Fitness crazed?

Back in the days of leg warmers and aerobics classes, the term ?fitness craze? was coined to reflect the trend towards a healthier lifestyle. As ?conspicuous consumption? set the agenda of the 1980s, soon no one's life was complete without a gym membership. The 1990s did little to halt the market's seemingly insatiable appetite for fitness studios, much to the delight of equity investors who bought their shares.

But when, in 2001, stock markets began to fall, the fitness sector hit hard times too. To investors in the UK, recently floated gym operators suddenly looked like so many unattractive small to mid-cap companies, even though their growth prospects still seemed intact, and share prices followed the rest of the market down. Even worse, much needed new capital was not forthcoming. At that point, private equity rode to the sector's rescue, funding a spate of public to private transactions. First into the fray was Royal Bank Private Equity which acquired Cannons in 2001, followed by Duke Street Capital's hostile takeover of Esporta in 2002 and Cinven's more recent acquisition of Fitness First. Meanwhile Bridgepoint Capital's longpursued take-private of Holmes Place seems finally imminent, having reportedly secured support from fellow equity sponsor Permira.

Apart from the collapse in the share prices of these businesses, what was it that sparked such excitement among financial buyers? Certainly growth prospects remained part of the attraction, despite the need for capital ? town centre locations and rows of gleaming machines do not come cheap. Equally important was the perception of the long-term attractiveness of the wider sector of which fitness clubs form a part: leisure. As a greater percentage of the population have grown in wealth, so an increasing proportion of this group are spending significant portions of their income on leisure activities. Therefore, the logic goes, although there may be bumps along the road, longterm this market can only grow ? or can it?

Recent evidence has begun to call into question the validity of such fundamental assumptions. Take the events unfolding around Holmes Place for instance, which may well represent a turning point for private equity involvement in the sector. At the time of this issue going to press, Bridgepoint's price mooted for Holmes Place was £47m. This is the same Bridgepoint that in the summer of 2002 made an initial offer for the same business of £177m, only to be trumped by RBPE-owned Cannons, which offered £203m. Cannons then withdrew this offer as news of trading results ?significantly below? expectations began to emerge.

The apparently dramatic, and sudden, fall in value is underlined by the fact that, for 2001, Holmes Place reported EBITDA of £34.1m, up 46 per cent on 2000. For the first half of 2002, growth appeared to be continuing unchecked as reported EBITDA grew 30 per cent over prior year to £17.4m. Based on available information, the majority of prior transactions in the sector were completed at EBITDA multiples of 7 to 7.5x. Cannons' offer, however, valued the business at a rather lower 6x 2001 EBITDA. Even adding a further ?discount?, bringing the metric down to 5x, would suggest that 2002 EBITDA will be around £11- £12m ? less than that reported for the first half How can this be?

It has been suggested that Holmes Place is disproportionately exposed to Central London and has therefore been hit heavily by high levels of job losses within the financial sector. This may be the case, although it's hard not to suspect that other premium end operators, such as Cannons, should be feeling similar pain.

What we seem to be witnessing is the beginning of a shakeout in the sector and the emergence of a handful of companies with real stamina ? in particular those appealing more to the many, rather than just the rich. Whatever the case, there is a rather more fundamental lesson here for the private equity sector, which unfortunately is not new. Just because the leisure sector ? or more specifically, the health club part of it – as a whole may be growing, not every company within it is guaranteed to be successful.

It seems very possible that there will soon be an upset or two amongst the various firms competing in this maturing sector. It is more probable that actual failure will be avoided, although with some pain experienced along the way. It would also seem, however, that such investments will require more patience, and result in more effort being expended on the part of the owners, than was anticipated when the investments were initially made. ?Fitness craze? no longer seems appropriate; hindsight may well prefer ?fitness crazed?.