Description

LONG: BASIC-FIT N.V. (NA: BFIT)

We recommend a long position in €1.8bn market cap / €2.3bn EV low-cost gym chain Basic-Fit (BFIT), the category leader in Western Europe. To simplify the pitch for many readers, we believe BFIT is a smaller, less-followed, and better-run version of hedge fund darling Planet Fitness. Led by founder/owner/operator Rene Moos, the company’s business model and membership base have proven highly resilient during what has been a tumultuous operating environment, to say the least, and we now believe the coast is clear for a monster 2021, both operationally, and for the equity.

We will frame the opportunity a few different ways in the body of this write-up, but however you cut it, we see limited downside, the prospect for significant near-term upside, and multi-bagger potential over the medium-term. Illustrating the asymmetry of the situation, we see 50% upside simply from the maturation of already built gyms to historical mature-gym profit levels. In a realistic base case, we believe BFIT can return ~120% (2.2x MoM) over the next two years, as the business snaps-back from the COVID-driven operating disruptions of 2020, finds itself in an enhanced competitive position on the other side of the pandemic, and resumes its aggressive new-unit development plans. 

Crucially, Monday’s news that a broadly distributed, highly efficacious COVID vaccine is now on the way significantly mitigates downside scenarios, and we believe the chances of capital destruction over a 6-12 month hold period are quite small. Further, whereas the debate for many other COVID-impacted names is not just around when the re-opening will occur, but what shape it will take, Basic-Fit’s subscription-based operating model affords it the luxury of effectively just turning back on the cash spigot once it reopens its closed gyms and resumes normal billing cycles. As a result of the vaccine news, it appears that the current European lockdown will be the last, and as investors wake up to the ramifications of this reality, BFIT’s equity will be heading much higher. 

Why the opportunity exists

We believe that many COVID-impacted equities continue to offer extremely attractive prospective risk-adjusted returns. Broadly speaking, investors have been either ignoring these names altogether and hiding out in stay-at-home/work-from-home and/or duration assets, or treating them as fast-money trading vehicles. As investors are ultimately forced to re-examine these businesses, we believe they will find that a large number of equities offer multiples of upside to more normalized valuations, and the moves higher on Monday in the wake of the Pfizer efficacy data will prove to have been just the first leg of a much more dramatic rotation back into these stocks. Of these names, Basic-Fit is among our favorites.

In analyzing these opportunities, we have focused on businesses where 1) underlying cash burn is limited 2) there is little vulnerability to disintermediation by, or competitive incursions from, COVID-friendly substitutes and 3) post-COVID industry structures are likely to be similar or improved relative to before the pandemic. Our work strongly suggests that Basic-Fit checks all of these boxes.

Further, within the “COVID-universe” we think there are reasons why Basic-Fit may be underappreciated and/or screen poorly:

1. Significant embedded growth that is not immediately apparent

1. A common framework to quickly assess returns in COVID names is to consider the return offered by applying a normalized historical unlevered multiple to 2019 earnings and incorporating capital structure changes (i.e. historical multiples x 2019 EBITDA = $XX stock price)

2. While this may be a reasonable framework for lower-growth businesses (hotel REITs), and/or those with a longer path to recovery (cruise / airlines), it implicitly undervalues the snapback in earnings BFIT’s subscription model enables, and the significant embedded growth built into the business as a result of a large number of new gyms added YTD which have yet to ramp membership

3. In short, we expect 2021 EBITDA will be >30% higher than 2019’s result, and won’t be materially lower than what would’ve been achievable absent COVID, so any market participant orienting to 2019 earnings power will significantly underestimate the opportunity

2. Artificially elevated cash burn due to continued new gym construction throughout 2020

1. On an as-reported basis, BFIT will likely burn €200m of cash this year, which is optically high relative to its current and pre-COVID enterprise value and market cap, screening in-line or even worse than some “peers” which we believe are in a much more challenged position

2. However, the vast majority of this cash burn is due to ~€175m of expansion capex spent on new gyms which we expect to earn very attractive returns on a go-forward basis

3. Effectively much of BFIT’s optical “cash burn” has really been an investment which will drive value creation going forward, sharply distinct from the massive capital destruction seen at loose COVID-comps such as cruises or airlines, where actual underlying cash burn has been massive

At present, BFIT’s gyms in France and Belgium, representing ~60% of the estate are closed, while most gyms in the Netherlands, Spain, and Luxembourg continue to operate. As new gym construction has now been suspended until the bulk of the estate reopens, we believe current cash burn is likely close to breakeven. With a €170m cash balance at 09/30, the company is in a very comfortable liquidity position. As the currently closed gyms eventually get the green light to reopen, BFIT has a luxury that few other COVID-infected stocks do -- they will in essence “flip a switch” and restore the vast majority of their pre-COVID earnings power by resuming billing for customers who have frozen their accounts during closure. From there, we anticipate a rapid recovery in membership to follow, which as mentioned should deliver significant earnings growth vs. 2019 levels.

Thesis outline

1. Leading low cost gyms such as Basic-Fit benefit from advantages to scale which enable highly attractive, sustainable unit economics

2. Upon reopening Basic-Fit should experience an immediate snap-back in earnings power, and find itself in an improved competitive position

3. Continued new gym deployment represents a massive, high-ROIC reinvestment opportunity which will drive significant growth for years to come

Background and Business Overview

Led by owner/operator Rene Moos, Basic-Fit has established market-leading positions in its home country of the Netherlands and in neighboring Belgium, and has been rapidly rolling out its category-killing concept in the attractive French market. A former professional tennis player, Moos opened several higher-end tennis and fitness centers in the Netherlands after his playing career, which evolved into a 250-club mid-market chain called Health City. In the mid-2000s Health City began to experiment with a budget-concept, before executing a wholesale pivot to the strategy in 2013, separating the value concept from Health City under the “Basic-Fit” banner, and attracting new backing from European private equity fund 3i. From that point, the low cost concept rolled out by Basic-Fit has seen explosive growth from

Low cost gyms compete on two key variables: convenience and price. Because of advantages to scale, and an intense focus on driving down per-gym capex and opex, Basic-Fit should always offer the most compelling combination of each within its markets. Lower average per-unit costs (both capex and opex) mean that Basic-Fit can offer a lower membership than most competitors -- our checks suggest that competitors rarely attempt to undercut Basic-Fit’s core €20 offering, and Basic-Fit’s ARPU is 50-60% lower than industry averages. Yet despite lower per-member pricing, Basic-Fit’s lean cost structure, which we’ll discuss further below, allows it to break even at a lower level of membership than competitors, a key advantage. 

The economics of the business are quite straight-forward. Basic-Fit builds a gym for €1.2m on average, of which ~€300k is spent on the fitness equipment. The primary direct operating costs (excluding marketing) are labor (BFIT gyms operate with just 2.5 average full-time employees), and rent, which together constitute ~2/3 of per-gym opex. Historically, new gyms have reached breakeven at around 1,700 members, a level typically reached within 5 months of opening, and matured to a level of ~3,300 members and 50% contribution margins within 24 months. At the current ~€21 / month ARPU, and including ~4% of revenue spent on marketing this implies annual EBITDA of ~€360k per gym, or a 30% cash-on-cash return. Including maintenance capex (~€55k per gym per year) and taxes, this results in a ~19% unlevered after-tax return. In recent years, BFIT has been funding a significant portion of this development activity with debt that costs ~2%. Needless to say, borrowing at 2% to invest at 19% is a pretty favorable dynamic for equity returns.

Long Thesis

#1: Leading low cost gyms such as Basic-Fit benefit from advantages to scale which enable highly attractive, sustainable unit economics

• As any investors who have followed the runaway success of Planet Fitness in the US over the last decade are undoubtedly familiar, leading low cost gym operators have consistently gained market share in the US and much of Western Europe in recent years by offering a compelling combination of greater convenience and lower prices than the fragmented competitive universe of mom & pops and aging mid-tier chains

• These concepts strip away many of the expensive frills of middle-and-high end gyms (pools, spas, sport courts, etc.) and offer access to cardio and strength equipment, and a limited array of classes (either in person or virtual), in Basic-Fit’s case for a simple and affordable €20 / month

• Basic-Fit’s key advantage vs. competition is its ability to leverage its greater scale vs. peers to 1) build high quality gyms at a materially lower cost than the competition and 2) operate with much lower operating costs per gym

• Basic-Fit’s best-in-class management team has an acute understanding that lower per-unit costs are the key source of its competitive advantage, and has devoted significant resources to continuing to drive down unit capex and opex

• As evidence, when compared to the three other low cost gym chains for which we have publicly available information (PLNT, Gym Group and Pure Gym, none of whom compete directly with BFIT), BFIT spends the least on new build capex-per-square foot by ~20% and the least on opex per square foot by 30%

• These advantages, which are certainly even more pronounced when compared to BFIT’s actual competition are almost entirely attributable to the leveraging of scale benefits -- bulk buying of fixtures and equipment, scaling of marketing, and investments in automation -- and as such incredibly difficult for BFIT’s largely sub-scale, fragmented competition to counter

• Because of these increasing advantages to scale, low-cost concepts are prone to winner-take-most dynamics, which means most growth for the segment is typically captured by the leading player

• Basic-Fit has thus been consolidating share with not only of the gym industry as a whole in its markets, but also within the low-cost segment

• In the Netherlands, we estimate Basic-Fit has 24% of total gym members, and likely 50-60% share of the low cost segment

• In Belgium, Basic-Fit effectively doesn’t face competition in the low-cost segment, and has >60% of total gym members in the country

• In France, from an effective standing start 5 years ago, Basic-Fit now has more gyms and members than any other chain, and seems to be pulling away from #2 low cost competitor Fitness Park -- Basic-Fit now has >1m members in France vs. Fitness Park with ~700k

• In sum, BFIT has more than 50% low cost member market share in each of its markets, a similar dynamic to that seen with PLNT in the US -- this is not an accident, or a result of value destructive “growth at all costs” but rather a manifestation of sustainable scale advantages

• This cost-focused operating strategy essentially sucks the oxygen out of the room for any would-be competitors, who struggle to match BFIT’s value proposition without making economically irrational, and thus unsustainable, pricing decisions

• As such, as long as BFIT remains disciplined in its focus on costs, and maintaining the low price position in its key markets, we believe the highly attractive returns they have historically earned on new unit development will not only prove sustainable, put could improve over time as management continues to wring efficiency and scale benefits out of the business

#2: Upon reopening Basic-Fit should experience an immediate snap-back in earnings power, and find itself in an improved competitive position

• While mentioned briefly previously, it is difficult to overstate the importance of BFIT’s subscription-based business model when making comparisons to other COVID-infected equities -- whereas the debate for many other such names is not just around when the re-opening will occur, but what shape it will take, Basic-Fit has the luxury of effectively just turning back on the cash spigot

• While the crisis has had an impact on membership, trends have been quite manageable to-date, with a number of relevant data point from the first round of shut-downs and subsequent reopening outlining a likely path forward the second go-round:

• Beginning in March, Basic-Fit saw its entire circuit closed down, with a full reopening not occurring until July 1

• Despite the mass closure, Basic-Fit experienced just a 6.5% decline in members from the 03/31/20 reported peak to the 06/30/20 trough -- a result of relatively normal levels of monthly churn, but a near total absence of any new joiners

• Importantly, membership began a rapid recovery in July, with new joiners significantly higher y/y, and the momentum continued into August and early September -- in fact, before the sharp rise in infection rates in September, visitation to BFIT’s gyms had largely normalized, and membership was on-track to regain pre-COVID levels by the end of Q3

• While the second round of closures is clearly an incremental headwind, a crucial difference is that the Netherlands, Spain and Luxembourg have all remained open, significantly mitigating cash burn and the likely impact to membership levels

• Moreover, when Basic-Fit does re-emerge from the lockdown and ramp-back up customer acquisition efforts, it should benefit from a number of structural tailwinds:

• Significant supply is likely to leave the market

• As challenging as the lockdowns have been for Basic-Fit, the impact has certainly been much more dire for its regional and mom and pop competitors, which don’t have the same access to capital, and have likely experienced much worse membership trends due to substantially higher price points

• While difficult to quantify, we expect a material number of these competitors will ultimately close, and while some locations may re-emerge as gyms under new banners, some will inevitably go away entirely, and some subset of these members will inevitably find their way to BFIT

• Rents are likely to go down

• Given significant stress in the retail ecosystem, market lease terms have fallen significantly since COVID, with our checks indicating as much as 30% lower rents for potential BFIT locations vs. pre-COVID

• While it will take time to work through the numbers, this is a major potential tailwind for BFIT’s unit economics -- a 20% reduction in rents would increase per-gym mature EBITDA by ~7%

• Demand for fitness memberships could be higher

• To be fair, there are puts and takes here -- certain cohorts of the population are likely to want to avoid gyms out of fear of infection until the disease has been eradicated

• However, there are others who will 1) want to get in shape after being largely cooped up for the last year and 2) be motivated to get fit given the correlation between general health and COVID-mortality

• On balance, we think the two factors will net out to an incremental growth tailwind, particularly for Basic-Fit given their young membership base, which is a major relative advantage -- somewhat remarkably, less than 10% of members are older than 50!

• Because many of these impacts are hard to quantify, or uncertain, we’ve incorporated none of them into any of our modeling or valuation assumptions, but the combined impact could well be significant, and potentially offer even more juice to the rapid rebound we expect in 2021 and 2022

• Finally, as a simple framing of the opportunity, and the margin of safety that we believe is created by the significant embedded growth that will be driven by still immature gyms within the estate, it’s powerful to consider the valuation support derived from just existing gyms:

• Despite all the disruption that has occurred this year, and the suspension of all new-build activity in Q4, Basic-Fit will finish the year with 913 gyms, +129 y/y, with the bulk (82) added in the second half, a period when they are unlikely to have been able to attract many members before the current round of closures

• If you simply believe that all of these gyms mature to the previously outlined average membership levels (3,300 members each), the business should generate ~€310m of EBITDA and €180m of Free Cash Flow within two years

• This would leave BFIT trading for 7.5x “mature” EBITDA (vs. a historical range of 10-12x) and

• At a more reasonable 10x EBITDA and 14x FCF, BFIT’s equity would be worth ~€43 / share, or +50% from current levels, even if they never built another gym

• As we’ll discuss below, we believe Basic-Fit has an enormous runway for future unit growth, so this is by no means a scenario we expect to play out, but serves to highlight just how undemanding the current valuation is

#3: Continued new gym deployment represents a massive, high-ROIC reinvestment opportunity which will drive significant growth for years to come

• Basic-Fit is benefiting from several industry-related tailwinds, which compound to create a very favorable growth backdrop, and one that should persist for some time to come:

• First: Continued growth in total fitness penetration across Europe, and particularly in key BFIT markets

• While there is variance across Basic-Fit’s geographies, European fitness penetration (gym members as a proportion of the population) is generally low, but steadily rising

• Compared to US fitness penetration of 19-20%, Basic-Fit’s most penetrated market, the Netherlands, currently stands at just over 17%, with Belgium and Spain are much lower at 8% and 9%, respectively

• Additionally, per an annual report from industry association EuropeActive and Deloitte, Belgium and France are home to the two least-developed gym industries in Western Europe, as measured by the number of gyms per “physically active person”, with ~40% lower gyms per “cap” than the continental average, further illustrating the structural attractiveness of BFIT’s key markets

• For a variety of structural reasons, fitness penetration has been steadily rising, led principally by young people -- over the last four years, Belgium has grown total fitness memberships at a near 6% CAGR, France at 5% and the Netherlands at 3%

• We believe that these demographic and secular factors will persist for the foreseeable future, continuing to support low-to-mid single digit member growth across the industry

• Second: Within the fitness industry, low cost chains have made significant market share gains, and are driving the bulk of industry growth

• While we haven’t been able to run-down comprehensive data on low cost market share by country, there are a broad mosaic of data points that demonstrate steady and significant share gains for low cost gyms as a category across a broad number of geographies -- essentially the only gyms exhibiting significant growth globally are low cost chains, with low-cost “national champions” frequently capturing effectively all of industry membership growth

• BFIT’s IPO Prospectus, while dated, includes data on the Netherlands, Belgium and the UK, which shows low cost gyms capturing 17ppts and 56ppts of market share in the Netherlands and Belgium between 2009 and 2014, and 24ppts in the UK between 2011 and 2014

• These compounding factors have allowed BFIT to grow all key KPIs -- gyms, members, revenue and EBITDA at very high growth rates over the last several years, and we believe should continue to be tailwind for some time to come

• From 2015-19, BFIT grew clubs, members, revenue and EBITDA at compound growth rates of 23%, 24%, 26% and 27%, respectively 

• Even the “mature” markets of the Netherlands and Belgium are seeing continued low-to-mid-single-digit growth in units and members, which management believes can continue, driven by the industry growth backdrop we’ve outlined

• There is significant upside to total gym units simply by bringing the deployment of BFIT locations on a per-capita basis in France more in-line with that seen in the Netherlands and Belgium

• Today, BFIT has 11.5 and 15.9 gyms per million people (and growing) in the Netherlands and Belgium, respectively -- in France, they have just 5.3

• Management has laid out a 1,000 gym long-term target for the French market, which roughly aligns with reaching the current per-cap penetration in Belgium -- reaching this target implies an incremental 550 gyms to be built in France, or a 60% expansion of BFIT’s total footprint -- in other words, the French opportunity alone is massive

• We think this is likely to happen much faster than the market is anticipating, and see scope for BFIT to add close to 3 million members in the French market alone over next 4-5 years vs. 2.2m total members currently

• It’s also worth noting that as BFIT rolls out new gyms, they typically stimulate significant growth in the industry as a whole, with 40-50% of joining members never having had a gym membership before

• In Belgium, we estimate Basic-Fit has been responsible for ~90% of industry growth in member terms over the last 4 years

• Similarly in France, where Basic-Fit has grown from ~70 clubs in 2016 to ~460 today, the company has captured (or, framed differently, been responsible for) ~88% of industry growth

• In effect, it seems that Basic-Fit’s key markets are actually supply constrained, a very favorable dynamic

• In the context of all the foregoing, Basic-Fit’s long-term targets by geography seem quite reasonable:

• Netherlands: 300 gyms targeted vs. 211 currently

• Belgium: 300 gyms targeted vs. 191 currently

• France: 1,000 gyms targeted vs. 447 currently

• Spain: 500 gyms targeted vs. 43 currently

• We expect France to be the key growth driver for the next four to five years, contributing ~70% of openings 

• France is an extremely attractive market for BFIT, and mirrors Belgium in many ways, with an underdeveloped and highly fragmented competitive set

• After cementing their leadership advantage in France, we expect Basic-Fit to turn its attention to Spain, where it has a toehold position, as well as potential expansion into adjacent countries

• The tables included at the bottom of the memo outlines historical gym openings by geography, and our base case projections in more detail

Valuation

As mentioned at the outset, with a long-enough perspective, we see scope for BFIT equity to be worth multiples of its current price over time. For the purposes of this pitch, we’ll focus on establishing the asymmetry of the situation by outlining two scenarios which illustrate the downside protection in the equity, even under unrealistically punitive scenarios, and what we view as a reasonable (likely conservative) “base case”. 

First, the downside. Before the Vaccine news, there was a low probability, but not implausible, downside scenario where BFIT faced off-and-on closures due to COVID for the next 18-24 months, and was eventually forced to raise equity at a discount to intrinsic value, risking permanent capital impairment. Given the Pfizer efficacy reading, we now believe that this outcome is effectively off the table. As such, the most punitive downside scenario we think reasonable to consider is one where mature gyms never recover the ~8% of members they’ve lost YTD due to shutdowns, implicitly assuming that, contrary to all indications, gym membership has experienced a 1x negative demand shock and never recovers. We also assume that Basic-Fit doesn’t build any more gyms beyond the 913 they are expected to have at YE20. On these assumptions the business would generate ~€720m of revenue, €250m of EBITDA and €130m of FCF, leaving it currently trading for 9.4x EBITDA and 13x FCF. While this is already a discount to historical multiples, for the sake of argument we’ll say the business would garner ~7.5x EBITDA / 10x FCF in this scenario, suggesting ~24% downside to €22 / share.

A second useful framing of “downside” / margin of safety is the scenario outlined previously where we just consider the potential earnings power of the gyms that BFIT has already built, a large number of which are yet to mature. As a reminder, in this scenario the current 913 gyms would attract 3m total members, and generate €785m of revenue, €310m of EBITDA and €180m of FCF. This would likely be a modestly growing earnings stream, that we conservatively price at 14x levered FCF, equating to 10x EBITDA and a stock price of ~€43 / share, about 50% higher than current levels.

Finally, in our more realistic “base case”, we assume the reopening of Belgium and France occurs as anticipated in late Q4 / early Q1, with operations normalizing in the first half of 2021. In this scenario we assume BFIT aggressively ramps-up new gym rollout in 2H21, and likely easily achieve its 1,250 gym target by YE 2022. By YE 2023, we forecast >1,400 gyms, supporting 4.5m members, and generating €1.1bn in revenue. As mature club membership and earnings contribution normalizes, and the large number of newly-built gyms climb the maturation curve, we expect consolidated margins to expand toward the mid-30%s, with 33% assumed for 2023. Assigning the business’ historical 12x EBITDA multiple (which equates to 15x EBITDA-maintenance capex, 17x normalized FCF, and just 9x “mature” EBITDA) implies equity value of >€60 / share, or +2.2x from current prices.

Risks

• COVID-induced closures last longer than we anticipate

• This could add some noise to the story, but the fact of the matter is if reopening happen in December or in March, it shouldn’t change the long-term outcome, Basic-Fit has a very comfortable liquidity position, and the vaccines on the horizon mean it is very unlikely that there could be a third round of closures

• At home fitness adoption during COVID will cannibalize gym memberships

• This perceived risk is likely one of the bigger overhangs, and one we find to be totally overblown

• We are happy to get into a more detailed discussion in the comments section, but both empirical evidence (BFIT gym visitation essentially normalized in July / August) and economic logic (options such as Peloton, which isn’t even available in BFIT’s markets, are much more expensive than a low cost gym membership; a significant proportion of BFIT’s membership likely doesn’t have room for workout equipment in their homes, etc.) all suggest that the risk is immaterial

• In fact, we actually see digitally-enabled fitness as an opportunity for BFIT -- the company has invested in a robust library of workout videos and coaching available via its app to all members, which should on the margin increase the value derived by customers, reducing churn, etc.

Exhibits:

Catalyst

End of lockdowns in France, Belgium

Results