. However, if they fail to find a possible suitor, the investor will be left owning a company, which can buy-back a large portion of its stock, have stable cash flows and competitive advantages, trades for a free cash flow yield of 27,3%.
Or in other words, head I win a lot, tails I still get to own a good asset.
A) Living in Sweden, I am unable to actually do the type of market research I prefer and visit the gyms. I have been calculating free cash flow as cash flow after investments in the cash flow statements. If the company the last five years has invested too little in maintenance capex I could overstate free cash flow.
B) One of the issues that hunts the company is operational problems; if the management is unable to get the performance issues under control the value of the company could shrink before a sale could be realized.
C) The management has not been skillful in their capital allocation decisions. There is a risk that the management continuous to either invest in a suboptimal manner or to refuse to distribute the capital to the shareholders.
A) At this price, price is its own catalyst. The company is available for an EV/EBITA of 4,48 and a Free cash flow yield of 27,3%.
B) An event driven value hedge fond, HG Vore Special situations, have established a position with 16% of the company’s outstanding shares. Both HG Vora Capital and the largest owner, Farallon Capital Institutional (together controlling 32,7% of the outstanding shares) have urged the board to prepare for a sale of the complete company.