While many who frequent gyms scoff at Planet Fitness as "the gym that serves pizza", according to Ben Axler of Spruce Point Capital in New York, there is also reason to scoff at PLNT:US as an investment. Planet Fitness was able to IPO under the relaxed conditions provided under the Federal JOBS act, legislation which was designed to allow smaller companies access to equity markets. According to Axler however, PLNT has over-aggressively used these looser reporting restrictions to make it look healthier, and may soon be sent to the locker room when it misses investors' expectations.
SumZero: What about Planet Fitness initially caught your attention as a critical minded investor?
Ben Axler, Spruce Point Capital: There are many factors that caught my attention. First, I understand the fitness industry fairly well both from having been a member at various gyms for over two decades, and from having invested in them. The business is intensely competitive, subject to constantly changing consumer trends and preferences, and has deflationary pricing. Planet’s $10 per month model is a perfect example. There is nothing stopping competitors from replicating its model and cutting prices even a couple of dollars per month, forcing further deflation. Secondly, as a recent JOBS Act IPO, Planet has taken advantage of numerous listing exemptions, but we don’t think that excuses its inability to regularly report quarterly customer churn and marketing and advertising costs, both critical components investors need for evaluating its performance. Lastly, we believe Planet’s valuation at 6.0x and 15x 2017E sales and EBITDA is expensive, and leaves little margin for error. There are numerous ways to evaluate Planet’s valuation, suggesting 7x – 10x EBITDA range (M&A deals such as Lifetime Fitness) and other historical ranges for fitness clubs such as Town Sports, or Ballys, along with fitness equipment makers like Nautilus and Cybex (it’s important to realize most of Planet’s revenues come from selling equipment). Our valuation estimate for Planet is approximately $8.00 per share or 50% downside. We also factor in the $140m tax payable that represents a real cash flow that analysts fail to address.
SumZero: What is the market missing about PLNT?
Ben Axler, Spruce Point Capital: The market believes Planet will have no problem adding 200+ clubs per year and be able to realize the same economics as it did when it had a few hundred locations. Its model works best in densely populated areas where it can sign up between 6,500 – 10,000 members per club. Of course, the densely populated areas are where competition is highest, and where Planet has already expanded. As they move to second and third tier markets (even internationally to Canada), replicating the early success of the business could become much harder.
SumZero: Is Planet Fitness still attractive to short at today’s prices?
Ben Axler, Spruce Point Capital: Yes, Planet is trading slightly above its IPO price of $16.00 per share, while competition intensifies every day. Despite reporting optically solid Q4 results and guiding ahead of Street expectations for 2016 (with headline member, club, and revenue growth north of 20%), we observed that its net income and cash flow barely increased. With think this is an early indication that our concerns are starting to play out. Digging a little deeper into the numbers, we believe Planet is having to spend significantly more in marketing and advertising to attract incremental members, while churn may be increasing. The competition appears to be quickly replicating Planet’s model in all major geographic regions. There are even gyms now popping up around the country at $5.00 per month such as a Fusion Gyms and Colaw Fitness. The deflationary forces in the industry are real.
SumZero: What key metrics should investors be paying attention to as your thesis matures?
Ben Axler, Spruce Point Capital: Member churn and marketing and advertising spend are critical components to evaluating Planet’s business, but as we noted, the company does not disclose it on a quarterly basis. Another leg of Planet’s growth story is that it will be successful in getting existing franchisees to replace aging cardio and fitness equipment every 4 – 6 years and refresh/remodel the gyms. This is a significant cost to franchisees estimated to reach over $1.0 million. It will be important to evaluate the degree of success they have enforcing this among the franchisee base. Planet is highly dependent on a core group of franchisees for its current growth plan. The company noted that 90% of new locations came from the existing franchisee base.
SumZero: What were the biggest risks associated with the trade in your view?
Ben Axler, Spruce Point Capital: The terminal risk in every short trade is that the company gets acquired at a price above the short entry price. Given that Planet trades at a substantial premium to every gym equipment maker and fitness club operator we’ve evaluated, we believe there’s some margin of safety in the valuation. It’s also worth noting that Planet leases all of its locations, so there’s no hard real estate ownership backing any of its assets that would make it an attractive target. Lifetime Fitness, which was acquired for 9x forward EBITDA owned a substantial amount of real estate. Also, Planet’s private equity backer still controls over 65% of the shares. It’s reasonable to assume its backer had evaluated an outright sale of the company before taking it public, but determined the public equity market would give the company its highest valuation. It’s also reasonable to assume that its financial sponsor could look to sell shares to monetize its large financial gain, and reduce its significant concentration in the shares (estimated at 20% of its portfolio).
SumZero: As the current number one ranked short analyst on SumZero, is this thesis representative of the Ben Axler and Spruce Point Capital investing style you’ve used so successfully in the past?
Ben Axler, Spruce Point Capital: We look for companies with; 1) unsustainable business models not capable of meeting Wall Street’s high expectations 2) aggressive accounting to embellish financial results, and reduced disclosures, and 3) Of course, outright frauds. We view Planet as falling into buckets 1 and 2. We believe it has above average risk of missing its long-term financial goals. In addition, there are some indicators that suggest Planet’s accounting may be aggressive, and its disclosures are below industry standard.
SumZero: Where else do you see value in the market today?
Ben Axler, Spruce Point Capital: At this stage of the economic cycle, valuations looks rich, world growth is anemic, and most of the easy value has been extracted from the market. We’re spending more of our time looking for shorts.
SumZero: How has your approach evolved over the years?
Ben Axler, Spruce Point Capital: The market has become much more efficient and difficult to make money in recent years. Ease of accessing public information has increased and costs have decreased. Wall Street continues to attract the sharpest minds in the world, resulting in escalated competition. Financial product innovation has also increased complexity with a corresponding increase in the degree of complexity of accounting. Algorithmic and high frequency trading is distilling investment decisions down to the millisecond. From an investment standpoint, it means to stay ahead of the curve and have an edge, I’ve simply had to work harder and focus on fewer investment ideas that I’m very confident with.
SumZero: Tell me about your investing background and investing mentors and heroes.
Ben Axler, Spruce Point Capital: My background is as a statistician and investment banker. Training as a statistician has been very useful during my investing career. Investing is a numbers game: plain and simple. It requires making decisions with limited information, and adapting your decision making in a dynamic environment as information changes. It also requires being creative and resourceful in acquiring public information, and interpreting the information in ways that other investors and analysts may be missing.
Furthermore, I spent 8 years as an investment banker prior to founding Spruce Point Capital. In order to buy financial products, it’s helpful to know how these products are created, marketed and sold. In my capacity as an investment banker, I advised companies on matters of debt and equity financing, risk management and mergers and acquisitions. Getting a 360 degree of corporate finance as an investment banker sharpened my skillset as an activist investor.
SumZero: What advice would you give to someone interested in pursuing investing?
Ben Axler, Spruce Point Capital: To be successful as an investor requires a few things: 1) Passion for learning: I define passion as making your job your enduring life’s hobby. Also, if you find yourself waking up Sunday morning at 5 am to read a 10K or 10Q, you’re probably a passionate investor 2) Patience: Markets can become disconnected from reality for long periods of time. Therefore, having conviction in your ideas and research process, along with the patience to see the outcomes realized is absolutely critical; 3) Skepticism: It’s important to always question the assumptions underlying every investment that’s made. My early investment mistakes came from not asking enough questions and doing enough research. Now I try to question everything, and check every piece of information presented to me. 4) Know when you’re wrong: This is by far the hardest skill to master, but to be an astute investor requires changing one’s mind when the facts point to an incorrect investment decision.
SumZero: Anything else you would like to add?
Ben Axler, Spruce Point Capital: Thank you Sumzero for the support and your interest in our work. Anyone interested in following updates should follow us on Twitter @sprucepointcap as well as on Sumzero.