crunching town sports international’s surprise fourth quarter & 2015 “profit”

8/19/2019 Crunching Town Sports International’s Surprise Fourth Quarter & 2015 “Profit”

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CRUNCHING TOWN SPORTS INTERNATIONAL’S SURPRISE FOURTH QUARTER & 2015 “PROFIT” 1

Crunching Town Sports International’s Surprise Fourth Quarter & 2015 “Profit”

Jordan S. Terry

March 8, 2016

In our January report on the New York Sports Club parent, and again in February, we said, and affirm:

We reiterate our belief that CLUB equity is worth zero, though we’ve been bearish for years1.

Anyone considering shorting this stock into the ground would be well-served to remember the

adage, “markets can stay irrational longer than you can stay solvent.” Low-priced micro-caps

can see huge price swings on little or no new information, so while we’re confident of the

outcome, we are not so confident of the path. Significant involvement of activist hedge funds

introduces an additional source and degree of risk to the terminal short case.

Take this one with an extra dose of CAVEAT EMPTOR!

On Monday, Town Sports International (NASDAQ: CLUB) reported $21.6 million net income and $0.84 in

diluted EPS for full-year 2015, a massive surprise, sending the stock soaring about 60% on the day.

Where is this surprise profit coming from?

Always, Always Read Past the Headline

Unfortunately for those buying hand-over-fist on the “news,” the only surprise in that earnings number

was that it included the huge impact of a last-minute wind-down of the company’s sale-leaseback

1 E.g. 2/20/2014: “For those still long $CLUB think it through. There is zero chance this co can turn it around without

an unpleasant restructuring/makeover .” https://twitter.com/The_Analyst/status/436551614418014208?lang=en

Town Sports International (NASDAQ: CLUB)

Price (3/8/2016) 1.86 Target Price 0.00

Shares Out (1,000's) 25,000 Return to Target -100%

Market Cap (1,000's) 46,500 Action ReiterateLT Debt 266,189 Rating N/A

Less: Cash 98,011

Enterprise Value 214,678

P/E (core) NM

EV/EBITDA (core) NM

Rationale Worse than expected, deteriorating

operating performance, ratings

downgrade, restructuring watch

https://www.hvst.com/posts/57002-town-sports-the-sound-of-inevitability



https://www.hvst.com/posts/57823-town-sports-international-the-sound-of-inevitability-subsequent-events








transaction for the 86th street location in NYC, which it sold, and received cash proceeds from in 2014.

Backing-out this one-time item, which is an accounting issue, unrelated to the company’s actual

operating performance, CLUB would have actually lost around $60 million, which still includes the $14

million tax benefit claimed for the year. Instead of the company delivering 2015 EPS of +0.84, core EPS

would actually be a loss of $2.35!

To be clear: Town Sports is not actually making money, let alone the enormous piles of it the headline

would have you believe.

Membership Jumps, Revenue Sinks

Revenue from membership dues was down 10% over 2014, and total revenue was down 6.5% from

$453.8 million to $424.3 million, despite membership increasing by 12%. I don’t blame the company and

bullish traders/investors for anchoring onto the record membership numbers and big membership

growth, but the problem is that to get these new members, the company is charging low fees, more

than offsetting the benefit from the new memberships. Average monthly revenue/member went down

16.4% from $78 in 2014 to $65 in 2015, and monthly membership fees/member were down 19.4% from

$59 to $48. Both of these will fall even more for the foreseeable future. By our generous estimates,

average monthly fee revenue will drop another 6-9% to $61 and ~$43 in 2016 alone!

3/9/2016 Estimated Actual

Case: Bull 2013 2014 2015E 2015A 2016 2017 2018

Membership Dues 358,761 343,185 333,280 309,096 281,880 272,830 280,041

Membership Dues Growth -4.3% -2.9% -9.9% -15.4% -3.2% 2.6%

Initiation & Processing Fees 14,392 12,044 20,000 13,644 10,000 - -

Ancillary Non- Training Club Revenue 24,720 22,304 22,400 22,138 20,000 20,000 20,000

Other Revenue 5,985 5,971 5,917 6,254 5,000 5,000 5,000

Fee Revenue 403,858 383,504 381,597 351,132 316,880 297,830 305,041

% Change -8.4%

Personal Training Revenue 66,367 70,338 78,300 73,191 78,300 82,215 86,326

Total Revenue 470,225 453,842 459,897 424,323 395,180 380,045 391,367 Revengue Growth -1.8% -3.5% 1.3% -6.5% -14.1% -3.8% 3.0%

Actual v SSA Estimate -7.7%

Total Members 497,000 484,000 540,000 541,000 540,000 567,000 595,350

Membership % Change -2.5% -2.6% 12% 12% 0.0% 5.0% 5.0%

Actual v SSA Estimate 0.2%

Change in Members/Avg # of Locations -83 368 376 0 180 189

Total Revenue/member/month 78.8 78.1 71.0 65.4 61.0 55.9 54.8

Monthly Revenue/Member % Change -0.9% -16.4% -6.7% -8.4% -1.9%

Actual v SSA Estimate -8%

Membership Fee Revenue/member/month 60.2 59.1 51.4 47.6 43.5 40.1 39.2

Monthly membership fee/member % Change -1.8% -19.4% -8.6% -7.8% -2.2%

Town Sports International (CLUB)

Historical Estimated

STONE STREET ADVISORS LLC




We explained how this would play out last May, again in our January report, and again in our February

update; it isn’t rocket science! Due to more and stronger competition from the likes of Planet Fitness

and it’s $10/month memberships, and high-end ones like Equinox or Lifetime (both >$100/month), mid-

range gyms like New York Sports Club are stuck between a rock and a hard place, losing members to

both. Their solution was to try to compete on price, lowering their monthly membership fees

substantially. This allowed new members to join at a rate drastically lower than what existing members

were paying, but allowed current members to drastically lower their membership fees and switch from

annual to monthly contracts. THIS is why membership is growing and why attrition is falling…for now.

Where Did the “Profit” Come From?

CLUB rents all of its locations, though until late 2014, it owned a building on 86 th street in NYC. They sold

this building on September 12, 2014, receiving proceeds of $85.6 million, and committed both to leasing

the space back from the new owner, and to leasing space in the new high-rise building that will go up in

its place. CLUB got the money, the cash, in 2014; it’s right there in the financial statements.

For accounting purposes (not really economic ones), this transaction is classified as a “sale-leaseback,”

so on paper, it doesn’t look quite like a simple asset sale, which is why I think many observers are so

confused with this year’s results. Lucky for us, they’ve gone ahead and explained it in their 10-k:

With a week left in 2015, CLUB decided to walk away from the future lease commitments. As a result,

the accounting treatment of the transaction dictates they have to record it in a certain way, in this case,

as a gain on the sale of the building.

The “gain on sale of building” they booked in 2015 that led to the “huge profit” is just accounting!

There’s not actually new money coming in the door!

http://seekingalpha.com/article/3155896-town-sports-high-value-low-price-strategy-is-doomed-to-fail










http://simplestudies.com/accounting_for_sale_leaseback_transactions.html











Getting Down to Business

I’m sure the company, the activist investors running it, and most bulls (especially new ones) will

disagree, but we prefer to look at firms’ “core” operating results. Management adjusts to its benefit, we

go the other way and adjust for how a long-term fundamental investor should look at the results. How is

the core, operating business doing, absent the effects of financing/accounting effects and non-recurring

items? Now that CLUB has sold and accounted for all of its remaining hard assets (the 86th street

building), we’ve gone ahead and adjusted CLUB’s reported results for 2015 by stripping out the effects

of the sale-leaseback wind-down to get to “core” operating results. We have left the gain on the debt

repurchase, however, as we see that as recurring, even though we think debt repurchases are, for lack

of a better word, extremely stupid. Why burn cash you desperately need to retire debt that’s not due

until 2020, AND destroy what’s left of your credit rating in the process? Far better to hoard as much

cash as possible, for the very rainy days ahead!

As you can see, the picture changes drastically. A relatively huge profit is actually, on a sustainable,

economic basis, a huge loss.





Case: Bull 2013 2014 2015E 2015A 2016 2017 2018

Membership Dues 358,761 343,185 333,280 309,096 281,880 272,830 280,041

Membership Dues Growth -4.3% -2.9% -9.9% -15.4% -3.2% 2.6%

Initiation & Processing Fees 14,392 12,044 20,000 13,644 10,000 - -

Ancillary N on-Training Club Revenue 24,720 22,304 22,400 22,138 20,000 20,000 20,000

Other Revenue 5,985 5,971 5,917 6,254 5,000 5,000 5,000

Fee Revenue 403,858 383,504 381,597 351,132 316,880 297,830 305,041

% Change -8.4%

Personal Training Revenue 66,367 70,338 78,300 73,191 78,300 82,215 86,326

Total Revenue 470,225 453,842 459,897 424,323 395,180 380,045 391,367 Operating Expenses

Payroll & Related 174,894 177,009 181,127 175,898 167,219 161,547 159,916

Per location 1,080 1,172 1,184 1,157 1,115 1,077 1,066

% Sales 37.2% 39.0% 39.4% 41.5% 42.3% 42.5% 40.9%

Club Operating 179,683 192,716 199,206 196,725 195,750 193,500 191,250

Per location 1,109 1,276 1,302 1,294 1,305 1,290 1,275

% Sales 38.2% 42.5% 43.3% 46.4% 49.5% 50.9% 48.9%

G&A 28,431 31,352 30,859 30,683 28,000 27,500 27,000

% Sales 6.0% 6.9% 6.7% 7.2% 7.1% 7.2% 6.9%

Impairment 714 4,706 46,129 46,129 - - -

% Sales 0.2% 1.0% 10.0% 10.9% 0.0% 0.0% 0.0%

D&A 49,099 47,307 46,000 47,887 45,000 45,000 45,000

% Sales 10.4% 10.4% 10.0% 11.3% 11.4% 11.8% 11.5%

Other & Non-Recurring Expenses (Gain) - - - (80,113) - - -

Total OpEx - Reported 431,817 453,090 503,320 417,209 435,969 427,547 423,166

OpEx % Sales 91.8% 99.8% 109.4% 98.3% 110.3% 112.5% 108.1%

Total OpEx - Core 431,817 453,090 503,320 497,322 435,969 427,547 423,166

Core OpEx % Sales 109.4% 117.2%

Operating Income - Reported 38,408 752 (43,423) 7,114 (40,789) (47,502) (31,799)

Operating Margin 8.2% 0.2% -9.4% 1.7% -10.3% -12.5% -8.1%

% Change - 9. 4% - 98. 0% -5874.4% 846.0% -673.4% 16.5% -33.1%

Operating Income - Core 38,408 752 (43,423) (72,999) (40,789) (47,502) (31,799)

Core Operating Margin 8.2% 0.2% -9.4% -17.2% -10.3% -12.5% -8.1%

% Change - 9. 4% - 98. 0% -5874.4% -9807.3% -44.1% 16.5% -33.1%

(Gain) loss on extinguishment of debt 750 493 - (17,911) - - -

Interest expense 22,617 19,039 19,000 20,579 18,550 18,000 18,000

Equity in the earnings of investees and rental

income (2,459) (2,402) - (2,361) - - -

EBT - Reported 19,691 (16,378) (62,423) 6,807 (59,339) (65,502) (49,799)

EBT - Core 19,691 (16,378) (62,423) (73,306) (59,339) (65,502) (49,799) Tax Rate 37.4% 35.0% -210.8% 35.0% 35.0% 35.0%

Tax provision 7,367 52,611 - (14,351) - - -

Net Income - Reported 12,324 (68,989) (62,423) 21,158 (59,339) (65,502) (49,799)

Net Income Margin 2.6% -15.2% -13.6% 5.0% -15.0% -17.2% -12.7%

Net Income - Core 12,324 (68,989) (62,423) (58,955) (59,339) (65,502) (49,799)

Core Net Margin 2.6% -15.2% -13.6% -13.9% -15.0% -17.2% -12.7%

% Change 3% -660% -9.5% -14.5% 0.7% 10.4% -24.0%

EPS - Reported (2.84) (2.50) 0.84 (2.37) (2.62) (1.99)

EPS - Core (2.35)



STONE STREET ADVISORS LLC




Note in the top left of these charts that the projections for 2016-2018 utilize my bull case assumptions,

for example, growing membership another 10% and cutting payroll significantly, both of which I think

are pretty optimistic. My base-case assumptions are just a tad less generous, but, it’s 70 degrees in NYC

in early March, so I’m feeling generous. Unfortunately, the numbers speak for themselves, and they are

less forgiving:

Cooldown

When CLUB earnings came out Monday evening, I was actually walking into the New York Sports Club

location on Mercer Street in Manhattan. As usual, I talked about the company with the employees on

my way in. Apparently the current plan is to upsell all of the new members in the $20-45/month single-

location (or regional) membership plans to the $60-$70/month Passport plans. In the former, you use

your home gym, and if you want to use another, you pay a fee, around $13/visit. I agree, that’sridiculous. They also agree, and think that by pricing that fee so high, they can more easily convince

single-location members that it makes sense to get the Passport plan. “If you’re going to another

location twice per month, you actually save money with the more expensive plan!” Which is true,

though I question how many people are going to buy that pitch, given how many existing members have

downgraded and how many new members were attracted by the low-price, single-location membership

plan.


Case: Bull 2014

9 months

2015 2015E 2015A 2016 2017 2018

CLUB Cash Flows 2014 9 months 2 2015E 2016 2017 2018

Net Income - Core (68,989) (65,838) (62,423) (58,955) (59,339) (65,502) (49,799)

D&A 47,307 36,042 46,000 47,887 45,000 45,000 45,000

Capex 42,054 24,073 32,193 30,471 27,663 26,603 27,396

% of Revenue 9.3% 7.4% 7.0% 7.2% 7.0% 7.0% 7.0%

Capex/club 279 157 210 184 177 183

Financing - - - -

Impairment 4,706 46,129 46,129 46,129 - - -

∆ W orking Capital (20,994) (10,000) 9,185 (5,000) (5,000) (5,000)

Debt Issuance - - - -

Preferred Dividend - - - -

Common Dividend - - - -

Debt Repayment/Repurchase 2,954 13,985 17,924 12,895 12,866

Asset Sale 83,400 - - - - -

Change in Cash* 19,854 (5,166) 4,559 (17,235) (54,926) (55,000) (40,061)

Beginning Cash 73,598 93,452 93,452 93,452 98,011 43,085 (11,915)

Ending Cash* 93,452 88,286 98,011 76,217 43,085 (11,915) (51,976)






While I understand the rationale, I’m not so sure this strategy is going to play out as they’re

hoping/expecting, just as I predicted – correctly – that the original “high value, low price” strategy

introduced in late 2014 would fail.

Most people do not appreciate a bait & switch, regardless of whether the economics make sense.

Again:

We reiterate our belief that CLUB equity is worth zero, though we’ve been bearish for years2.

Anyone considering shorting this stock into the ground would be well-served to remember theadage, “markets can stay irrational longer than you can stay solvent.” Low-priced micro-caps

can see huge price swings on little or no new information, so while we’ re confident of the

outcome, we are not so confident of the path. Significant involvement of activist hedge funds

introduces an additional source and degree of risk to the terminal short case.

Take this one with an extra dose of CAVEAT EMPTOR!

Disclosure: The opinions presented herein are solely those of Stone Street Advisors LLC. Neither Stone

Street Advisors LLC nor any of its members has a position in CLUB or CLUB derivatives, nor any plans to

initiate a position. Nothing contained herein shall constitute a solicitation, recommendation or

endorsement to buy or sell any security or other financial instrument. Stone Street Advisors LLC makes

no representation or warranty as to the accuracy, completeness or timeliness of the information

contained herein, and disclaims all liability arising from errors or omissions contained in this

presentation. This document is presented for informational purposes only and does not constitute

investment advice. Stone Street Advisors LLC is not an Investment Advisor.

2 E.g. 2/20/2014: “For those still long $CLUB think it through. There is zero chance this co can turn it around without

an unpleasant restructuring/makeover .” https://twitter.com/The_Analyst/status/436551614418014208?lang=en

crunching town sports international’s surprise fourth quarter & 2015 “profit”

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