Yet Another Value Podcast - Buckley Capital Partners' Zack Buckley provides update on $XPOF thesis following short report

Episode Date: August 2, 2023

Zack Buckley, Managing Partner at Buckley Capital Partners, joins Yet Another Value Podcast for the second time to provide an update on his Xponential Fitness, Inc. (NYSE: XPOF) thesis since he was last on the podcast and following the Fuzzy Panda short report on the company. For more information about Buckley Capital Partners, please visit: https://buckleycapitalpartners.com/ Zack's first appearance on YAVP discussing $XPOF: https://youtu.be/listaT3Bx6Q Chapters: [0:00] Introduction + Episode sponsor: Stream by Alphasense [1:35] What happened to $XPOF following the short report is released [3:57] $XPOF short report details - first allegation; Tony's first venture, Interactive Solutions [10:20] $XPOF short report details - second allegation; LA Boxing venture [12:16] $XPOF short report details - third allegation; 2015 incident [14:33] CEO is a loose cannon or are these just one-offs? [15:33] $XPOF short report details - addressing culture of sexual harassment [19:02] $XPOF short report details - economics of the business and franchisees [23:47] $XPOF franchisee transfer rates / understanding franchise network industry norms [29:34] $XPOF billing practices and BBB complaints [33:28] $XPOF financial covenants [34:30] $XPOF fair valuation [37:33] $XPOF capital allocation [42:52] Upcoming $XPOF catalysts [47:08] What Zack hopes to see at the $XPOF investor day [48:25] Zack's $XPOF differential insights gained from talking with franchisees [53:14] $XPOF final thoughts Today's episode is sponsored by: Stream by Alphasense Are traditional expert calls in the investment world becoming obsolete? According to Stream, they are, and you can access primary research easily and efficiently through their platform. With Stream, you'll have the right insights at your fingertips to make the best investment decisions. They offer a vast library of over 26,000 expert transcripts, powered by AI search technology. Plus, they provide competitive rates on expert call services, and you can even have an experienced buy-side analyst conduct the calls for you. But that's not all. Stream also provides the ability to engage with experts 1-on-1 and get your calls transcribed free-of-charge—all for 40% less than you would pay for 20 calls in a traditional expert network model. So, if you're looking to optimize your research process and increase ROI on investment research spend, Stream has the solution for you. Head over to their website at streamrg.com to learn more. Thanks for listening, and we'll catch you next time. For more information: https://www.streamrg.com/

Are traditional expert calls in the investment world becoming obsolete? According to Stream, they are, and you can access primary research easily and efficiently through their platform. With Stream, you'll have the right insights at your fingertips to make the best investment decisions. They offer a vast library of over 26,000 expert transcripts powered by AI search technology. Plus, they provide competitive rates on expert call services, and you can even have an experienced by-side analysts conduct the calls for you.

But that's not all. Stream also provides the ability to engage with experts one-on-one and get your calls transcribed free of charge, all for 40% less than you would pay for 20 calls and a traditional expert network model. So if you're looking to optimize your research process and increase ROI on investment research spend, Stream has the solution for you.

Head over to their website at streamrg.com to learn more. Thanks for listening and we'll catch you next time. All right, hello, welcome to the Another Value Podcast. I'm your host, Andrew Walker. If you like this podcast, it will mean a lot if you'd rate, subscribe, review, follow wherever you're watching or listening to it. With me today, I'm happy to have on for the second time. My friend, Zachary Buckley, Zach, how's it going?

Good. Thanks for having me on. Hey, I'm really glad to have you on for the second time. We're going to talk about why we're doing this in a second. Before you get there, let's just start with the disclaimer. I always start with nothing on this podcast is financial advice. That's always true, but probably a little bit particularly true today because we're going to be doing an update on a stock that had a widely published short thesis on it.

So people should just keep in mind, you know, not financial advice. Please do your own research consults financial advisor. So anyway, Zach, we're kind of the impetus for you coming back on was you came on in October. We talked about exponential fitness. The ticker there is XPOF. After that, the stock did absolutely fantastically. And it all was going kind of swimmingly until in late June, a short report came out, a very detailed short report, very interesting short report. I'll include a link to it in the show notes.

But, you know, the stock, obviously the market shot first and asked questions later. I think the stop dropped about 50% in a day. It's recovered a little bit since then, but it's still well down. And I know you have just been doing a ton of research on the company, kind of just like following up all the leads. So, yeah, I'll pause there. I've got the short report. I can go through all of the things, but it just paused there and turn it over to you.

Yeah, thanks so much. Yeah, I think, you know, when the short report first came out, obviously we were concerned and there was a ton of information to digest. And so, you know, I would say we spent the entire morning just trying to go through all the information. And by about 3 p.m., I felt like we had gotten to a point where we were very comfortable. The vast majority of the report was misleading or inaccurate in some cases. And so, you know, we basically doubled our position size that day. And, yeah, basically the stock, you know, prior to the short report peaked at about 33, you know, was trading at about 29 or so,

you know, the week or two weeks before, you know, the day of the report opened around 25 or sorry, the night, it closed at 25 the night before. And then that day, you know, intraday, it traded as much as like below 15 a share. It closed around 16. So it was down about 37%. And then the next day, I was up about 10% as management started to defend themselves. But yeah, there's a ton to go through. It was a very detailed report.

Certainly parts of the report were true. But I think the vast majority of the important facts about the company were misleading. And so we feel very good. about the investment. If anything, I think we have higher conviction and exponential today, having spent so much time going through every single facet of the short report. So the short report's released late June. The company comes out with a quick PR saying, it's kind of typical of what you think, hey, our business remains strong, but they go into blackout pretty quickly. So we're recording August 1st. We're going to get this out before them,

but the company's going to report after market August 3rd. So I think they've been a little bit blacked out in terms of what they can say. But I guess just to go into the short report. So it's kind of a two-angle short report, right? The first is talking about management and particularly the CEO's background in some allegations there. And then the second is kind of economic questions around the business. And both are, you know, either one when you've got a credible shirt seller coming out against you is scary. But the combination, you know, I think has let a lot of people say, hey, I just can't touch this life's clarity. Obviously, you've done a lot of work on both sides.

What side do you think we should kind of start by addressing? We could just kind of go chronologically, you know, we'll start with the short report, like the personal attacks. Okay, so the short report starts off with a bunch of, I don't want to say tax, but allegations, whatever you want to call it, against mainly the CEO of Exponential Fitness, Tony Gessler. The first thing, it comes right out, and the first image there is Tony when he's, it's Tony, right? Correct, yeah. Okay, just making sure. I was saying that, and I only have his last year and I was like, oh, Anthony, Anthony or Tony, either one. it's mid-20s he's the CEO of a startup gaming business and the first image in the report is him on a TV show holding up a box and it says this box is empty and then it goes on to say how the company he was the CEO of was they say it was a pump and dump so do you want to talk about kind of the background there and what you kind of uncovered yeah definitely so Anthony was CEO of interactive solutions you know which basically went public through reverse merger

in February of 2000. You know, essentially what happened was is there was a rogue shareholder group that owned interactive solutions and then was selling, you know, those shares illicitly or improperly through basically a firm in Thailand called the Britain group.

And so the purported stock sales, you know, all came from the Britain group, which had essentially no affiliation with interactive solutions. So you should imagine just it was a shareholder group that had nothing to do with the management team, nothing to do with the board. And that shareholder group essentially was selling share certificates that they shouldn't have been selling. And the FBI was aware of it. You know,

the Australian police, the FBI and the Thai police collaborated and raided the Britain group. And obviously, you know, 84 of the 85 employees of the Britain group were arrested. And like, as we know, no one from basically all of interactive solutions was indicted or implicated. So the FBI was aware of it. And, you know, there was no one from. from interactive solutions that had any sort of indictment or charges pressed against them. I'm just left 84 of the 85 employees arrested. How would you like to be that 85th employee? Was it like, was it the janitor and they just didn't know, RDA?

Or was there like one person who was doing actual work and then everyone else went to jail? Wait, what? What just happened to everyone? So I guess the question there is, as you said, the FBI was aware they never charged anyone at interactive. So maybe the pump and dump elements kind of don't apply. But then the other allegation is that interactive, even if he wasn't involved in the pump dump, was selling vaporware, right?

Because it says, the first image says, this box is empty. So how, what did your research kind of turn up on that side? Yeah, so Interactive Solutions was building a game that allowed users to play casino games on their computer at home. And guys started holding a box that's representing the graphics of the game at its expected completion later that year. And so, you know, there was every intention of publishing that game. You know, they had deals with the Venetian as an example, you know, in order to sell that.

So it was it was a legitimate game that they were selling. So it wasn't paperware at all. Yeah. And I think the game was commercialized and had real partners. Like it wasn't paperware. Yeah. I think it was commercialized. In February 2000, I mean, I'm in grammar school at the time.

But it also was, it was the dot-com bubble. So you think, like, hey, you're the CEO of a publicly traded gaming tech company. company, right? Like, you've got this, you've got a partnership with the Venetian. Like, a lot of it is the promise of releasing a game and they do ultimately release a game. Yeah, it's not successful, but, you know, they release something and tons of the companies from back then weren't successful. It kind of just strikes me as an entrepreneur doing what they did and maybe taking the, like, actually executing versus everything else then. Am I thinking about it incorrectly? No, I think I agree. I mean, I would also say, like, Anthony was 23 years old at the

time. You know, he's a really young kid, right? And this was like probably one of his first business ventures. So the fact that he was CEO of a public company when he was 23 years old, I mean, I think it's somewhat impressive. He didn't do anything wrong, the public company didn't do anything wrong. Ultimately, the company wasn't successful, but I think a lot of successful entrepreneurs have, you know, business flops early on in their career. And so I don't view that negatively, if anything, you know, the fact that he was 23 and already doing that kind of, you know, that kind of thing at that age, I think speaks to how entrepreneurial he is. To me, at the start, when I saw, like, obviously they led with that for reason.

That was the most concerning, some of the other stuff is concerned, but that was the one that got me because I was like, oh, if you're involved in a pump and dump, like, I just can kind of never trust you going forward. It's the old, like, there are some people who are like, oh, this company is great. I'll be like, yeah, but the last company they ran was a fraud and everyone ended in jail and they did serve three years. It's like, but once you kind of dig into it and it's not that, yes, the stock got manipulated, but he, it doesn't appear anyone at the company was involved.

Like, I do think it's the scariest allegation, but I think it's also probably the one easiest to dismiss do you disagree with any of that no i agree with you and i think the other thing is like the video also looks very damning right like he's he's declining to comment over and over again and so if you watch that video on youtube you're like wow this this looks really sketchy um but when you understand like his lawyers have probably just told him to not comment on anything and he was you know he was somewhat blindsided by the reporter i don't think he would have ever gone on had he known that the line of questioning would have gone to a place where he just had to continually say no comment.

And if you're looking at least, the videos that's referring to is I think it's a local ABC affiliate doesn't interview with him after the pump and dump scheme has kind of started to unravel. And I think it's pretty clear that he was on there to talk about the product and how excited he was for the commercialization efforts. And all they ask about is the pump and dump. And he's like in a no comment state and pretty flustered by the almost bait and switch, if that makes sense.

Yeah. And I would have been flustered by that as well. Well, so let's turn to the second allegation. And this is allegation that, you know, before Exponential, he was the CEO, L.A. boxing, which you can correct me wrong, ends up selling to UFC for hundreds of millions. I think it was even $2 billion in 2013. And he's the CEO there. And the second allegations are he's kind of screwing his partners over.

And a lot of the L.A. boxing franchisees don't like him in his time there. So he, like, screws people over. And it's kind of just overall, hey, adding to. the, this is an unscrupulous guy, right? He screws over his partners, the franchisees doesn't like him. Yes, it's a successful business outcome, but if you're partnered with him, this is a sign that things aren't going to end up well for you. Yeah, I mean, I think, again, anyone who's been in business for a long time, you know, at some point in time may not make some of their partners happy. You know, what happened at LA boxing did not concern me at all. You know, there were two

lawsuits essentially, you know, that came about in, you know, that were presented, I would say through the short sellers work, and neither one of those lawsuits really had any concern for me. I mean, I think in one of them, it was basically like a disagreement around termination. And then the other one, it was someone who founded one LA boxing studio trying to get paid for the selling of the LA boxing franchise. Now, anyone who knows franchise or economics, you know, if you found one studio, you know, that doesn't give you any right to the value of the franchisor. So that would be like if I founded a club Pilates and then I wanted to get paid equity in exponential fitness. I mean, it just doesn't make any sense. And so, yeah, neither one of those

were concerning from my standpoint, but happy to go. Yeah, I agree with you. It did add to the, some of the stuff in there did add to the overall feel like when you go from pumping up to the stuff we're going to talk. It's like, oh, it's just adding to that, but that was the least concerning. Let me go to the weirdest one. So they uncover, I think it's from 2015. It's a case where a court-appointed process ever goes to Tony's house to, you know, serve him documents. And he gets charged with trying to, I guess he has a gun, he goes out there and he gets criminal charges filed against him for assault without a firearm. So even though he has a gun, it's assault without a firearm.

And then he also gets charged with a kind of like threatening or intimidating behavior because he's got the gun. And he goes, and then, you know, it's a big red flag. It's like assaulting or threatening a process server. So I've, it's a strange story. I'll pause there and just like turned over to you. Did I say all of that right? And how do you think about that?

Yeah. So I think, I guess the first thing I would say is that, you know, when Tony talked about it after the short report came out, he said that he didn't have a gun. So I think whether he had a gun or not. not is at least according to him he didn't. I think that's up for debate. Let's assume that he did have a gun. In that case, why would he have a gun in this circumstance? There is like a strange man who he doesn't know who's inside of his garage on the day that he's moving. And he has to go confront that person who he has no idea who it is, you know, with his wife and kids inside of his

house. If I, like, I don't own a gun, but if I had someone that's standing in my garage who I didn't know who it was, you know, at three hours after sunset, I would be very concerned by that person being there. And again, I don't carry, like, I don't own a gun. I don't carry guns. But I can understand why, you know, that's the reason people have guns, right? There's a strange person in your house. Like, that's why lots of people own guns is to make sure they feel safe and protected against that person. So I don't know if he had a gun or not. But to the extent that he did, I think you going to understand why you might want to do that in a circumstance where there's a strange strange man in your house, essentially.

It was, that was just, I definitely hear that. It was just the weirdest one, because it was also, it was moving day. So I think there were movers there and stuff. It was just very strange. And again, it landed to the credibility of, it lent it to the reports, hey, is this guy like kind of a loose cannon or is this all just one-offs? no i agree i mean when you put all of those things together you know i think it it certainly hit its mark or created the intention the short seller was looking for which was to really you know

disparage and calling the question anthony's character and so i think that's why it was important to spend a lot of time dissecting each piece one by one and like going through the case summary and you know reading basically exactly what was said um you know publicly and just understanding that you know there was i think reasonable reasons why um and also all of the charges were dismissed ultimately. So there was also, the second charge was assault with a deadly weapon or instrument other than a firearm. Yep.

And so we're unclear what occurred there. It doesn't require any actual physical assault for this to happen, but it does require the use of an inanimate object to attempt assault. So we don't know what that was, but it was ultimately dismissed. So both charges were dismissed. Anthony said he just walked into the garage and basically started yelling at, get out of my house. So without any objects, you know, gun or otherwise, I tend to believe that what he said is true. You know, both charges were dismissed. And so, you know, I feel pretty

comfortable that it would be. Last question. So the last thing on kind of the personal stuff is he condones a cult, XPOF has a culture of sexual harassment and he condones the culture of sexual harassment and discrimination. I'll just turn it over to you. I mean, I guess as a as a first statement, obviously, you know, this was deeply concerning to us hearing this as shareholders. Of course, you know, we would never want this to happen with any company that we own stock of. And, you know, I think it's also a really tough allegation because unfortunately in the past 10 years, we've seen so many of these allegations ultimately turn out to be true. And so I think oftentimes when people are accused of this, it's a, you know, shoot first and ask

questions later because so frequently people have been guilty of these kind of allegations. Now, we had done a bunch of work prior to the short report coming out, and we had never, we had talked to a lot of female employees, you know, 70% of exponential employees are female, you know, a ton of the franchisee owners, like most of the pure bar owners as an example are female. So there is a very female-centric culture at exponential fitness, and we had never heard any allegations of any sort of sexual harassment or anything as being an issue or part of the culture.

You know, the second thing that I would say is that, you know, there's a lot of, you know, never been a lawsuit or a complaint filed against Tony or Anthony over the last 20 years. So you would think if he was at a company with 70% females, you know, there would be something at some point in time if there really was a culture of sexual harassment. You know, we did a ton of calls afterwards and asked people about this and we never heard anything that gave us any implication or any idea that this would be a problem or that there was any culture. of condone sexual harassment as the short report talks about. And so I would say the probability of that being true,

just given the fact that there were so many other, I would say factual inaccuracies in the report, I think is extremely low. And certainly it's not a pervasive culture-wide because we weren't able to find anyone that had this complaint. And now, a quick word from our sponsor. Are traditional expert calls in the investment world becoming obsolete? According to Stream, they are.

And you can access primary research, search easily and efficiently through their platform. With Stream, you'll have the right insights at your fingertips to make the best investment decisions. They offer a vast library of over 26,000 expert transcripts powered by AI search technology. Plus, they provide competitive rates on expert call services, and you can even have an experienced by-side analysts conduct the calls for you. But that's not all. Stream also provides the ability to engage with experts one-on-one and get your calls transcribed free of charge, all for 40% less than you would pay for 20 calls

and a traditional expert network model. So if you're looking to optimize your research process and increase ROI on investment research spend, Stream has the solution for you. Head over to their website at streamrg.com to learn more. Thanks for listening and we'll catch you next time. Man, I will tell you, that was, I don't know how journalists do it, that was a lot less fun than going through all those lists and allegations.

Like obviously they're all serious allegations. Talking about them was a lot less fun. So let's turn to the stuff I think you and I are more interested in and that is actually more fun to talk about and think about and debate. And that is there's lots of questions, you know, it leads off with the personal tax, but then it goes into lots of questions on the economics and the stuff that I think you and I actually prefer to think about, right? So it starts talking about, hey, you've got a lot of franchisees losing money.

It goes into hiding permanent closures, kickback charges, billing and practices, all sorts of things that I think are really interesting, right? And these are, if you've ever looked at franchisees or any type of retail business, this is is stuff that scares you, right? Because if you've got a thousand stores and you're opening a hundred stores per year, it can be really easy in the short term to kind of cover over, oh, some of these stores are underperforming or a lot of these stores are underperforming because you can pull things in and out of same star stales. You can say, oh, if you've got some really good stores, they can cover up the economics. So let's start talking about this. I think the first

economist questions they come out with is, hey, maybe XPOF is reporting great growth and great units, but they have a ton of franchisees losing money. And if you're a franchisor and your franchisees are losing money, that's always going to come back to get you, right? Because either you're going to have to give them concessions or eventually they're all going to go bankrupt and your business is kind of going to be gone. And so this was a really concerning one, right? If franchisees, their economics always look great until their franchisees are gone. What do you think about the franchisees losing money piece of the report? Again, you know, we found very different results than I think what were presented in the report. We talked to a ton of different people.

we believe that 90% or over 90% of franchisees are profitable. And the vast majority of franchisees that are not profitable are mainly because they're just getting started. And, you know, Exponential has very rapid studio openings. And so there's a decent percentage of the studios that are currently open that have only been open for a year or less. And it does take six to 12 months for most franchisees to get profitable. But after that one year period, 90% plus of the franchisees are profitable today.

And importantly, I would say the concepts that are doing really well, are where there will be more studios opening going forward. So there definitely is a dispersion between the success of various franchisees. Club Pilates, which is the largest, you know, it's about 45% of the system-wide revenues, is extremely profitable. The Club Pilates franchisees are very, very happy. And, you know, I would consider opening a Club Pilates myself. Like the economics look great on Club Pilates.

You know, Stretch Lab is also over 10% of the system. The Stretch Lab franchisees are also very happy. Stretch Lab is doing extremely well. And the short report did show that. It did show that those two are profitable. The biggest thing that it did is it mischaracterized the labor cost by about two times. So I think it overstated the average labor cost per studio by about two times. And it was also using like a last 12 month revenue calculation, which, you know, 2022 was not nearly as strong of years, 23, mainly because people were still recovering from the pandemic. And so, you know, same store sales has been 20% in Q1 because those studios are improving very, very rapidly on a year-over-year basis

coming out of the pandemic. And so to look at things on an L-TM basis instead of a normalized basis mischaracterizes it a bit because, you know, revenues are improved pretty dramatically. It's easy to forget now because, you know, I think COVID is officially as a federal emergency, COVID's over, right? But it's easy to forget now. Early 2022, especially, like Q1 in Q2. Yeah, you could go to a lot of public stuff, but a lot of people were still very concerned about going to public stuff. Like, Delta comes through late 2021, early 22. Like, if you're talking about where are germs and disease is going to spread, like I love going to the jam. One of the saddest things about COVID was all my gyms being shirt down. But when you were

worried about catching COVID, the easiest place to avoid it was, hey, let's not go to this exercise studio where 30 people are going to be packed together in one room, breathing heavily, sweating all over each other. Like, it's really easy to forget that. So, I'm with you, like, 2023, especially even if you were just run rating the back half of 2022, there could be some economic questions there. I guess the other thing is they used to support it, right? You and I can say, hey, we can go dig through the franchise fair disclosure stuff and everything and say, hey, we think you've overrepresented their labor costs.

But I guess the other thing they would probably point to is they'd say, hey, we found lots of examples of the ultimate proof is in the pudding, right? If franchisees are doing well, they're going to open more stores and they're not going to close stores. And XPF would say we're opening lots of stores, but I think they would say, fine, you're opening lots of stores, but you are hiding permanent closures, which is a disaster in terms of franchisees, right, when your franchisees can't make something to open, or you're either hiding the permanent closures or you're buying a lot of your franchisees out for kind of a dollar, just like taking it over so you can, again, high permanent closures. How would you respond to that?

So I would say, first and foremost, it's very normal to have transfer rates at any franchise network. So healthy franchise networks have, you know, significant transfer rates amongst franchisees over time. So unfortunately, people die. They get divorces. They have, you know, various things that make it where they need to, you know, not run their business anymore or not own their business anymore. And so, you know, we looked across the transfer rates of a lot of different, you know, franchise concepts and the published franchise rates for exponential are literally right in line with the other franchise concepts, whether it's McDonald's or Planet Fitness, European Wax. So there's, yeah, I think there's, I think what the short report did is it took norms within

the franchise industry and tried to make them appear like a big deal. So it took, you know, equipment sales, which is a normal thing. You know, they have a 32% gross margin on equipment sales, which is completely normal within the franchise industry. And they tried to make it, you know, exponential is vastly overcharged. charging their franchisees. And that's just not true. They're just doing what's normal within the industry. This was, so this is different than the closure rate. This is the kickbacks and overcharge rate, right? They've got something in there where it's like, hey, your average Peloton costs $1,500.

And because XPOF makes you buy the bike, if you're doing their spin brand, they make you buy the bike through XPOF. They charge you 220. So they were saying, hey, they're overcharging you, kickbacks, overcharge, that type of stuff. I'm with you. Like, anybody who's seen the franchisees, it's completely common for you to have to go buy the equipment from the franchisor. A, because the franchisor, if it's a thousand studio, a thousand studios, or whatever, they do get some pricing power. They want brand uniformity. And B, they just kind of figure, I do think they can make some profit on it.

But like Planet Fitness is the most famous example of this, right? Like Planet Fitness does it. Domino's, I think you're required to buy all the Domino's pizza dough from Domino's headquarters. Somebody can check me on that. I think that used to be the case. I'm not sure if it is. but it's pretty common practice. I was a little surprised by that.

It is. And again, they were taking a lot of things that were just normal within the industry and trying to make them a big deal. I think going back to what we were talking about, I think the most important thing is the unit economics are very healthy and exponential, and the store closures are completely in line with industry norms. If anything, they close less than industry norms. I don't think exponential is hiding store closures.

I think there are some stores that are either being transferred or being taken in by corporate. And frankly, you know, I hope that exponential does start to close stores because they've had this policy of we're never going to close a store. And I just don't think that makes sense. You know, I think, and I think they're coming around to that as well. You know, I don't want to speak for them, but I wouldn't surprise me if we start to see them, them start to close some stores. And it's completely reasonable on a system of, you know, 2,700 plus studios to close 30 studios a year. I mean, that's just sometimes you're not going to have a perfect location. Sometimes you're going to have people struggling for various reasons.

Like, I don't think you need to try and keep all those stores alive. I could be wrong, but I also think a lot of the arguments on the, both the financials and the store closures relate to some of the brands that are clearly struggling a little bit. Like Roe House is a brand. I think there used to be like three in New York City, and I think they've really been struggling. AKT, it seems to me, has been struggling. So I think a lot of the closures, non-closures brand issues might relate to the brands that, yeah, you'd hope they do better and you'd like them to grow.

But at this point, this is really a pure bar, club Pilates, stretch lab, or those are the growth drivers in the main engines. And from all I can see, it does seem like those are doing really well. Do you think I'm thinking about that correctly? Yeah, totally. Yeah, there's 10 brands in total at exponential. There's no question that Roehouse, AKT, and Stride are struggling. But when you add those together, they're less than 3% of system-wide sales, by my estimates.

And so the reality is they don't really matter. And so I think, again, what the report did is, of course, there's going to be unhappy franchisees in a network of 2,700 studios. And so it found those unhappy franchisees and then tried to display them as being representative of the entire system when that just wasn't true. And if you did enough research and talked to enough franchisees the way that we did, you could get very much. very comfortable that the vast majority of franchisees are happy, even though there are unhappy franchisees, but there are always unhappy franchisees in any system. There's always tension between the franchisor and the franchisees. They're business partners, but they're also negotiating, right, because the franchisees are paying the franchisor over time. I'm sure the

franchisor, if the franchisees are doing really well, the franchisor wants to charge them more. I mean, those are all understandable things. I would like to see exponential charge the club Pilates franchisees more because they're doing so well as a shareholder in next exponential. And obviously the club Pilates franchisees don't want to get charged more. So it's natural for there to be tension, but the vast majority of people in the system are doing very well. And I think that's what's the most important for people to take away. If I remember the club Pilates, they just boosted the franchise rate, or I guess the royalty or whatever, to 8%. Right. So the historical clubs were, the historical clubs were paying less. Clubs going forward are going to

play 8%. But you see that and you say, hey, if you're actually raising rates, like that is all straight margin straight off the top. If you're raising rates and new clubs are accepting that, that's probably a pretty good sign that people are really enjoying the economics of this thing. Yeah, I honestly, I'm surprised they didn't raise it by more. I mean, I think, like the club Pilates people are just doing so well. And Club Pilates is 45% of the system. Like, it's a meaningful portion of the system. You know, they're at over 800 stores today or studios today, and they're going to be over 1,300 studios over times. There's still a lot of growth left in the club Pilates. another kind of scary one i you know i've looked at jims a lot so i i don't think i was too concerned by

this one but i did hear people who were worried about this billing practices and uh bbb complaints i'll just flip that over to you yeah i think again bb complaints are normal you know within a large system you know certainly you know i don't think there are an unreasonable amount of you know When you look at the BPP complaints, you know, the complaints per year are like, you know, basically 0.3 or 0.4. So, you know, I don't think 0.3 or 0.4 complaints, you know, is a big deal in a large system. So, but, you know, exponential, there's a lot of franchisees and, you know, they're imperfect human beings who are, you know, employing imperfect human beings who are dealing with imperfect human beings. So of course, there's going to be disagreements. Of course, there's going to be

complaints. Buffett always talks about that within Berkshire, right? You know, Berkshire is a large company that has a ton of employees that serves a ton of customers, and not everything is going to go perfect across every single Berkshire line within, you know, every single Berkshire subsidiators. There's, of course, going to be problems over time. But there was nothing that I saw that looked, you know, unreasonable or out of a normal, you know, amount of complaints. And so, my, my experience here might be tainted by the old New York sports club. I don't know if you ever, when you lived in New York, if you ever subscribed to them or not, but like they were famous for, you could sign up so easily. But if you ever wanted to cancel, it was like, send a certified

letter that it has to be delivered to this office at this exact time. And if it's, if all the eyes aren't dotted and the T's aren't crossed, then we won't acknowledge your, your cancellation. And they got me several times, right? It would take like three months to cancel. But they would have BBB complaints out the wazoo. And it wasn't that they were like, yeah, I kind of I thought they were shady, but it's not that they were like lying to people. They were just difficult to cancel and people would complain. So I always kind of thought gyms with recurring memberships and people who like might lose the desire to go to a gym or something.

I always just kind of thought, yeah, you're, you're naturally going to get one or two of those. I mean, I know people that, you know, were Equinox members, you know, and absolutely hate Equinox now because of, you know, canceling on Equinox. So it's, it's normal to have tent, right? gyms have high turn, and they're going to try not to have their customers turn over time. Not so. Oh, go ahead. Go ahead. Yeah. And just, yeah, there's going to be tension between the customer and the gym, you know, basically the customer trying to leave the gym and the gym trying to keep the customer. So, you know, I think averaging one BBB complaint in the last three years,

that seems like good performance to me and not indicative of a system-wide, you know, or pervasive gym theft scheme or, you know, any type of improper billing practices. not to call anyone out, but have you, are you familiar with the information, the newsletter service? No, I don't think so. It's like a tech, like they give all the details of tech and like, especially in 2020, 2012, when just like tech was going crazy. Like they will have scoops every now and then. I subscribe.

Anyway, I tried to cancel this year. They, for some reason, my cancellation didn't go through. I got hit with the charge. And the moment the charge hit, I was like, hey, I tried to cancel this. I don't want this. And they were like, no, too bad. You've got another year of this. And it's like, it's $500 a year.

a subscription. I was like, that's pretty expensive for something I don't want. So I'm in a dispute with them right now. And I've actually thought about submitting a BB complaint or whatever just because it's so ridiculous. Like this service I don't want, I tried to cancel one second after it hits. You're like, no, take the service $500 as a consumer. Seems crazy. Anyway, I just like, it happens with subscriptions, right? You want to cancel. You can't. That's kind of where you get it. There was one other, this goes back to the hiding closures point, but there is one other point I particularly want to address in their financial covenants packages, right? It says, I can't remember the exact number, but if they close more than I think it's 30 franchisees or 50 stores over time, if they break that, then they are actually out of compliance with their financial covenants.

And one of the reasons that they, a lot of reasons that they might be trying to hide store closures, but one of the reasons that I think is pretty concerning is if they're trying to hide store closures to avoid a financial covenant default. I guess I just want to talk about that quickly. Sure. Yeah. So first, I just want to point out that exponential fitness is not in default on its debt covenants. The short seller referenced the wrong indenture. It's a retired debt instrument in the short report when they were saying that XPOF would

be in default on its debt if the stores were permanently closed. So I think that's just the most important point is that what they were referencing and the indenture they referenced was a retired indenture. And so, yeah, we have no concern about them being into fall in their covenants. Cool. Let's talk about what we're trading for you, right? So the stock has come back, call it a little over 32. As you and are talking, it's trading for $21 per share.

I guess I just want to quickly talk about, you know, if I just pull up a simple Bloomberg, I'm looking at it right now, it's got a billion dollar market cap, it's got about $1.5 billion enterprise value. Bloomberg's kind of showing me, hey, it's 15-ish times this year's EBITDA. And I think a lot of people might say, oh, on the both side, you might say this is a growth franchise concept, right? Capital light, it's going to scale really quickly, a lot of cash flow coming behind that 15 times EBDA. On the bare side, you might say, this is the pushback I gave on our first podcast. Hey, you know, these brands tend to rise and fall pretty quickly. I think I gave the curves example, 15 times EBITA in a world with four and a half percent, five percent interest rates.

maybe not as attractive as two years ago. Like, kind of talk to me how you're thinking about fair evaluation these days. Yeah, sure. So I guess just as a clarifying point, you know, I think enterprise values, the way we calculate it, a little bit under $1.5 billion, it is close, but just slightly under. You know, I think on our numbers for next, for this year, that's like roughly, you know, 14 times evita today. And then when we look out to next year, you know, we're closer to like somewhere between

10 and 11 times on our next year's numbers. You know, when we look at the kind of the comp group, you know, we use Papa John's, Planet Fitness, Domino's, European Wax, Joint Wingstop, Young Brands, QSR and McDonald's. You know, the average of that group today is 19.8 times EBITDA. And so, you know, it's trading at about a six-turn discount to the average of what we use for the peer group or the comp group. And within that comp group, it's growing the fastest, you know, with the highest projected growth. So the farther you go out in the future, the cheaper it gets, you know, again, when you look at this year, obviously it's 14 times, but when you look at next year, you know, it could be as little as 10 times, you know, but somewhere between 10 and 11 times.

You know, most of the peer group is growing, let's say, roughly 10% a year. And so, you know, the average of the peer group for next year is 18 times EBITDA. And exponential is, you know, is 10 to 11 times. So it's trading at a huge discount to where the peer group is. And I do think it should be comp at the peer group. You know, when you look at Planet Fitness, in its growth phase, Planet Fitness traded between 20 and 25 times evens at the entire time it was growing. And it was growing less quickly than exponential was at that point in time. So, you know, we think there's actually pretty significant multiple expansion. And also keep in mind, the free cash flow conversion is very high. And so it's 60 to 65 percent free cash flow conversion. You know, we think exponential could do

you know, close to $2 a share in free cash flow next year. So you could be looking at a business that's trading it, you know, roughly, you know, 10 to 11 times free cash flow on a forward basis or on a 2024 basis. And for a very, you know, high quality recurring revenue business that's growing rapidly, you know, we think that's extremely attractive. Let's talk capital allocation. So exponential on this dates back to before the IPO and everything, they've got kind of a funky cap structure where these convertible prefers, which they've been, I think they did a pretty big buyback that the convertible prefers earlier this year. But let's talk capital allocation. Like this is going to start, if they continue to grow, they're past the franchisee like the break even point,

right? EBITDA is going to be 100 million this year. If they keep growing, it's going to be 140, 150 million next year. They're going to generate a lot of cash. How do you think the company is going to be approaching capital allocation going forward? Because they could look at to go buy another brand, though they generally buy smaller brands and kind of spin them up? Or, you know, do they look to start becoming a return of capital story in some way? Yeah, I think they have multiple different options. You know, I think my first choice would probably be retiring more of their preferred shares and simplifying. You know, they have a little bit of a confusing cap structure. And so to the extent that they could, you know, retire all the preferred equity

or the preferred shares, I think that would be preferable from my standpoint. It's not a little bit of a confusing. It's really confusing because I was brushing up my model to prepare and it's like they've got 30 million diluted shares outstanding if you look at it, but then it's 60 million once you do the flips and the class A and class B. It's really confusing. I feel like they used to do a better job of providing you. Here's the share count. Here's the net debt than they did at least in their Q1. Yeah. I agree with you. I mean, it's definitely, it's definitely something that I think could be simplified. I think they're aware of that. So I would think and I would expect for, you know, the preferred shares to get taken care of next. And then, you know, my guess after that,

you know, I think at some point they would look to acquire another brand. But, you know, I don't want to put words in their mouth. I don't know exactly how they're thinking about capital allocation. But my best guess and my hope would be, you know, number one, the preferred equity and probably number two, you know, an acquisition of another brand. Because, you know, some of their returns on these brands have been amazing, right? I mean, they acquired Club Pilates when it was 25 studios and now it's over 800 studios on its way to 1,300. So just the potential return on investment for them and a successful acquisition is just huge. And so I would love to see them do, you know, another really successful acquisition. And we talked about it more on the first

podcast, but the interesting thing with them is they're rolling up X pass, which is they're, hey, you subscribe to this and you can go do like, if I remember correctly, you would get like, you know, 50 credits and you can buy 12, use 12 of them to go to a club Pilates class and then four to go to a row house class and eight to get a stretch lab class or something along those lines. And it is interesting because if that works out, every brand they do, they should have, like, they will have a competitive advantage because they can just go buy a brand and say, hey, we're going to plug you into this huge X-Pass network and it will instantly juice your numbers. You'll get more users. It's just kind of interesting. Am I thinking about that wrong? They didn't mention X-Fest as much as I thought they'd be hammered on the Q1 call, to be honest. Yeah, I don't know how impactful X-Pass is. I don't want to overstate. I think there's definite value to X-Pass, but I don't think that just having X-Pass and plugging people in a new studio is really what's going to drive it. I think it's more that they found a system with Club Pilates of really making, you know, boutique studios, boutique fitness, a really attractive and successful business model.

And I think they're taking that same playbook from Club Pilates and applying it to all these other verticals. And I think that's really the value is that they've found a very successful and profitable way of, you know, if you follow this system, you're going to have a very profitable studio. And so to the extent they can apply that to more, you know, other verticals. I mean, I think a really interesting one is something like, obviously there's people are really getting into, especially in the podcast community, like cold plunges and infrared saunas. You know, I think it'd be super interesting for them to get into like a rejuvenation, you know, type of modality. Like if there was a place in, I live in Miami Beach, if there was a place in Miami Beach where people could go and do a cold plunge and then a sauna, you know, I think that would be a really successful concept. That's interesting, though, you know, you want something, like you're almost getting into a spa at that point, right? Like, don't you want something that people are going to go to multiple times per week and spend some time?

And like, to me, a cold plunge, you hop in for five or ten minutes or something. Is that really going to lend itself to a 200, 400, 600, 600 unit franchise? location? I think it's possible. I mean, people, you know, all the studies recommend four saunas a week, and most people do a cold plunge every single day. And if you look at buying an at-home cold plunge, I think it's like five. It's like 3K. Yeah. And I've seen it for, yeah, I've seen it for five, you know, so in terms of, I think the value proposition of, you know, can I, if there was a cold plunge sauna place, you know, near my office that I could pop into for 20 minutes, three or four times a week, like that's, that's something I would be interested

have been. So I don't know for sure, and I'm just throwing out a modality as an option. Yeah. I guess we don't mean to break down the Zach Buckley cold. I like it, though. I'm just kind of like at that point, it's just a, you're just a capital cost, right? Like there's no person. A stretch lab has one person. A pure bar, you're going because you get the instructor in the community, a cold plunge. You're just replacing the capital cost. But unrealized that. So you're talking to August 1st. And what's interesting is they have the short report come out at the end of June. Again, the company goes into a quick blackout date. But they do announce in the beginning of July, hey, we're going to host an investor day.

Sometime in September, I can't remember the exact date. So you've got two. Say again? September 6th in New York. So you've got two catalysts here, right? First is they're going to have Q2 earnings in two days now. By the time we release, this will probably be one debt. And that'll be their first time they can address this.

They can go into their unit breaks down and try to say, hey, we're not having mass closures. Our business is going really well, all that type of stuff. And then B, and best your days, everyone knows when a company hosts. Investor Day. It's really interesting because especially if it's their first time or their first one a long time, it's a reintroduction. A lot of times the company will announce their growth, growth plans, capital allocation, things that people didn't know, all that sort of stuff. And it can serve as a big catalyst for shares. Like one company I follow two cows. I don't know if you know them, TCX. I do. Yeah. We were long in like 2012 and then, yeah.

I think Elliot's coming on the pod in the near future. He's one of the best CEOs I've ever seen. They did an investor day earlier this year. Stock goes from 18 to 30 and 24 hours. And I, only own a little bit of it and kick myself. But that type of thing, like, it's not uncommon to see around investor days when they reintroduce people to their business bottle, reaffirm it, reveal some new information. So my question is, we've got these two catalysts coming up. What do you expect or kind of hope to see from them either alongside the earnings or maybe with the more full, like kind of open the kimono September investor night? Yeah. I mean, just as a starter, you know, we have a highly correlated alternative data source

that is showing roughly like a 6 or 7% beat for Q2 and roughly a 6% beat quarter to day period in Q3. So the data that we have is very likely to be right and it's trending, I would say, very positively for them. So I think certainly on a top line basis, I can't speak to margins, but on a top line basis, I think they're likely to report a very solid quarter and probably have a solid, at least top line guide.

So obviously that's an alternative, alternative data source. And I'm always curious about that. I know you've done great work with them and continue to do great work. But when you see that, like a lot of times my worry is you have that. And that's almost like the whisper number where everybody kind of has that and says, oh, it's going to be a 6% beat. And then if it's a 4% beat, it's actually a miss because everyone thought it was a 6% beat. Do you think yours is like really proprietary or do you think a lot of people are kind of looking at the same beat misnumber? Definitely a lot of people have that. But with that being said, you'd be surprised how often a lot of people have the

data and the stock still trades up when the number's good. That's the classic thing. Like sometimes you'll talk and I'll be like, oh, everybody knows this quarter is going to be a disaster and the quarter's a disaster, but it's maybe less a disaster than I thought it was going to be. And the stock's still down 15% because the quarter was a disaster and it's never obvious to everyone. So you think near numbers, go ahead.

Just to add to that, I think it's important where the stock is trading, right? Like they, like, you know, basically the stock has reacted well on every single earnings call that they've had until the one that they had in April of this year. And, you know, the stock was at like over 30 when, you know, when that earnings call came out. And so even though that was a beat and raised quarter, you know, with the stock at like, I think it was at 32 or 33 when they reported, there was just a big expectation embedded in the stock price. You just think it was valuation? Because I ran and reread the Q1 call and prep for this pod. And I actually thought it was pretty positive. I thought things were going pretty well. You just think it was. Yeah. I mean,

look, the company was trading at a high valuation, right? Put $33 a share into your model. Like that was at the high end of the peer group, you know, at that point in time. And so here, I'm just doing it right now. So, you know, that's, that was basically, you know, call it a $2.1 billion enterprise value. And so at that point in time, I was trading it, you know, roughly 20 times 40. And so, you know, that's at the high end of where it's ever traded from a valuation standpoint. And so even though they had a great quarter, I think it was, it was mostly just valuation. But, you know, in terms of now we're going into it at more like 14 times. And so, you know, I think that's, I think that's the difference between the two is if you have a

beaten raised quarter when the stock is already undervalued, you know, that can lead to, obviously, you know, a much better earnings reaction than if you have a beaten raised quarter when all of that, it's already priced into the stock. What about what do you hope to see at the investor day? You know, I'm sure they'll do a lot to address what came out of the short report. I'm sure they'll do, they'll talk about a lot of the same things that you and I talked about on this podcast. I'm sure they'll spend a lot of time on franchisee economics. I'm sure there will be a lot of franchisees there to talk about franchisee economics. On that note, the people that we spoke to were really interesting, right?

Like we talked to one of the former employees who basically used to be in charge of, you know, franchisee sales. So their whole job was talking to new franchisees, but also helping franchisees who wanted to relocate or resale their store, you know, helping those people resale or sell store. You know, we talked to someone who basically was in charge of selling franchise concepts to people who were interested in becoming franchisees. You know, those two people gave us a lot of confidence in exponential because they were wildly positive about the business, right? They were saying, you know, everything very positively about Anthony's character and also just about the business economics. You know, the guy who obviously, he brings his clients to whatever franchise

concept he thinks makes the most sense and very frequently you know he's bringing to you know a ton of his clients to exponential and his clients are doing extremely well so obviously if exponential is a failing system that would never be the case i should have mentioned you know i said at the front you did a ton of research and i think one of the things you you did was you talked to franchisees from eight of their 10 brands if i remember correctly obviously all the big ones yeah we skip stride in AKT just because those are less than one percent each yeah so you talk to franchisees from eight to the 10 to get a like kind of up-to-date feel for how they're going. And as you mentioned, a few people who were in the franchisee, the franchise community, but maybe not direct franchisees. The most interesting

one to me was that if I remember correctly, that franchise, that franchise placer that you talk to, I think he said, oh, I read the short report and the stock went down. So I went and bought a bunch of stock because I'm so competent in the exponential story and kind of the culture there. Totally. Yeah. That's exactly what he said. And yeah, it was definitely, yeah, I think he was one of our strongest calls just because he has the option of working with anyone. And he actually chooses to work with exponential. And he felt like the report was extremely misleading, given all of his personal experience with the company. And I think he said he had personal experience with like people at the top. And he said that his view of their

character. And obviously, some people, you interact with them and you're completely wrong on it, but his view of their character was completely different. Not financial advice that he went and bought the stock or anything. But I just thought that was a anytime you hear somebody who directly works with a company and they say, oh, they're so good. good. When some bad news came out, I went and bought the stock because it's so diametrically opposed to what I'm seeing on the ground and my interactions with them. I always find that really interesting. It just, it's one of those classic stories that just, it seems to work out well. Yeah. It wasn't just one person that said that. It was, it was the compilation of,

you know, we talked to over 20 people. It was just the compilation of all of those people put together, you know, all backing exponential. You know, there was, you know, there were a few, you know, the unhappy franchisees were like, I talked to someone at Roehouse, you know, that person wasn't happy, you know, there, and they talked about some people at Roe House also, you know, struggling. So it's not to say that every single person was perfectly happy with exponential, but the vast majority of people were. And of course, you can empathize and understand that like, you know, that one of the struggling brands, of course they're going to have franchisees that aren't doing well. Or as you said, like, people forget this is a, these are huge concepts. And a couple of

them, if you've got 800 stores, of course a couple of them aren't going to, aren't going to work. And I've done work on franchisees where I'll talk to someone about the stock, they'll be like, oh, yeah, I talked to a franchisee and they're really struggling. So I'm passing on the stock and be like, dude, this is a 2,000 count store. I could find, I could probably find you eight people tomorrow who are struggling with it. Like, what I want to know is what the, what kind of the 25th percentile units are doing? Because if they're profitable, then this is probably working really well, the 25th percentile. And if the 50 percent are making a lot of money and trying to expand. This is working. You know, so yeah. And you have to ask,

like, why are there so many, you know, multi-unit holders? You know, like, there's a ton of people that own multi-units. Like, why would that be the case, you know, unless the business was doing well? Like, why aren't the transfer rates higher? Like, why are the transfer rates in line with, you know, industry norms? Like, you know, why does exponential, like, how have they been able to close so few stores? Even if there are theoretically 30 stores that are closed, you know, that's still an extremely small closure rate for a system of 2,700 studios. So I think all the data, I mean, I don't think we talked a lot about the same store sales in the AUVs. But like if you look at same store sales, I mean, they did 20% in Q1.

I mean, that is a tremendous number. It is. A lot of it was, we talked about the COVID. Q1, 2022 was kind of the last of the, I think they're still comping a little bit of the reopening, if that makes sense. They are, but I still think they're going to comp, you know, high single digits, even, you know, coming out of that. So same-store sales numbers are going to decline over the next four or five quarters as they're not comping COVID anymore, but I still think you're going to see 6% plus same-store sales comps, and you're seeing AUVs that are significantly in excess now of pre-COVID numbers.

And now, a quick word from our sponsor. Are traditional expert calls in the investment world becoming obsolete? According to Stream, they are. And you can access primary research easily and efficiently through their platform. With Stream, you'll have the right insights at your fingertips to make the best investment decisions. They offer a vast library of over 26,000 expert transcripts powered by AI search technology. Plus, they provide competitive rates on expert call services, and you can even have an experienced by-side analysts conduct the calls for you. But that's not all. Stream also provides

the ability to engage with experts one-on-one and get your calls transcribed free of charge, all for 40% less than you would pay for 20 calls in a traditional expert network model. So if you're looking to optimize your research process and increase ROI on investment research spend stream has the solution for you head over to their website at streamrrg.com to learn more thanks for listening and we'll catch you next time yeah that's great look i think we we hit everything that i had in my notes obviously uh yeah i think we had everything i had in my notes anything else you want to talk about or anything no i think you know i think the main point is just that the business is is doing extremely well you know you have an opportunity to buy it because it's depressed

you know, at least temporarily from the short report and from, you know, some of the, I would say, misunderstandings that investors had from the short report. And, you know, we feel really confident we did a ton of research that, you know, the primary research we did, you know, came back very positive. And then, you know, the alternative data that we have, which is highly correlated, shows the business has done, you know, very well actually post the short report, right? So there's been no, no impact on the business performance, you know, after the short report. You know, we've continued to see really positive results. And we think the shares are really undervalued as a result of that.

Yeah, no, look, this is why I wanted to have you on because it's just an interesting time. The company's been blacked out. And when somebody says, hey, I've done 25 expert calls and I've got something to say. And this is a very kind of timely, but in front of earnings in the investor day. I just thought it was great. So, Zach, look, I think you've done great work. We'll see how it plays out. We'll learn a lot more in 48 hours and then a lot, a lot more in a month with the investor day.

But I appreciate you coming on and looking forward to having you on again and tracking how this one continues to do. Yeah, thanks so much for having me. Appreciate it. A quick disclaimer, nothing on this podcast should be considered investment advice. Guests or the hosts may have positions in any of the stocks mentioned during this podcast. Please do your own work and consult a financial advisor. Thanks.