Chit Chat Stocks - Xponential Fitness (XPOF) with Paul Cerro

Episode Date: June 16, 2022

Xponential Fitness is the parent company of fully franchised boutique fitness locations. The company focuses on classes that are specific to the consumer and their needs. Listen as Brett and Ryan ask Paul questions about the company, its business model, and valuation. Enjoy the show! This episode is sponsored by Commonstock, a social network for smart money investors. Check-out the platform here: https://commonstock.com/  Subscribe to 7investing with the code "Money" and get $100 off: https://7investing.com/subscribe/aff/4/ Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Interested to see more of Paul's work? Find him on Twitter here: https://twitter.com/paulcerro?s=20&t=RWkQ1LAYvdaXBVZIrXIUpQ Contact us: [e-mail]  Timestamps Xponential | (5:15) Licenses | (13:02) Rollup Strategy | (20:08) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. This is our Thursday deep dive episode. Today, we have on the show Paul Sero. I guess for context, on this show, we interview a single expert or analyst to discuss one stock. And today, we're talking about Exponential Fitness. Pretty fascinating company. It's kind of, I guess you could call it a conglomerate, maybe? Roll-up. Roll-up was probably a better term. It's a franchise model for boutique fitness studios. If that doesn't get you excited, I don't know what will.

Either way, though, we've been finding lately a lot of people that know or want to pitch stocks that personally we haven't heard of, and I think a lot of people haven't heard of, but are really, really interesting models. I think about Hagerty, which would have come out two weeks ago from when you're going to hear this, or Playway about a month before that. Those are ones that a lot of people haven't heard about, but have these really interesting models that are quite profitable and exponential pin is kind of in line with those. And it's the kind of area where you can find really good returns as an investor. But before we get to

the interview, I want to talk about our sponsor for the episode. It is Common Stock. So I'll give, I know Brett has been posting a little more often on Common Stock. So I'll let you talk about that, but I'll give sort of the elevator pitch. They are a community of experienced traders and investors, and they're the only social investing platform that lets you connect your existing brokerage account. So you can actually validate whether people are, uh, full of it or not, or actually, uh, giving what they're truly doing. Um, and they call it sort of a Bloomberg terminal for main street. I like that idea. It's a lot like Twitter, but, uh, We talk about some products here that might be more for professional investors. If you're an

individual, this is a perfect product for you. Um, there's a lot about your experience. Yeah. So I've been posting on there, uh, just in conjunction with our podcast releases, kind of throwing out some questions we might have had while we recorded something get some conversation going and it's nice um the community is building up it's a lot bigger than it was say a year ago which is great and yeah you get a lot of people um you know posting sub stacks posting good write-ups themselves they're asking good discussion questions you can learn a lot and also maybe you know get some feedback on anything you've written uh so either while you're if you're looking for research or trying to grow your own research or share something that you did,

it's a perfect place for both. It's a good interaction. Okay, perfect. And visit commonstock.com to join. I believe you can also look up the app on the app store, but commonstock.com. Without further ado, let's get to the interview. Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts, and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast.

Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guest is not formal advice or a recommendation. Now, please enjoy this episode. All right. Today, we are welcomed by Paul Cerro. He is a portfolio manager or the portfolio manager at Cedar Grove Capital Management. We met through Twitter, and I saw you, I think, in the mentions of, it was talking about like F45 Fitness, and you said, no, you got to check out this other company, Exponential

Fitness. And then I kind of got put onto your sub stack. But before we get into what Exponential Fitness is, can you kind of give us your background what cedar grove is what's kind of your strategy as an investor yeah of course so i started off like i had a college i worked at merrill lynch and investment banking covering the consumer goods and retail group so it's anything from going inside of a store to purchase things or online my specialty back then was in restaurants fitness luxury retail and also cannabis that was when it really came to market. So when I started Cedar Grove Capital, it was mainly because of

a few beneficiaries that were like, You know what? You have some pretty good ideas. Let's throw some money behind you. And our area of focus is a long-short strategy, specifically geared towards the C&R space and cannabis. And now that it's 2022 at this point, so a lot of consumer companies have some type of tech component or online component to them. So we kind of stretch that out to any type of technology company that can directly interact with a consumer. So it's kind of like two main core areas of focus with like a third if you kind of push it. And there's really no cap on what type of market cap focus, what type of subsectors,

it's just there's an opportunity within those spaces and we'll take a look at it. How did you find Exponential? How'd you come across it? Because I don't think anyone's heard of Exponential. They may have heard of some of the companies under the umbrella, but how did you come across it? Yeah. So actually back in my investment banking days, it was an actual client of ours. This was years ago. And me being the analyst back then, it was like, hey, you know what? They're potentially looking to IPO, we might have an opportunity to be the book runner for it. We left on it. And so one of my last projects that I did before leaving was putting together a pitch deck

for management, potentially IPO at that current point in time. They did not. So that deal got shot down when I was a banker. But then last summer, I got an article thrown through me that they had filed for an ipo in summer 2021 and as soon as i saw that i wanted to just double check like if anything everything still made sense from when i last saw it and it did and i was more than excited to hop back on that bandwagon and can you explain what they do and how how it isn't a traditional gym operator obviously so how does it differ from the typical uh gym based company yeah so exponential fitness is actually like the parent company and they are a fully franchised uh boutique fitness um company so they don't they actually do not own or operate any

uh franchises uh to caveat that they have in the past but that's because they just purchased some from uh previous franchisees and kind of turned them around and repackaged them and resold them but they're core business models. We don't hold it. We just sell licenses. And they're different from a traditional gym operator. If you were compared to a Planet Fitness... Planet Fitness is... You go to the gym, there's hardcore... I mean, not Planet Fitness, but there's a lot of equipment there. There's treadmills, there's dumbbells, etc. And that's great for certain people. But Exponential took a different approach. and instead of having it as traditional gym equipment they essentially teach classes based

on certain aspects of what you're trying to accomplish in parts of the body uh to people who want to go there in person and not try to get like lose weight or get bulk bulky you know they're more so like focused on um like movement compound exercises etc that just don't involve lifting heavy weights can you talk about some of the what what those the names of some of those subsidiaries are yeah so every oh i'm gonna say everybody a lot of people should hopefully know a few of them but for those are out there some of the classic ones are pure bar club pilates in new york city which is really big part of the pandemic was like rumble the rumble studios Dave, Yoga Six, Stretch Lab.

There's a lot of different boutiques, concepts that they technically own that they rolled up into this exponential parent company. Have you visited any of these locations as a customer? Yeah, you know, because in 2019, before New York City went into lockdown

and a very long quarantine, Rumble was actually like one of the hottest things. And if you brought that up in conversation, like, yeah, I'm going to Rumble. a people were like whoa you got money and then number two um it was like such a millennial thing here in new york city that everybody just wanted to try it and there's like kind of two concepts one was rumble uh tread which is basically you do half running and then half like weightlifting

and when i say weightlifting it's like just like a 20 pound dumbbell and then there's another one where it was rumble boxing uh where that's you got to like literally go in with boxing gloves like punch some bags and then also do uh like a concept of a training on top of that so i've been to that one i've had friends go to pure bar um they are mainly women but they go to pure bar um those who love pilates go club pilates um so that it seems that what they've done um especially especially me they found a home for anybody who wants to experience that type of uh this fitness exercise Yeah, that makes sense. And we're going to get to financials, but one more just quick question.

Do they have like a yoga type brand as well, or are they only in these Pilates and bar stuff? No, they have one. It's called Yoga 6. That's what they offer yoga classes as well. Is there a subsidiary that accounts for the majority of their studios or their business, or is it kind of pretty well diversified? so it actually it actually started off with um club pilates and then over time they just kept

rolling up uh existing and then new boutique fitness concepts so it does lean more heavier towards the original og uh concepts that they started with i can't hear barbie one of them utilizing another um so uh as they continue to roll on new acquisitions like most recently was uh body fit training everyone was was rumble um depending on what the market is you know they'll hopefully ramp those up on equal weighting to others but as of right now it's still heavily weighted to the beginning concepts gotcha and we'll get to the your thoughts on the roll-up strategy and how maybe investors should look at that but i think the most important thing to go through now because it's such a unique model um can you go through the unit economics i know they

have a lot of different revenue streams um you know what does it cost for a franchisee to pay for this and what does exponential fitness get you know back from it yeah so considering it is a fully franchised model um they make money by a selling licenses um and then the royalty revenues from that and i like to have some miscellaneous stuff as well so if we're going down how they actually make money um so if you look at their their revenue line it's really four main things One is the loyalty revenue, which is 7% off the top. That's just for every licensee who has revenue that gets 7% off the top. They have an additional 2% marketing fee that goes along with most franchise concepts that have to get the name out there.

They have other revenue, which is basically their digital offerings. So there are on-demand video classes and another concept library that is static. And then if the fitness concept does require equipment, it's not going to be like a fitness type level, but they do sell the equipment that is necessary to put into those fitness studios. So those are really the four, I guess, ongoing revenue drivers, but then they get the immediate revenue from the actual licenses that they sell. And I'm assuming the franchise licenses are the main gross profit driver, like they have the highest gross margins? Because the equipment, are they selling that at cost or are they trying to make money on that as well? No, I mean, you're right. I mean, when they're selling the licenses, that's basically like 100% flow through. There's really no associated costs with that, if you think about it. I mean, the only real cost that you're paying is the salesperson to go out and sell it, if that's what they're going at. For the equipment, they're really not trying to make money on it. It's more so just like a function of them doing business with franchisees

that just need the equipment. They can just facilitate it. And they do offer, it's very minuscule, but it's like the apparel that could be sold in those studios, like they do offer that as a driver. Like not really, it's more like nice to have. But their core is really off of that. Not royalty revenue, not marketing fee.

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included with Cox Panoramic Wi-Fi. Advanced Security must be enabled in the Panoramic Wi-Fi app. Restrictions apply. Okay. And you might have mentioned it, but what are they paying on like an annual basis, monthly basis, all up front, or a mix of both on, you know, for the people when they're buying a license to operate one of these studios? yeah so whenever so it's actually a good point you bring that up because when they sell licenses um in north america they basically like amortize the um the revenue off of that over a certain amount of years but what's interesting is that when they do it internationally just because of the the accounting rules abroad whenever they sell that because they're selling

like a master franchisor they actually can recognize revenue 100 up front um so as they continue to sell those licenses abroad you're seeing like a massive like pull forward immediately just because of the fact that that's just the way the accounting system works over there whereas um once they sell the licenses in north america they have to you know amortize it um but then the franchisees i believe they pay it on uh an annual basis um if i remember correctly but but that's this one important call that I'm actually glad you brought up. What does the franchisee's payback look like? I mean, what's the incentive for them?

How much are they earning, let's say, in year five versus how much they pay up front? Yeah, so depending on what concept you choose, and they have 10 brands. they range anywhere from a very capital light uh model so you're talking about like a yoga a boutique yoga studio you're really not using too much equipment to do that right if you're talking about um like a rumble or a body fit training where you're going to need some pretty some pretty heavy equipment in there uh the capital investment changes but if we're talking about like kind of what they've pitched uh so their their plan is essentially hopefully to drive about half a million dollars in AUV for the franchisee and with it's presumed like 25 to 30%

of people to margins so if you're going to do the math on that you're taking like a two-year cash-on-cash return of about like 40% again depending on what kind of concepts you're looking for and then I know we'll touch base a little bit later having this new omni-channel approach to people who go in person and just want to do things from home the franchisee signs up for that type of plan they can also get a cut of the digital revenue as well should um the i guess customer sign up for that as well so it's it can it can get rolled up but the plan is to get the franchisee to at least half a million dollars in run rate all right that makes sense uh let's talk a little bit on their margins they have invested heavily over the last few years pandemic has been

you know obviously for business like this was a bit tricky uh but they've gotten through it what or maybe the next few years i don't know what sort of operating leverage do you expect this business to get to and maybe if they're still reinvesting um at maturity whatever that is what kind of margins either cash flow ebit whatever can this business have Yeah, so it's really great because the reason why I fell in love with this company in the first place is because since it is not an owner and operator, they just make their money off of making sure they sell enough licenses to continue growth and then helping the franchisee scale their average unit volume. So when we're looking at the leverage that they can essentially obtain, if you really have no variable costs and your fixed costs are essentially your SG&A, over time, as your top line keeps getting bigger and bigger and bigger from the new licenses that you sell,

the more franchisees that you get on board, the more you can optimize said franchisees, your top line keeps growing. but your core expenses, like SG&A, are really not going to be growing as fast as your top-line revenue. So because of that fast, you're going to be seeing this huge margin expansion that's going to be occurring, assuming that margin expenses stay the same. Just from the sheer size, you just don't need that many people

to operate a business that you're not actually operating. You're just running the company. So management has, in recent transfers, noted that they're kind of targeting over 40% as EBITDA margins. Right now, they're not quite there. They are projecting, like this year, for instance, they're going to be jumping from about 17% to just over 32% margins.

So if you think about a one-year difference, you're almost doubling your EBITDA margin expansion just from the sheer size of your business growing. And they didn't know, and I will caveat this, they didn't know because, like I mentioned earlier, they have operated some studios in the past but only to repurpose them and sell them. A large benefit of that also comes from

them not having to pay the employees straight up anymore because they've sold it to a franchisee. It's off their hands. It's off the books. So they recognize a little bit more delta sooner rather than later. okay and ryan you want to just what are their primary costs just personnel or like do they have rd for this tech stuff too the the app and technology rollout is that part of it yeah so they have the sg and asus blanket from across everything that you need for the business they

have the marketing costs that are associated with getting the brands out there which depending on um location and uh what concept you're actually marketing it varies um but then the other things they really did push against you, which is a really smart move, was their digital approach to fitness. So pre-pandemic, in-person was the thing. Digitally, it wasn't that big. Maybe some people dabbled in it. But in a post-COVID world, even during COVID world, they recognized like, hey, if in-person is not going to be a thing for a while, we got to put some money behind digital. And that's exactly what they did. They launched X Plus, which is essentially their digital video library of workouts which you can pay for signed up and do them at your home and then they also

offered um x plus i'm sorry x pass which is the um video on demand uh option while being able to um go in person to studios and try different concepts without actually being married to one brand. So this push, it did take a lot of money. But if you think about how it's going to be normalized in the future, because they're not going to be spending up on the initial build-out, it's more so of upkeep and optimizing. So it's more like a maintenance type of spend more than it is a brand new concept at this point.

What are your thoughts on the roll-up strategy and what kind of multiples have they paid in the past for their acquisitions? Yeah. So I love this strategy. And I think you mentioned at the beginning when it comes to F45 fitness, I was actually looking at that as well. We had, we actually owned both of them at the beginning of the year. And just from being able to decide, like, maybe you should hold one rather than both. We ended up dropping F45, which for a decent gain before it completely collapsed. um and the real difference is because f45 is a one fitness concept it is as it's a workout for 45 minutes backed by mark wolbert that's it um a blind seeker but then if you fast forward to exponential you have a what i like to call it is a essentially a pseudo fitness etf right you have this one company that just owns different brands with different concepts inside of it and they essentially act like a hedge against any type of concerns that come in about being overexposed to

one area or the other. They've realized that, hey, you know what? As more fitness concepts come to market and more consumer tastes change, we have the ability to act on it relatively quickly, roll it up into our overall brand, help them scale, help them grow, and reduce the risk on our side without having to worry about overarching trends that could really damage the business. So I love the idea of it. When it comes to multiples, they've been pretty hush-hush about it. I wouldn't say they're too crazy, especially considering the fact that they know where these brands can go with just a little bit of gasoline to the fire. So if we look at the most recent one, Body Fit Training, for instance, they paid $44 million for the brand. If she had to put rough

revenue estimates to it, you're looking at probably a five-time sales multiple on that, which I would not say is crazy, just because of the sheer... Just because of the fact that once they paid for it, they sold hundreds of licenses of it already. so it's it's goes back to my comment about you know pouring a little gasoline into something right now is worth spending a little bit more money if you're going to get your reports pretty early on okay and is the one of the core parts of your thesis this diversification strategy where they're not exposed to say the loss of a trendiness of a fad like um what like a p90x or an orange theory i know orange theory is still popular or a peloton or something like that is that really a

core part of the thesis here of how this can be the better fitness asset to own than a lot i know there's there's quite a there's a few out there in the public markets yeah so it's actually a bit of both um but if i had to apply a weight towards one side or the other it's it's it's a matter of me being more comfortable with it rather than me being like this is a growth driver um and the reason why that is from i mentioned before i mean talking about the consumer taste consumer case changing uh it can really destroy the business which we've seen with the peloton we've seen in that 45 we've seen with other with other players um so is it a growth driver no but it definitely does help because i believe that since management is very conscious of the fact

um they know that they can't just be a one two three branded company um they can be bigger they will need to be bigger if they want to be able to grow to the size that they eventually can't be uh so that's kind of where i've seen it it's more so in downside protection than what i've said that's what yeah it feels like that's one thing that's always kept me away from the fitness category is it seems like i'm always convinced like well this could be the you know history student of history that all of them have died eventually else p90x would be a monster still but i i don't think i don't think that's still around maybe i'm wrong but yeah it's funny he actually made a basically a p90x like 2.0 because the sales of the og p90x for dropping because you

know i had that initial spike like oh i want to work out like a navy seal i want to get cut like a navy seal and then when sales started dropping um that's when he went ahead and made the 2.0 version it didn't do as well but um that was a try that was a try to uh revive that kind of brand um i think it eventually just died but we tried i give it that yeah and uh we're i guess you're you follow the fitness industry closely a lot of people have seen the rise and fall of peloton um how from your point of view maybe anything that exponential fitness management has been saying how has fitness really changed since the pandemic are we do you think we're going back to what 2019 was and just kind of going like this blank period and then we're going back or have there been any

lasting changes maybe the at-home technology and uh the app-based subscriptions yeah so i actually published an article about this in the beginning of january which actually coincided with um the research that i published on exponential and um it's funny because in 2019 i was i mean i was hard into fitness in 2019 i was working out uh an hour in the morning and like two hours after works like three hours a day religiously um so that was so obsessed with it and that was just the way it was and we talked to people who wanted to use an app they were like why not just go in person but then as soon as covid hit it completely changed everything um so that's when all the stay at home models blew up right we know peloton i think it was i think before we went into quarantine

it's like 50 a share capped out at like 150 a little bit more than that because that was that was that was the new thing that was what the future was no one's ever going to go back to the gym no one's ever going to go to in person again the home was just better and a lot of these incumbents so you know your planet fitnesses your other uh like gold's gym uh your sports club like all the other places that had the ability to kind of go online quickly ramped up an online presence because they either do or die at that moment um but what was interesting and this is this is the play that i have and full disclosure i actually have the long position in exponential but i'm also short peloton still um so it's it's kind of a pair trade there because i was betting on

reopening being way more powerful than i guess anybody kind of really pictured and being in new york city it's i guess it's kind of an advantage because you kind of see how people were so cooped up inside and how over they were being cooped inside yeah with the density of the population right oh my god begging to go just outside to do anything like i don't want to be in my apartment anymore and i also have my friends who are diehard peloton fans that you know they bought the the bike in in covid they were riding it like three four times a day and even they were saying yeah i'm kind of i'm kind of over i want to go i want to go out into the real world i want to go even i want to go interact with people that i don't even care that i'm interacting with them

which is basically then going outside into this green in the world um so whenever i did my research it was a combination of like what i was doing it's not very big into fitness but my friends are doing because they also have a lot of similarities and then honestly i was i was going down the uh down certain parts of new york city here with just my phone on the notes app and i was just asking people like general questions about how they how they how their fitness tastes have essentially changed from pre during and post pandemic just on my phone um and luckily they were able to give me real insights the fact of like hey there's some real there's some real uh demand here for in person again more than what all these sell-side guys are basically saying um so that's

when you know i went long uh exponential on top of the other stuff and then recently went short peloton is because it's just easy money at that point um but tastes are not one side or the other it's going to be omni-channel going forward and depending on where you are maybe an urban city or suburban area um optionality will be key and players that can give optionality will be successful going forward um if you lean towards one or the other i don't believe you're going to have so much of an advantage there another thing you talked about in your article was the um The contraction of supply from COVID. Can you talk about that and how that benefits Exponential?

Yeah, so I'm a very big, small business. So it's unfortunate to see businesses close during the pandemic, especially here in the city. It's almost as if everybody just left. But if you think about the gyms and fitness studios that were going on in the country, a lot of them, due to COVID restrictions, could not be open. So even if I wanted to, I literally could not go to them. And we had so many articles in the past where people broke rules and regulations to just have their doors open to attract business. But unfortunately, a lot of them closed.

So if you think about the population in the United States who were going to work out pre-pandemic and all the supply, the gyms, studios, etc., that were giving them that option to do so, When you talk about a reopening, a lot of them just evaporated because they went out of business. So if your demand is still there, but your options are limited now because there's just not that many brands out there that can do that for you, you can really benefit from that as a company because just the sheer supply-demand economics that like that's... I can attract more people to my business because Joe Schmo down the street went out of business.

So they either come to me or they really don't come at all. that's that's uh what's a really big part of our thesis just because of the fact that like your options are your options are limited will they taper out over time yeah but as of right now it's a really big leg up for anyone to survive and open their doors again an exponential can help because they can are they helping finance any of this stuff or is that sort of an advantage like they i don't know what if it's the right way like sort of how could they be a crutch during yeah like a crutch during any sort of time like like that is that part of their proposition yes even during kobe they actually dropped down their um commission fees uh for marketing so it was a

two percent marketing fee during kobe they actually dropped it down to one percent they were doing their absolute best to try to alleviate any type of pressure they could where they could to the franchisees just so they you know didn't didn't go out of business um even during kobe Their loss was, as far as units, was not anything close to what other people were experiencing. So they actually did a really good job of surviving. And then once things started slowly opening up, rules and regulations started getting less tight, they were ready to hit the gas. And that's exactly what happened. So they are very much aligned with the franchisee.

And even if you think about it. Um, so the, the co-founder and the CEO, um, Anthony, uh, I always mess up his name and he's like Geisler Geisler, uh, he's an operator himself and he founded studios itself. So he is, when you, when you listen to him, speak on the call, you can kind of hear how compassionate he is with these franchisees because he wants them to succeed because once upon a time he was one, um, and he knows that the business scene, the franchisee has to, otherwise it's a, it's a losing game

there, you know, it's not like a subway franchise. it's it's something that he's like he's wet too right and we want to hit a little bit more management but i'm realizing we forgot to do a valuation question so i guess general thoughts on valuation versus their whatever financials what they're going to do in three years i guess maybe how do you look at their valuation yeah so in this day and age um the whole idea of ebd sales multiples are to put um that should not be a thing anymore will i say that um i think this last year i think this last year has eliminated well hey well i just saw it if we just do you know aws 15 times sales just knock that out oh yeah the twitter sphere is big on that um but no so uh

when it comes to exponential they're they're adjusted even to profitable right so you carve that anyway you want with adjustments. They're expecting to be net income profitable in 2022. Not by much, but they will reach true profitability this figure 2022. If you keep zooming out past that, to 2023-2024, if they're continually opening up 230 to 250 studios every year, they're expanding abroad, which they've grown from 5 countries to 12 countries now um they keep going up these new brands where where i had pegged them back in january i was like you know what i could easily see them being a 30 company um within the next 12 to 18 months and if you look at the chart they got they got pretty close to it um i think they

got i think they hit like 27 a share if i'm looking at it right now yeah 27 is really capped out. So they got pretty close because they're so strong. Market term, I'll drop them. But if we're looking at long term, I've spoken to other PMs about this who also share my enthusiasm with the brand. If they can execute well, which we have no doubt that they will, in two to three years time, this could easily be a $40 stock. No problem. Just from the sheer execution, just how asset-light they are and the operating leverage they spoke about before it it only seems to get better as long as no other black swan events come around or consumers just throw their hands up in the air and ditch fitness altogether but you don't see any of that happening do how big are they

uh just in terms of market cap or enterprise value whatever you use yeah i mean if you look at it right now they're a little over a billion dollars right now um or around a billion dollars keeps fluctuating the i will admit the liquidity of this name is as great as other ones but so it balances um so if you're thinking about their growth over time yeah doubling tripling that you know sbc totally fine system-wide sales are actually supposed to be reaching um uh forget exactly what it was um but it's over it's over a billion dollars revenue is coming in, including licenses, I think a quarter of that, 30% of that.

So they're just growing double digits. It's insane. It's jaw-dropping. And are they using stock to acquire these companies or is it all cash flow or do they do it by debt? What is their general strategy with that? Yeah, so it's a bit of both. One thing that I like is

that when they do acquire the brand, they typically like to keep on the management that owned that brand on board. And in order for them to do that, they offer a stock component of that, which kind of ties to basic part-out payments. So if the performance is there,

if the performance is aligned with what Exponential has, hey, that founder gets rewarded handsomely. It also helps them because even though they are technically cash flow positive, they don't generate much

cash flow right now. Their strategy is really, hey, let's just get this out as quickly as we possibly can. And if you have new acquisitions, use what cash we have on the balance sheet to do so. and then also issue or use our stock, if need be.

But if you're looking at the most recent acquisition, $44 million, part cash, part stock. I mean, you're not talking big numbers here, right? So it's not a bargain to me. You talked briefly about X plus, and can you maybe remind listeners what exactly that is? And then how big do you think that can be as a part of the business?

yeah so um there's there's two digital components of exponential one of them is the x plus offering which is the video content library of workouts that are offered by all the brands that people can use um uh whether at their home or they can just go somewhere else or wherever they are they just access it so it's the video content library and also the um on-demand feature of classes is that like a membership thing where you just pay for the online strictly or is it a part of joining a studio how does that work so so it's actually separate so it's a 30 a month fee um to access it and it's it's what i would compare it to is literally any other um fitness app that you can

get. Nike is big on one. If anyone uses the Nike app, whether it's a running one or a training one, etc., it's very much like that. So that's what you're paying for. Okay, that makes sense. And then the X, what's the other one? The X Pass?

The X Pass. So this is the one that I actually thought was a really smart idea. So X Pass, if anyone is familiar or maybe not familiar with Class Pass, it's essentially an in-house class pass and for those that don't know class pass is essentially a offering of different fitness brands that you essentially buy credits for and you use the credits to go do um let's say pilates one day or yoga one day and we want to do boxing another day

these credits depending on what you've paid as far as your memberships here allow you to take advantage of switching up what brand you would like to work out with that day, as opposed to I only pay for PureCore or I only pay for Ruffle. This essential membership allows me to kind of go into different ones the way I would like to, when I would like to, without being wed to just the one brand. So it offers optionality for those that would like to pay up, but would like to diversify their workouts. Gotcha. And you may have mentioned this, and it might be different in certain areas, but how much is this XPAS cost?

And maybe, have they given out how many members they have? Yeah, so they actually recently went out fully with, I think, almost all of their franchisees in North America. It's kind of a no-brainer not to do it. so in order to take advantage of it there's different tiers which gets you essentially points to use for whatever classes you're trying to sign up for so they range anywhere from $49 a month all the way up to $140 a month this gives you depending on again what you pay for anywhere from four classes all the way up to 12 classes to take advantage of again access to all their studios all across the country um so that's that's kind of how they've structured it um and

the take rate so the split between the franchisees that opt in and the company is a 70 30 split company getting the 30 the franchisee getting 70 so that's where we're talking about like optimizing revenue or optimizing auv not just for the franchisee but also the revenue from the company by being able to offer this model which helps just drive basically everything else that flows down what are your overall thoughts on the international strategy i know we were talking about it before we hit record they seem to have had success in the u.s do you think they can have that do you think that same success can translate to other areas and what what have they what has management kind of given out on that so far yeah so i actually even when you look at other consumer companies

they can get saturated in the united states and most every question that an analyst will ask or care about is what about growth outside the u.s how's international looking like you know even like into like starbucks or even like the frustration hardware which i know i'm a big fan of i know i've talked to you guys about it on twitter as well international is kind of the uh you know like total empty white space that everybody wants a company to eventually grow went to. So when you look at fitness, super big in the United States. So the runway in America is huge. But then when you zoom out to the runway and abroad, the countries that Exponential is currently in are actually, believe it or not, some of the ones that you might not actually think

they would have touched base in. Most people think that Europe is one of the more obvious uh areas of growth for expansion but you know they've they have um uh brands in australia they have brands in like some parts of like indonesia they have parts in like a big uh dubai south korea japan etc they have like i might be leaving out some other from other countries there since they're 12 but they're in they're just getting a football in these places and strategically growing it out if we look at kind of how many licenses they're contractually obligated to open we're talking about over a thousand already with 2100 studios being planned on opening so the growth there is massive and i think over time uh they'll they'll essentially be doing the exact same

thing that they're doing here right it's just in other places in the world i don't see why fitness is not a big thing anywhere else given the brand of uh 10 portfolio companies would not be able to appease some type of consumer abroad right and is i guess i'm thinking because each a lot of you know cultures are different are they have they mentioned anything about adapting to different cultural fitness styles or it might be too early for that and are they trying to add on this digital overlay for say you're in the middle east you still have access to a lot of the stuff that has been built up for the united states consumer over the last decade yeah so to your first point i'm actually glad you brought that up so um body fit training which is their

most recent roll-up acquisition that they did is actually an australian brand um they the the owner over there they just saw an opportunity because they love the concept so So while they're actually building it out abroad, they're actually bringing that brand from abroad to the United States. It's actually not, it was not a concept in the United States. So when you're talking about the strategy that they have, it's very much taking a concept from anywhere and bring it all together where it makes sense. And that's where they saw one happening. When it comes to the digital component, they're more focused on making that available in the United States and making sure that all that rolls out within their core market before they really put more pedal to the metal abroad. But that just gives you more context to kind of like how they see these concepts and where they see they can grow.

So it goes back and forth. capital capital allocation is obviously a big um it's very important for a roll-up based company so what are your thoughts on management and um i guess their capital allocation thus far like have you do you like them have you enjoyed their strategy yeah so if you actually look at the management team most of like senior leadership have actually been either an operator in the past of a fitness franchise or a fitness brand, or they actually were part of the brand that Exponential acquired. So if you're talking about their knowledge and know-how of the business, it's actually relatively high because the CEO, Anthony, he started at LA

Boxing, which some people might be familiar with it, sold it, started Club Pilates, partnered with private equity firm. And he's been growing since then. Other senior leadership started with the brands that they acquired, have stayed on to be the COO, president, etc. So they know what they're doing. And I'm not going to give them too much credit, right? But they're not oblivious. Some could argue with other management teams of what's going on in the industry and how to make it better at how to optimize things they very much know how to do it um and i think with their with their strategy of how they're actually um allocating capital is working right now um even if they're in the most recent earnings call i mean the stock dropped which for no reason literally

um i was speaking to other pms and like every everything on this call made sense so like what happen and if you look at the chart it quickly betrays um but this thing this thing's a slam dunk with the type of management team and how they how they see things going forward and where they see the opportunity so i have no issues there and i think it's pretty brilliant for what they've done so far okay and uh ryan you i guess have the final question here but sure no i i think just the the last question because it sounds the strategy seems sound it seems like they are less susceptible to the ebbs and flows of fitness trends being that they're so diversified what how does this end up being a bad investment like what go wrong here

yeah so there's a few and that can change based on what perspective is so number one some type of covid resurgence happened right and it puts everybody back indoors um monkey Yeah, maybe monkeypox. I mean, I've seen pictures. It looks tough. So, for instance, that can push people back indoors. You still have the digital component, but that's nowhere near the level of money that you're getting when people go indoors. So that's number one. Do I see that happening? No, but that is a risk. Secondly, which is really big, which is one of the bold cases of Peloton, actually, was that the the people that teach these classes they're in such high demand right now that you

really got to pay up for them i know like some peloton instructors were getting paid like half a million dollars just to teach for peloton or like do the classes for peloton so if you're talking about making sure you can acquire and retain top talent uh that's another risk because i'm not sure about you guys but when i go to a gym and there's somebody there who remembers my name i'm like i don't even know who you are but i like this place so much better because of that that you know pseudo relationship that we have like i just feel better about coming there you know um and uh if we talk about um the other one it's more like the consumer tastes changing which i know i mentioned before which they do have a natural hedge too because of the fact that like

they just have um their different portfolio of brands but for instance it's for some for some reason consumers are just like you know what i hate pilates now or i hate yoga etc um that can obviously hurt the business um and then one thing i will mention too is kind of we haven't seen it yet we might it's a very real risk is the kind of cannibalization amongst the digital arm of the business and the actual in-person arm of the business so we'll have to see in the coming quarters kind of how that plays out but if um more people sign up for this digital offering then let's say pay for the in-person studio um strict membership then things might need to change uh maybe the take rate might change etc but right now there's really been no mention sorry about that

but we'll see what happens in the future so those are kind of the biggest things that i see i can really put a deck in this uh in this thesis do you see any world where exponential owns peloton in the future absolutely not um i hope not you don't want that inventory problem right oh my god i i i have taken a lot of heat on twitter for the short cases that i've made and peloton being one of them it i mean you talk about a dumpster fire that's just not going to be able able to put out and then so many people behind it are saying like amazon should buy it they're saying apple should buy it they're saying even planet fitness they're saying any anybody who has money to buy this someone please buy it if anything or if anything i would have been worried

well maybe this would have been a good outcome for exponential fitness they get bought out for 100 premium by peloton while peloton was at a 50 billion dollar market cap that seemed like a decently plausible scenario because they were making all these grand ambitions about how they're going to dominate all of fitness so um i don't know but that would have been a good outcome for exponential shareholders maybe i don't know i would have been happy oh yeah i would have been happy i mean like i'm still up on the year a year for even after the even after the pullback just because i kept we just kept buying more when it was down um but no no world would that ever happen i think i think the team at exponential is looking at the peloton management and are not only a

learning from what they've done wrong not that there's too much similarity because one's asset light one's asset heavy um but looking at me like wow this if this doesn't if this doesn't back up our assumptions on consumer trends for a reopening play then i don't know what is it um so it's pretty wild to see so that's why i have that that pair trade going on okay well i think wrap it up yeah i think that's all the questions we have paul where can uh people keep up with you what's the substat called yeah so um you post a research on substat uh under cedar grove capital um so you You can find us there. It's free to subscribe.

I don't charge anything. Just trying to spread the news. And if you want to, if you're a part of Twitter, it's just my name. So at all Sarah C E R R O. And very vocal about the, our thoughts and our positions on there.

So it's a good follow. It's a good follow. I recommend our age. Good write up on our age. I remember correctly. Yep. As it paid out so far just for other reasons, but yeah,

the company is still solid. The write up was good. It's all about the good writing. Don't worry about that. Yeah. Well, that's going to do it. I want to hit the disclosure here. Brett and I are not financial advisors. So anything we say or discuss here on Chit Chat Money is not formal advice or recommendation. We are, however, general partners at Arch Capital. So clients may have positions in the securities discussed in this podcast. Thank you all for listening. Thank you, Paul, for coming

on the show. We will see you guys next time.