Yet Another Value Podcast - Oxy Capital's Pedro Sousa thesis on high quality, low cost gym facilities in the UK $GYM.L

Episode Date: February 22, 2024

Pedro Sousa, Principal at Oxy Capital, joins the podcast to discuss his thesis on The Gym Group plc (LSE: GYM) - founded in 2007, the Gym Group is the original provider of high quality, low cost gym facilities in the UK. For more information about Oxy Capital, please visit: https://oxycapital.com/homepage/ Chapters: [0:00] Introduction + Episode sponsor: Fundamental Edge [2:05] Overview of Gym Group $GYM.L and why it's interesting to Pedro [9:09] Competitive analysis: Basic-Fit and PureGym [18:00] Raising prices and margin expansion [25:40] Replacement cost and margin of safety [31:29] Discounting of membership in October 2022 [33:42] New CEO in Summer 2023 [37:29] Three-tier pricing membership [41:14] Normalized earnings levels looks like and free cash flow [53:18] EBITDA multiples [56:35] Bear case on $GYM.L [1:07:28] Final thoughts Today's episode is sponsored by: Fundamental Edge You’ve probably heard it’s an “apprenticeship” system, or that you’ll “learn by osmosis”? But what if there was a better way to learn the equity analyst job? Fundamental Edge is re-defining training on the buy-side. Use the code "10YAVP" for a 10% discount. Website: https://www.fundamentedge.com/ Whether you’re already in the seat or looking to break in, the Analyst Academy from Fundamental Edge offers a thorough and flexible path to developing the tools and frameworks employed by leading hedge funds. Breaking in: https://www.fundamentedge.com/breaking-in Check out the Academy syllabus and sign up for future free content: https://fundamental-edge.ck.page/academyinfo

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With me today, I'm happy to have Pedro Asosa. Pedro is a principal at OxyCathral. Pedro, how's it going? Hey, Andrew. Good to be here. Great to have you. I'm super excited to talk about the stock we're going to talk about today because it's one of my favorite sectors, a really interesting company, but we'll get there in a second. Before we do, just a quick reminder to everyone listening. Nothing on this podcast is investing advice. That's always true. But for my domestic listeners, maybe particularly true today, we're going to be talking about an international stock. I always joke, it's London listed. And I always joke that London might be an emerging market at this point and not a developed market. And people respond furiously. It's a little bit of a joke. It's a little bit of a joke. But We're going to be talking about an international stock on the smaller side, so people should just keep that in mind.

Please do your own research, not invest in advice. Pedro, I was so thrilled. You reached out to me about this idea a few months ago. I'm so thrilled to get it on because it's one of my favorite sector is a super interesting company. The company we're going to talk about today is Jim Group, and I'll just toss it over to you. What is Jim Group and why are they so interesting?

Yeah, thanks, thank you, Andrew. It's great to be here after hearing so many of your great podcasts as well. So hope I can bring something to the table as well and contribute with an interesting episode. So gym group is a low-cost gym saying, as you mentioned, based in the UK. It's the number two there behind Pure Gym. They have 230 more or less gyms,

which is about 30% a bit less than Pure Gym. And they IPO back in 2015. They initially had a good performance and then hit a rough patch during COVID, and the new CEO entered the last year. The company trades at six times the beta, 24. It's a 260 million enterprise value, so significantly smaller than the other company

that listeners will probably also know which is basic fits. The reason it's interesting is too full. And maybe before going to that, just to give some background, here at OxyCAPTal. So we also do private investments and the low-cost team sector is one sector we've been invested in

on the private side since 2014. So we think we know some of the more operational dynamics from an insider's perspective and that gives us some of the building blocks for our thesis here. So in terms of why, it's interesting. First of all, I think the overall the market, public markets, mispriced this sector, because there's a number of dynamics

you need to understand in order to price this correctly. One is the ramp up of the new gyms. So it takes two, three years for them to reach maturity, meaning to reach the normalize the beta per gym level. And so both basic fit as well as gym group, they open a lot of gyms during COVID and in the year or two afterwards. and there's this hidden earnings potential of these gyms ramping up to full potential. And, you know, as an outsider, it's difficult for you to believe in that

because you've never seen it happening yourself. It's company management sale of things, and sometimes it's difficult to believe in 100%. We've seen this happen in our holdings in the private side as well, so we're comfortable in the right thing, this evolution. Then there's also the fact that the sector is working through normalization of energy costs, which were a really strong hit last year. And I think this is not entirely price-deen at this point, at least in June Group. And then there's also some distrust by public investors, I think, of the sustainability of

the RIC, of these concepts long-term, and of the white space that is there still to be for growth in the next few years. And we are comfortable with this Again, I mean, we are invested right now in a Spanish gym chain And it's a large player in that market So we know inside out the energy cost impact as well And you're comfortable in writing that

And you can look at planet fitness In terms of the white space We think there is in the European markets And the growth they've had over the last 30 years And you can just compare You know, gym penetration of different countries in Europe versus the US to gain confidence on the long-term potential for growth here. The REOC sustainability issue, I mean, you have a podcast about basic fit that went into detail

on that, but we're also going to tell here, but we're also comfortable with that. And then this is more the general side, and then specifically for Jim Group, I mean, we think it's a really interesting way to play this theme because it's cheaper than basic feed, first of all, so it's six times a beta to 24% seven times for basic feeds. So you're kind of paying less for potential growth in units going forward. And there's these six times a bit that has more low-hanging fluid for management to actually increase it, even like-for-luck.

existing gym states relative to the basic fits because if you actually look at the mature gyms and if you they're actually still 30% below the pre-COVIDE beta okay and if you assume that they were to close that gap and you apply that current state and already adjusting out for the for around 15 gyms that are really workforce dependent so those are probably not going to recover But if you just look at the other ones, if you look at the adjustment, then the company will be trading three times a bit. If you do the same thing for basic fit, it's 5.5 times. So, you know, again, greater margin of safety there.

And we think they're still, they have a similar or almost similar potential for our growth going forward compared to basic fits, just, of course, starting from a smaller base. So they need to open less clubs in order to grow at the similar pace relative to their current size, right? But the UK is still behind the U.S. and the Nordics in terms of gene penetration, low-cost penetration. In addition, there's a number of interesting near-term catalysts. So the new CEO, management turnover, made it so that guidance was very conservative last year. They're likely to have the C&D, capital markets today this year.

And I'm expecting them to, you know, grow to the market and be a bit less conservative, tell the story again. and help the sell side and investors get comfortable again with the potential for growth going forward and for 30% R.I.C. on new openings which I think investors are not pricing in at this moment.

And there's this potential to return to pre-COVIDA, maybe less so through volume, which originally was the way they got there. But the genes right now have less volume, less members. But maybe more so through yields because they have a price gap

versus pure gym. That in our view is not justifiable because, you know, customer reviews are very similar, even better for gym group gyms. And just closing that gap alone, bring them back to pre-COVIDA bit per gym. Well, Pedro,

you did a great job. You hit all my questions I had, so we could end the podcast here if we wanted to, but I'll try to earn my bones as a podcast host here. Let me just start. You mentioned, I mean, look, the reason I was so excited to have you on is the basic bit podcast I did a few

year, I guess it was like 18 months. I can't remember. Time flies so quickly was one of my favorite podcasts I had done. It's one of the companies I got most excited from about, I've been following it pretty closely since. And, you know, the stock's kind of gone nowhere since then. And I've been a little surprised that the thesis. So I was so excited because I've been excited about the sector and you've got the private

background here. Let's just start with the first thing. You mentioned a little bit why this over basic fit, and it seemed to come down a lot to multiple. So I just want to start with that because I think it would help us go into a few different directions. You know, I hear you, this is trading cheaper than basic fit. But, you know, basic fit, I think people would say, hey, it's a larger player. They're in multiple markets, so you get kind of like the market diversification. And as the larger player, you know, people, one of the things I said once that a lot of people have taken is like, look, if you're always buying the smaller,

player, like do it once, it's okay. But if you're always doing it, you're probably not willing to pay anything for quality. And I think a lot of people, including some who I talk to prepping for this podcast, would say, hey, look, basic fit, you just get a larger, better run player. There's more leverage of the SG&A, more leverage of the tech, more leverage of the marketing, like pay up a little bit because maybe it's cheap, maybe gym group's cheaper one year off. But if you look like kind of four years out, basic fit actually might be better quality and cheaper. What would you kind of see to that? Yeah, so, I mean, basic fit is also interesting in our view of career.

In fact, we're also invested in basic fit, although Jim Group is a larger position for us. I mean, in terms of being a smaller size company, I think you have to look at the size relative to the market. They are still very large in the UK, right? And that's what matters for their competitive position mostly. On the other hand, being smaller, you have less funds looking at the company. If you look at shareholder registry of basic fit, it's a lot of American funds. So I think for me it's more difficult to think that basic fits is conceptually misprice than Jim Group.

Jim Group is mostly UK investor-based, very gap-burns-focused, very dividend-focused. That doesn't lend itself well to the low-cost gym segments at its growth stage, especially after a sort of disruptive event as COVID. it. And it's not just about multiples. It's about margin of safety. So you're paying a lower multiple on depressed earnings while basic fits earnings have already fully recovered to pre-COVID. And it's not just because of better management

at basic fit. It's true that there was turnover in management at Jim Group and that may have made it more difficult for it to be managed and recover quickly. There's now a strong team in place. But also, Jim Group, the one difference, versus basic fit is that it's a no contract model, right? So members can come in and out whenever they want. Basic fit does employ contracts in some of their memberships. And they actually did one thing that was smart,

which was they froze membership fees during COVID. So people didn't have to cancel. So when things started to recover, membership recovered faster at basic fit in a team group. So that's, I think, part of why there's this lag in recovery. over it, you know. The no membership, the no contracts at a low-cost gym just blows my mind just because I've used a lot of low-cost gyms in my life. And the one knock on all of them is if you ever try, like, you kind of have to, you know, go to the post office and send a certified letter that

arrives at, you know, between the hours of 2 to 3 p.m. on a Friday or else that reject you. So the no contract, shockseat. Let me just ask one more question on comparison here. You know, I think the other thing you will say is. I'm sorry. For that, just one other thing, which is, if you look pre-COVID,

Jim Group had more members per square meter than basic sheets a lot more. So I think it's also a more higher volume, even lower price model, starkly than basic fits. So that's also,

I think, why it's a bit, it had a bit more difficulty adapting to the newer reality where there's, you know, less members. Maybe they work out more, so they're more willing to play.

So it's a period of adjustment. But I think you can look at the basic feed markets at the U.S. markets, the planet, and their corporate stores, to see a bit where the industry is going to be in the UK in a year or two from now. And you just have a much greater margin of safety because, you know, in a scenario of the world where we are wrong and low-cost gym economics, actually the jury rates, you're probably not going to lose money in gym group because, you know, you've already had this margin of safety. In a scenario of the world, where we are right, you're going to make money in both cases,

from both basic fits in Jim Group. Just not on basic fit particular, but I think the one other thing people might say choosing Basic Fit over Jim Group is, hey, basic fit is the leader in most of their markets that matter these days, right? They have the most. And I think people really like this kind of entrenching franchise, this entrenching model, right, where you build three stores in one small market. And then because you've got three stores and they kind of overlap with each other,

you crowd out every other you crowd out every other possible entrant and this is you know domino's pizza talks about doing this basic fits talked about doing this i guess with gym group my understanding and tell me if i'm wrong because pure group pure gym is private so it's tough for to get information i think pure gym is larger than them and obviously you know planet fitness is larger than all of them but planet fitness is u.s so size doesn't purely matter but pure and gym group are both similar markets and they're both UK focused so i think pure group is large And I guess I just wanted to ask, you know, buying the number two player in the low-cost fitness space. Like, how do you think about those dynamics?

And if I said anything wrong, please feel free to correct me. Yeah, no, it's true. So pure gym is larger. We actually also invested in pure gym a year, a year and a half ago, I think, because they have probably traded bonds. Yep. Back when they were at the 15% yield to maturity, now it's more normalized. But last time I remember, so they had around 500 gyms, but part of that is in the Nordics. Okay, so in the UK, it's around 300 gyms, and the gym group is at 230.

So it's not a major size difference. It's more of an oligopolistic market compared to the planet in the U.S. or the Netherlands for basic fits. But we think it's a rational oligopoly. We spoke with former, you know, former employees of gym. group, current people at Pure Gym and the other meaningful competitor, which is JD. And the takeaway really is that both the quality of the gyms, the member satisfaction, the quality of the operations surrounding the gyms seem very similar to us, especially between Pure and Gym Group.

If you actually, you know, you can map out the gyms. and the gyms and the locations on Google Maps. We did that and you go look at the reviews. There's actually more underperforming gyms at Pure Gym, a longer tail of gyms with three stars, three and a half stars. And if you compare, for example, cost per gym, it's actually lower at Gym Group than Pure Gym. The problem is that the price is much lower at Gym Group

than Pure Gym. and historically they made up for that with high volume. But given the quality of their operation seems similar to pure gym, we think they can close that gap and get back to a higher EBIT. So we think you're not too disadvantaged by being the number two in these markets. Brett Coffron, founder and lead trainer of Fund Edge, barely remembers his first year as a hedge fund analyst. Most of the year was spending a blind panic.

Was his research any good? Was he learning fast enough? What did his PM really want for them? Training on the by side was non-existent 15 years ago when Brett was a new analyst at Maverick Capital, and he actually got demoted. Then he worked harder, found mentors, and asked for uncomfortable feedback. Eventually, he turned it around, learning by osmosis from the talent of people around him, and rose to managing director.

But is this the best way to develop talent? Brett doesn't think so, and that's why he founded Fundamental Edge. The Fundamental Edge Analyst Academy provides students with the tools, frameworks, and confidence to excel in any fundamental equity analyst seat in the industry. Lose the panic and fast track your career on the by side. Find out more about their next cohort at Fundamentedge.com. So just speaking of raising price, right, like one thing they've consistently said, and there's a slide, I'm trying to remember it properly in my head,

there's a slide that shows them versus their top three competitors and shows that they're consistently under them. And even though they're raising prices, like they haven't really fully closed that gap because their competitors are raising prices, which is great, right? Like, one of the nice things about a low cost, but if you're the lowest cost player, you've got a little bit more room to catch up here. they did say something interesting on their earnings call, though, right? On their last earnings call, and this was their earnings call from H123, so the new CEO who

will talk about had just joined, they said, hey, we've had some of our competitors who are moving out of the low-cost space and moving into the mid-market space, right? So they're kind of transferring, scaling, enhancing the value a little bit, going up price point. That's really interesting because I could read that two ways, right? I could read that as, hey, all these guys are taking price and what's happening is in the post-COVID world, with all the work from home, the space has completely changed and people are realizing, hey, the low-cost model doesn't work anymore. So we kind of need to flip it around. Or I could read it as, hey, all these competitors, you know, you've got maybe players one, two, and three are profitable, but players four through 10 are looking and saying, hey, we can't compete with the big guys. They've got more spaces, better leverage of their SG and everything. We need to do something different. So we need to do something different. So we need to. to go mid-market. So I guess to you, which is it when I read that quote to you, you know, some competitors moving from low-cost to upper, to mid-market. Yeah, I think it's, I mean, I think it's a mix of in general the industry's increasing prices.

In the US, Planet Fitness is trialing $15 subscription, $12 subscription, which is a sizable increase from their, from their $10 currently. basic feed you can look at their output it's also been growing a lot pure gym as well they have some public reports because of the bonds that are traded and then everyone is increasing

prices so it's normal to expect the industry to increase prices and I think management was also a bit saying that saying that given such a high increase some of these gyms are actually now going to what was previously considered mid-market

with that said I mean If you look at the industry reports that are around, it's true that the, what they say is that in 2023, the number of low-cost gyms was relatively flat in the UK. In fact, I think even declined a bit, although the larger players obviously grew, like through gym and gym group. So it's possible that I don't have specific data on any specific chain trying to adapt their offering. But, you know, certainly the ones below JD, which is number three, and close to heavy gyms, the ones below that level, they're going to be much less competitive. And if gym group is still struggling a bit, you can imagine that those guys are going to be much worse, right?

So you probably have to adapt to this model. Let me switch to another question. So I mentioned, you know, I've been loosely following basic fit for two years now, right? And I have been surprised both that basic fit and especially Jim Group when I was looking at them at, you know, I thought the inflection would be here by now. And on Jim Group in particular, and I'm just looking, they have not reported the full year, 2003 numbers, right? They did give the trading update where they said revenue and leverage, but they haven't reported like the full hog. But let's just use their H-1-23 numbers, right? revenue was 204 million pounds, adjusted EBITDA less normalized rent was 17 million.

It's about an 8% margin for H123, and that's down from, I have it at 20, am I reading this right, 20% in H122. Is that correct? My numbers look a little funky, but margins, yeah, it has to be down a little bit. I'm not sure if it was 20%, but it has to be down because even in their H1st, even in their trading update, they said, hey, our revenue growth has been offset by cost inflation, right? And I guess I'm just surprised by that because, you know, I would have thought 2003, particularly like COVID's in the rear room year, everybody's going back. They've had

three years at this point to refill the gym. I would have thought we would see some of this kind of margin inflection story, the refill story. And I understand that, especially in the UK, there have been issues with utilities and energy costs. But I just don't think, and when I dig into their numbers, it doesn't seem to me like the utility and energies cost completely explain why the margins aren't inflecting up. So like kind of why aren't we seeing this inflection happening? Yeah, so just on the numbers.

So I have them at 37 million EBITA for 23. It's in line with consensus. And that would be an 18% margin, at debit level pre-FRA 16, so after rent. Yes, that's right. I think I was using a H-1 EBITAN number, but still margins did, margins did degrade from 22 to 23, I think, is my overall point. And I would have just overall expected them to have expanded over that time period,

even ignoring the utilities just because of this refill, the gyms maturing. It's not like they opened a ton of gyms in 2023. they are going to accelerate in 2024, but I would have expected some margin expansion and it's not playing out. You know, H119, back in 2019, I think they were doing low 30s margins and now they're in the high teens. It just feels like they continue to go kind of backwards. I don't know if that's too. I'm rambling here, but I just wanted to ask what's going on there, you know? Yeah, so, I mean, the energy cost increase was close to 10 million impact in 2020.

So, you know, if the margins would be up, would be up adjusting for that. Because a bit of margin in 22 was 22%. Yep. 38 million, right? And 18% in 23. If I just add 10 million on top of the 37 million, that would give 47 million a bit, which 23% of the beta margin.

Yeah, it was 22 for 202. Yeah, so that's slight expansion. But even with that, like, you would have thought just because early 2020 was kind of the last of the COVID restrictions and they're getting lifted. Like you've had, you know, 2023 was a clean year. I just would have thought you'd see more margin expansion here. Yeah, that's true. They've had a lot of inflation in general, right? In the other costs as well, there was a minimum salary increase.

minimum wage increase last year as well in the UKA it's and in general it's true also the

gyms that are ramping up are not just last year's gyms but also the ones from 22 I think that with COVID and the after COVID effects of place people going to the gyms for a while in general the time for a ramp up

of the gyms got longer because it takes longer for a new gym to acquire members to reach that at the rate level. So I think that's also a factor. Perfect. So one of your angles, which I thought was really interesting on the both side, is you said, hey, there's this famous thing where Exxon CEO comes out in the 80s or something. He says, the cheapest place you can drill for the oil is on the New York Stock Exchange, right? And I think what he was kind of saying is at the time, we could go drill new well, and our costs, all in cost for oil would be 25, but if we buy back stock, it would be,

you know, we're buying our implied oil reserves, which are probably better than the oil reserves we're going to go drill for. We're buying them at 20 or 18, so a big discount. You had an interesting thing in your write-up that said, hey, when we buy Jim, like, forget this asset, forget the earning stream, forget, like, the advantages we have. We also think we're buying it for below the replacement costs of their gyms. Do you just kind of want to walk through that math? Yeah, so that was when the share price was a bit lower.

So now I'm not sure if it's exactly below replacement costs, but, you know, they have $230,000, around about that, a bit more. And the cost to open a new GM would be $1.4 million. So just multiply that, get it to $320 million, and the current EV is $2,60,000. 60 million. Yeah, that's a bit of the rough math. If you factor in depreciation, not at their actual depreciation rate,

because useful life is shorter than reality because they are depreciating some of the building improvements that last a very long time. Then they are trading slightly above depreciated costs. But not too much above, and that's quite interesting if you think that they can get back to a 30% RYC on that pace. even if you exclude the

again the workforce dependent gyms which are only 15 gyms that they've identified that are really in the city centers even if you exclude that it would probably still be trading below replacement cost and we think again just closing that price gap

we'll get them back to 30% ROIC and maybe just one thing on that as well even with the current epitabase and gym base below the 30% ROIC, which is the case. They disclosed in age 1, 20%. Even then, we think they are opening new gyms at 30% R1C, because the 20% on the existing base is driven by the fact

that those historical locations were disrupted with changing consumer patterns post-COVID. And of course, also, you know, energy cost inflation, et cetera. But, you know, we see from our private investments and from speaking with management as well at Ging Group that you can adapt your locations to open new locations still at the three-year payback, 30% ROIC. And we think the market is not pressing that in either. So just on the slide on the RIC. No, that's great. I like that.

I just back to the replacement cost. Like one of the things I do love, I love buying assets with a subscription business. where you're buying it kind of at or below replacement cost of the asset because you're getting the in-place subscription business for free. And like, as you know, going and getting what I think each gym is between 35 to 4,000 members at gym group right now. I could be misremembering if that's a, it might be slightly lower. I'm pretty sure I'm in the right ballpark though.

But, you know, it takes time. It takes money to go acquire all those 3,800 members at the gym. So when you buy the asset base for the asset value, you're buying that subscriber base for free. Now, obviously, there's lots of other stuff going on. But I just, I've always like something about that by the asset cable companies. You know, when you, sometimes you'll go find a cable company. And a cable company would probably take $1,500 per home pass to go, like, recreate the assets. And when you can buy it for $1,000 per home pass, and that ignores that they've already got, you know, 30% of the homes already connected paying the monthly, which would take three years and

X tons of money for someone to go replace that. Something about that just always has really struck me as attractive. Let's go to... Yeah, I agree. Maybe just to pull up on that, that increases the margin of safety, right? Because if you're buying...

Yes. If you're buying cheap on earnings, that, you know, that... Basically what you're saying is that you're buying at a low ROIC because, right, So if you're paying up a lower RIC, that means that there's not going to be new players opening new gyms, right? Because of low RRIC. But you're still playing, you know, it doesn't matter to you what is RIC of the existing base because what matters to you is the price you're playing for those earnings.

So they're actually more protected by the fact that you have a lower RIC on the current exercise. We don't think they can get back to those higher RICs. But just to say that, you know, the fact that the existing. base has a lower RRIC now than before, it's not necessarily a bad thing. As long as you think that on the new capital they deploy, they can get some good RICs, which would take out. A cheap enough price can make up for a lot of bills, right? Like, I personally wouldn't want to get into, I don't know, what's the worst business

you can think of right now? I can't think of, I would normally say coal, but coal prices are off the chart, so coal's not a bet. Yeah, let's say, I personally wouldn't want to, but if you could buy all, all the coal mines in the world for a dollar, like, that's pretty interesting optionality. Let me ask two more questions that just jumped out at me, right? I'll start with the earlier one. In October of 2022, the company did a massive discounting of their membership to try to fill up.

And they, you know, they've said they're not going to do that again. They had a lot of learnings. They learned a lot. And I like that they've learned from it. But at the same time, you know, when I hear a low-cost gym discounting, fill up especially it's not like it was october 2020 it was october 2022 i just look at that and again i just say hey is there something i'm missing here you know why what happened with that huge discounting wave in october

2022 yeah so i mean we don't know the the inside of that story of course but i think it it comes comes back to post-covid i think the key for them is to focus a bit less on volume and more on yields, historically, they had a lot of members per square meter, more than pure gym and basic fits. And that's how they succeeded with such a low price. I mean, it's far below basic fits, especially if you consider it's 16 pounds versus basic feet in euros. And post-COVID, I think, you know, there's some people that didn't come back to the gyms. The ones that did come back, they go there more often. So there's a bit more of a higher willingness to play.

So I think you probably charge a bit more. And that's what you're seeing with basic feet increasing the penetration of their premium offering. They are at the gym group at an earlier stage of that progress. I think they've realized that that's the way to go

more than just go for volume and nothing else. And the new CEO is also well suited for that. I mean, he's not from the industry but he's got a lot of experience in subscription businesses and in optimizing these dynamics around, you know,

the price of charge, volume. And that's where he's focused. And so I think it's going to play out well. So you actually hit there the final two things I really wanted to drill into. So let's start with, I think the more important one in the second. The new CEO, right? Because the other thing I see here is I see, hey, the discounting in 2022 kind of, in my opinion, the ramp-up not quite happening as good as well as you would hope post-COVID.

And they changed CEOs over the summer of 2023. New CEO joins, like, right before the H-1-23 earnings call. So he talks a little bit on it, but you don't get tons of info because he's very new, right? But as you said, he is not from the fitness world. He is from the, as he says on the call, the subscription and membership world. So you can see the company is really focused on, hey, we need somebody who knows how to manage churn, growing memberships, not somebody who can bench 500 pounds or something. But I just want to ask you, I'm sure you've talked to him.

What's your thought on the CEO and the CEO change? Because again, CEOs don't change lightly. So the fact that they change CEOs shows there was something they thought they needed to improve or work on. What's your thought on him? Yeah. So I spoke with him once so far. And I'm waiting for the results, the problem to speak with him again afterwards. I have a good experience, I have a good view on him.

I spoke with people that worked with him at prior companies. Where did he work prior? Do you just want to let listeners know? Yeah, so he was at the time with media for three years, you know which is the company for the that equates the times and silly times to to newspapers in the UK so they have you know those subscription dynamics same as a as a as a as a as a as a gym and and just also at British gas so also has a bit that subscription dynamic for eight years and so not not not the same kind of business but

but it has similar dynamics in terms of the subscription side, and the people I spoke with, they had very good things to say about him and overall his reputation. But we still have to see what he's going to do. Now, the information that I have is also that the prior CEO, Richard, which I also met, some of the shareholders or at the board thought, you know, the company needed someone with more ambition. That's that's the information I have, okay, and they decided to conduct the process and end up with will. In practice, I think it's also because Richard, you know, he presented this plan for the company to reach 100 million EBITDA in, I think, 2025 back at 22

CMD. And because of the energy costs increase in 23 and just a bit longer term, a bit longer that the recovery to pre-COVID is taking. This is going to be quite difficult, so I think this kind of deteriorated a bit is starting at the company and made it a bit natural to search for a replacement. I don't think there's any, you know, I don't think there's any cockroaches in the kitchen, let's say.

So we spoke with a lot of people, including senior former employees, and nothing like that came up. so no i've got the response to the to the the thing about the discount that didn't go well so we think there's nothing you know very bad behind the curtain i i don't think there no completely agree i agree with everything you said no need to add anything let's talk they're they're working on the three-tier pricing membership and you did start talking about a little bit but i just want to drill into it a little bit you know the three-tier pricing membership a what is it and you have seen and i'll kind

to lead the witness here. You have seen other gym groups, you mentioned Planet Fitness earlier, Basic Fits played around with it. Other gym groups have started exploring, obviously, the two-tier, but also the three-tier membership, so like, what is the three-tier membership gym groups going for, and how do you think that kind of affects the economics going forward? Yeah, so it's just basically a way to price discriminates more of the members, right? So the more tiers you have, just basic microeconomics, the easier it is to charge the full willingness to pay of each customer because maybe some are willing to pay a bit more

in order to have some better amenities or just to have more flexibility in the times that they go to the gym. The third tier they are introducing is, I believe it's a half-pick membership at the lower price and that makes sense because especially after COVID the people that do go to the gym are going more

so with less membership in a specific gym you have greater attendance so there's a need to kind of sort that out and price discriminating that through an off-peak option is a good idea they gave the example like look

the gym, when is it most crowded? Generally, gyms are most crowded 7 to 8 a.m. in the morning or 5 to 6 p.m. at night, right? So right before people kind of leave to go to work or right after. And you could imagine, with work from home and everything, you could offer, hey, Pedro, you work from home every day. You go to the gym at lunch. Our gym is empty at lunch. You never go at 5 to 6 o'clock. If you will forego a 5 to 6 o'clock or 7 to 8 o'clock membership, we'll charge you $70 instead of $100. That's great for you. might take that up. And then you charge me and say, hey, Andrew, you go to the gym before you head to the office every day, 7 to 8 a.m. You've got to pay $100 to go at peak that smooths out

demand. It smooths out. It makes, for me, it's more valuable because you know, you know what I hate, waiting 30 minutes for my squat rack when I've only got an hour at the gym. So it kind of decreases the peak demand. It smooths out. It makes tons and tons of sense to me. Sorry, I cut you off. Please continue. No, yeah. That's exactly. I mean, I'm also a fellow gym goer as well. so I can confirm it's quite annoying to have two ways and so and that happens more frequently

nowadays because the people again that are going so even though the membership level is below pre-COVID attendance is actually closer to pre-COVID and up versus pre-COVID in many sites and that just speaks to the opportunity to optimize yields right because

maybe less people are going but the ones that go there go more often so they value that more and and again in just also on the premium side as well of things. So they also have a premium tier where you have access to all the clubs and you pay more for that, five to seven pounds more, which is around 30% increase to the base price.

And we think there's also a good opportunity there because they're 30% penetrated. So 30% of the membership pays uses that. Basic fit is targeting 50% in 2024. So again, you can look at these other markets and extrapolate a bit with a one year lag, I think, to the UK, and it bodes well to the gym economics at Jimbrook. Let me ask kind of what we're playing for, right?

So let's say right now 230 clubs, let's say by 2025 we're up to 250 clubs, which I think is kind of reasonable, right? They said they're going to do 10 in 2024, 10 in 2025 sounds reasonable. So let's say 250 clubs. walk me through kind of what normalized earnings level you think we could hit in 2025 or you can run it out a few more years if you think normalization takes a little bit longer but let's just walk through what normalized earnings level look for these guys yeah so I think they should be able to open more than 10 gyms a year

and at the 22 CMD they were actually targeting 25 to 30 a year now of course new CEO and all the problems in 23 with the energy increase, the cost increase, and they contracted that number, at least for 23 and for 24. And they haven't said what they're going to do in 2025. But one in terms of white space, there is white space. So the UK is 16%. Members go to the gym.

The US is 20%. And there's 50% of the gyms are low cost in the UK, up to 70% in the Netherlands, for example. So there's space for them to open more gyms. And they can do that with their earnings. So they should be at, call it 45 million a beta in 2024. That's my number. It's a bit above consensus.

And cash conversion, pre-new openings is probably 50%. So they're going to have 20 to 30 million after maintenance CAPX to deploy in new gyms. That allows for 20 to 25 new gyms a year. So, I mean, I think they could open 20 a year or for a couple of years, let's say for five years, but to be 100 gyms, it could get to 330 gyms. You can take out the workforce dependent gyms, which are 15, applications to 315 gyms.

And now here it depends on whether or not you believe that they go back to 2019 levels. I mean, we call it five years to increase our pool to get there. We think it's close that gap to pure gym. We think that's quite feasible. And that would mean doing about $430,000 a bit per gym. And that doesn't even account for inflation, right? So KAPX has increased since 2019, KappaX per gym. So actually believing that they're going in five years to reach this 400 and something,

a thousand EBITs per gym, and it's still a right below, below pre-cop. If I can just pause you, it's funny you said that number because that's exactly the number I have for my perjim, EBITA. I don't think it's crazy. Like there's lots of, you know, I look at basic video. I've looked at all these. You look at the pre-note. But I guess, you know, for people who are listening at home, if you just kind of said, look, right now, you have, they're doing

19 pounds per month in Arpoo and they've got what is it let me just do this minute 19 pounds per month in Arpoo and they've got about 3,750 members per gym that means each gym is doing about

850,000 pounds in revenue per month so you already know what the revenue is you know you kind of said 870 there I think or 850 you know the revenue and now it's just trying to figure club level EBITDA margins. And, you know, I think most people think 50% club level EBITDA margins are about right. So that gets you to the 435-ish,000, 450, whatever the number is. But that gets you

around there. So I was just laughing because I have basically the same number. And I just wanted to reinforce that. So that's the club level EBITDA number. Let's just walk through the rest of the income statement, right? We've got club level. Obviously, there's SG&A. We can talk MCX, but let's go through. And I've got my numbers that I'll all intersperse as you go through them as well. Yeah, yeah. I just want to point on the EBIT for gym. So right now they're at 320, right? At least that's my estimate for 224, 223, it's 10k less. And to get from there to the 430, if they close price gap,

that gets them above that level already. Because 12% price increase, which is gap for superior gym on such a model with high operating leverage. and that gets them more than 100k for gym in additional epita. So then, you know, it's multiplied that by the number of teams gets you to 135 million EBITA pre-HQ. Right now they're at 20 million HQ costs.

In five years, let's say 25 million. That gets you to 110 million EBITDA. And Q20V is 260 million. And they could do these openings with their internal cash flow. And obviously that's 2.5 times a multiple of a bit of five years out. So we think that's quite attractive. Right now they trade out six times, a bit. But they start to trade it at 10 times.

And if they do this in five years from now, they're not going to be trading at six times because the market is going to be again pricing in this potential for growth because the sell side and investors would have regained confidence in the 30% ROIC on the open. This is a bit the investment case. I guess we can also walk through the bridge from EBIT to cash flow. Of course, we underwrite based on free cash flow, but it's easier to communicate through a bit. I don't want to harp too much on the bridge. Maybe we should because there were, I got some questions that were like, hey, why does this company,

Why does this company never produce cash flow? And I get that on basic fit. I actually think here it's much less of a concern because, look, yes, they are opening new gyms and you can break that in, but they're generating cash flow from operations. You know, you can make assumptions around maintenance cap X. They've said five to six percent of sales are kind of maintenance cap X that fuels maybe a touchload to me, but directionally correct, directionally correct. So, you know, I don't think there's any huge issues.

issues with they're investing new gyms. If the returns aren't there, they can stop investing new gyms. If you believe the returns are there, obviously you do, obviously they do. It's going to be a good investment in the long run. So I'm a little surprised by that, but I'll let you comment if I missed anything there. If there's any, I don't, they're not really that levered. So I don't think there's crazy interest expenses to do. No crazy tax situation. But all go ahead, please. Yeah. So I agree. I mean, 2023, you know, you'll see that they look at the first half, they generate the model free cash flow because they kind of stop the openings a bit

and confident that it's going to be the same for the full year. And if you go back and you add back the new opening KAPX, you get to healthy free cash flow levels. And in terms of the maintenance KAPX, I think this is a bare point around the industry in general as well because especially in Europe, most of these changes were started not too long ago, 10, 20 years ago. So you can look at Planet Fitness again.

That's the longer one concept and the franchisees seem to be okay with levels of maintenance capex that they have to do. It's been around for 30 years. We also, I mean, we looked at each historical vintage of openings at gym group. and when will they need to replace the cardio equipment, the strength equipment, et cetera, at what prices? And if you do that bottom up, we got relatively comfortable with the management target of 6% of revenue. Maybe in some years, there could be some lumpiness, could be higher than that, but on average, it shouldn't be too different from that. And that is not factoring in something that also helps them, which is that in general there's a trend towards less cardio at the gyms.

And you'll know this issue also with the gym frequently and more strength equipment, functional equipment, which is much cheaper and lasts longer than treadmills, let's say. And then as a lifter, I mean, I was until I've told everyone I tore my peck bench pressing. But, you know, as a lifter, every time I read one of these things, and they're like, hey, treadmills are still important, but we're taken out. They said it on one of the things. They're like, we refitted 13 gyms to take out some treadmills and put in some extra squat racks. I'm like, yes, let's go. We're winning the war here. That might be too far as a little bit.

Quick question. Oh, please, go ahead. No, I think that's supposed to be just one last point, which is you should also see what basically did with Matrix. They announced that the other CMD. that they did a contract with them so that it's substituting the equipment after six years, they're executed after 12. And at the six-year market, they just do a reform, that's lower than the maintenance cap X a lot. I mean, Jim Group is also a substantial client of matrix.

So maybe they don't get as good terms as that, but that also gives me confidence that in general. You can manage through that. Just quick. So let's say people listen to you and they believe, all right? hey, you know, the eight, the four to five, you're out, 300, 300, whatever they want to use generates, I think on my numbers, that generates about 100 million EBDA, right? 100 million EBDA, this is a 263 million EV company, so that it's a lot of EBDA for that. But what type of multiple should people be thinking about there, right?

Because I think people will have two things in their mind, planet fitness, which is pure franchise, trades for roughly 1,000 times, EBITDA. Or, you know, a lot of people might think a gym, you know, your typical gym, a one membership gym, lots of MCX, you know, the EBITDA here, there is a MCX component, as we just talked about, lots of hard costs, that type of stuff. Oh, solo gym is not going to trade for a big EBDA multiple. This is somewhere in between. I just gave you a 2x EBDA, 2,000 X EBDA, somewhere in between there, right?

what even how multiple should people be thinking about this trades for four years out, five years out, if the numbers that you talked about are correct? Yeah, yeah. Can I just mention one last thing on the free cash flow? Of course. Yeah, so just for listeners to understand. So if you have 430,000 EBITDA per gym, just to understand a bit of bridge. So then you probably have around 60 to 70k of maintenance cap X.

and then taxes. So that's around 60% cash conversion at the gym level. In fact, there's also a negative working capital, so it's a bit higher than that. So the 30% ROIC that they state, it also bothers me a bit that the world industry uses a bit as the RIC measure, not free cash flow, right, but it still translates into a 20% more or less cash IRA.

And at the gym group level overall, with the HQ costs on top of that, we think it should be around 50% cash conversion. So these abeta multiples are attractive considering that because the implied free cash flow yield is quite high. And that gets me also to the exit multiple that you mentioned. So if you consider in a couple of years from now, maybe these companies are going to be mature, less white space. It's going to be more of a cash flow story, I think. I think it's still going to be defensive because it's still going to be low cost. So resilient in a recession. We saw trading down happening in 2008 and also in our own private holdings in 2014 here in Portugal

because it was a tough time economically. So there's a bit of breach. There should be a bit of a premium on the cost of capital for that. And it's going to be more. of a cash flow story. So you can imagine earnings at that point growing 5% a year, maybe a bit over inflation with a couple of openings a year. If you think the right cost of capital is, say, 12%, it could be higher, could be lower, let's say 12%. Then the implied free cash flow yield for a fair price would be 7%, right, 12 minus 5, which is a 14 times free cash flow multiple,

seven times if you a bit. So I think between six and eight times is reasonable when these concepts get mature. And with that said, for example, with case of team group, I think they could be able to double the number of chips given the current white space

just because there's probably 30% upside on the population in the UK that goes to a gym because it's 16% versus 20 in the US. There's probably not a 30% upside in terms of higher market share of low costs within the overall gyms, or maybe more like 50%, if you compare with the Nordics and the Netherlands, which are more mature in terms of low cost concepts. So the market as a whole could almost double and then consider that the largest operators which usually take most share of new openings.

Gym group could probably more than double the size of their current gym base. And at 25 clubs a year, they will not do that in five years. So in five years, I think there's still going to be space for them to continue to grow. So maybe they should actually trade at a high multiple than these six to eight. Not that we need that to do well here. In fact, I mean, if they don't open any gyms, but they're just able to close that, that a bit of the gap to pre-COVID. You already wouldn't do too badly because you're already paying like three something

times a bit for that. Yeah, I mean, the nice thing here is, again, price protects a lot of downside. And the 2023 results, which as we talked about are hopefully the bottom for a lot of different reasons, the utility reasons we talked about, new gyms that are still ramping up, still a little bit of fill in from COVID, there's still some pricing power to be, all this or yourself. Like, if you just took 6x on the 2003 numbers, 6x EBTA, you'd get a little bit of upside from today's share price.

And again, for all the reasons we talked about, you'd hope there's upside. Last question, and then I'll turn it over to you for last thoughts and then wrap it up. You know, look, I think I said at the beginning, the basic fit story when I first heard it a few years ago, I was so interested in. I followed it pretty closely since, and it just hasn't worked. I guess just on this one, you know, what kills it, right? Because for the past couple of years, it just, it feels like it hasn't inflected. And when I was hearing people responding, I think a lot of people, I was very curious by the free cash comes, but I think a lot of people were just like, this isn't going to work. Something's going to go wrong. What kills this in your mind? Like,

how does this fall apart? Ignoring COVID, I guess it would be like 8.0. this point, like shutting everyone going down from the gym, we can put pandemics that keep you over. What kills this particular story short of pandemic? Yeah. So, first, just on the fact that it hasn't worked yet, I think the energy thing, in point 23 was a major factor because otherwise, if it would have grown by 10 million in 2023 and probably stopped it up from a year, quite a lot already. So if energy prices in Europe, and they are coming down, a little bit, right? They were absolute peak. If energy price is just completely normalized,

is that a 12 million tailwind to Jim Group at this point? Or have they kind of hedged out the cost so much that they actually wouldn't see much benefit? They veged out until I think mid-2025, if I recall correctly. And the price that they veged out implies a 2 million benefit in 2024 relative to 2023. With that said, you cannot analyze the first half of the 23 because there's already going to be a bit of a decline in energy

costs in the second half. Yeah. But in terms of the energy costs, we think they can still do more. So if you look at basic fit, they were able to reduce energy costs more relative to peak impact. And they are targeting to

reduce, continue to reduce, like for like, consumption at their gym's gym group. Like all the best investors, Fundamental Edge believes that the learning process never truly ends. That's why the Analyst Academy is just the beginning of their journey with you. Fundamental Edge alumni gain access to exclusive content, such as their guest speaker series. It recently featured TEDCDs of capital allocators. Alumni can also look forward to frequent webinars, case studies, and content from industry

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cohort. That's Fundamentedge.com. Perfect. Okay. Oh, sorry, but just ignoring energy, I guess I did want to make sure I asked, like, what kills this idea to you? Yeah. I mean, I think the key thing is really the, oh, two things. One, the recovery of the, a bit of the mature gyms or of the current gym base, right?

So for that, we need to believe that they can increase prices above inflation or get back the volumes that they lost. I am comfortable with that because I see other operators increasing prices. It's obvious that gym fees have to go up because of the inflation you see in everywhere. If you look historically, you would think that because it's a low cost concept, they would have had difficult increasing prices. But they've actually kept up with inflation since 2012 until 2019, increasing ARPO 2% a year. And since 2019, I mean, they've been executing so far.

I think they've increased 5% a year, our pool since 2019 until 2020. And again, you see other operators doing the site. The other thing that could kill it is that the, well, not kill it because they're not paying for it. But at least take out some of the upside is the white space and their ability to deploy at a third. 30% ROIC. If you ask management, I mean, they think they can get 30% on new openings. We also see that on our private holdings, okay? That some of the existing genes may have been impacted, but I do hear you on that,

but that doesn't kill the idea, right? Like, as we discussed, it's cheap enough now that even if they don't get the white space, like, yeah, it would suck. If this grows to 500 units at 25, 30, 35% RIC, this is. This is gangbusters, but it doesn't kill it because you still have the existing base. And that's what I like so much about it. But the one thing I struggle with them is I look at these and basic fit as well. And I'm just like, hey, how do I lose?

And I've had one friend who I talked to about it. I was like, I don't understand why this hasn't worked. Like, how do I lose? And he's like, dude, look at the numbers. And yet they haven't been as good as you probably hoped at the end of 21, early 22. But they've been fine. And if you kind of didn't look at the stock price, you'd be like, yeah, this business is performing kind of, maybe, you know, slightly below my base case, but it's fine. And you're just

resulting on the stock price. And I think that's correct. But I also do wonder with them, like, how am I going to blow up? Because I've seen a lot of, I used to cover gyms pretty closely. I've seen a lot of gyms blow up. And I always do worry, like, yeah, about that. So any last thoughts on the blowup risk here? Not blow up, but how this doesn't work, what kills this investment. Yeah, yeah. So you write what I was mentioning. It's most, thanks, takes out some of the upside, but doesn't kill it. So, I mean, leverage is low here. They blow two times, a beta.

So I think it's not a risk of, there's not a blowup risk here. Are all the leases non-recourse? Do you know? They, I believe, yes. I believe they are, yeah. So, yeah, because obviously a lot of the gyms do have hidden leverage, but with non-recourse leases, you can't have seven gyms go bad and take a 300 gym chain under.

Yeah, it's also good. it also gives comfort that spoken with people that former employees and people of PRG and everyone is quite positive on story. So we also like to do that just because there can always be things that

don't know us if you're not an insider and but there doesn't seem to be anything like that. But just on your point, so one, if things work out from a fundamental perspective but the stock doesn't move you know, that's good because they can do

buybacks with all the excess cash they have. And they have a shareholder rebates that's probably going to push them to do that, especially the largest holder, I vote. And two, it hasn't worked so far because they were trading at 10 times a bit pre-COVID. So the price you pay matters, especially if you lose not the five-year investment horizon. But that's not the case nowadays, right? So it's already, and all the pessimism that could be in the stock, I think, is already there. That's what makes it interesting

for us as well. You have this marginal safety on top of the business that I think is going to be able to grow at good RICs. One thing that could kill it that I haven't mentioned is maybe we long in terms of the resilience to a recession. And I think that's also

part of the bare thesis on some of these companies is that this is actually consumer discretionary and you know, if you're going to a session people are going to cut their gym memberships and you have the old this whole story of there's a lot of people that have the membership but don't go so they're going to cut very fast

their subscriptions and then with the rents it all blows up that this is a bit of you know tell me if I'm wrong but I mean one of the things I think planet fitness has seen shown proven out is that the low cost model is actually a lot more resilient than you know the equinox $250 a month model to recession because it's so small. I mean, I've told this story before, but when we were diligent scene planet fitness, we would talk to people and they were like, hey, I pay $10 a month. I never go to the gym, but they have pizza Tuesdays. And I just walk in every Tuesday and grab two slices of pizza and walk out.

And, you know, I get free dinner three times a month. And that's worth it to me. And I'd be like, Jesus Christ, this is the best business I've ever heard of. But I do think the low-cost gym is a little bit more recession, resistant than the typical gym people might be thinking of. Do you agree, disagree? How do you think about that? I agree.

So we should go with transcripts on interviews to Planet Fitness franchisees that were operating back in 2008, 2010. They will tell you that as well. You can look at same store sales growth for planets during that time, although that's a bit potentially misleading because they were opening a lot of stores. Yeah, but it was also positive. Jim Group was actually founded in 2008 so worst possible time

economy-wise and you can actually piece together through their old reports the members per square meter during 2008 to 2014 and it was stable so it doesn't seem like there was a lot of shirt there

so yeah we agree with that we saw that again we were invested in the largest local chain in Portugal in 24 2015. And that was a very bad time for Portugal because of the European debt crisis, etc. And they grew quite well through that. So in general, I think that's also part of the season, right? It's the market thinks this is discretionary and it isn't. I'm not saying I agree that, but that's the one thing that kills it, but we think it's not going to kill it because it's

not going to happen. Quick mention it. Have you done a high rocks race? No, I have, I have a It's a big partnership. And look, it's not going to move the investment thesis one way or the other, but I almost did one last year. I was gearing up to do one this year and probably not just because of the peck. But I saw it and I like, I follow Hirox's Instagram and I really like the race and competition and stuff. So I saw it. I was like, oh, I love it. I just love it when things you follow personally, like pop into investment thesis.

Doesn't change it one way or another, but just have to ask. Cool. Any last thoughts before we wrap this up? No, I think that's it. So we think there's a lot of upside, both on the long term as well as the short term, with potential CMD. If you look at consensus earnings, it's much easier to see upside for gym than for basic fit as well.

I think that motivates us to like Jim. So we like the company. We think management is quite capable and it's going to execute well in the next few years. No, look, and what I just love about this thesis, aside from being a gym, and I just love thinking about gyms, I just love the thesis of, hey, you normalize the current store-based earnings, and this is cheap to, this is fairly value to cheap, but they've got this huge white space to invest in at really attractive returns that we've proven out across multiple markets, and you kind of get all of that upside for completely free.

So I just love, absolutely love that combo. Yeah, it's more, it's very cheap, right? if you normalize the, because it's, it's like three times a bit for, so I don't say it's fairly priced. It's fairly priced if they cannot get back to the 2019 levels. I agree with that. Perfect. Well, hey, this has been great. Pager, appreciate you coming on. We're going to have to have you on for a second time because I know there's one or two other names, one that we've done a podcast on, a few others that we haven't, that I'm looking through your letters. That would be interesting. So appreciate you coming on, and we will chat soon.

Thanks, Andrew. A quick disclaimer. Nothing on this podcast should be. considered investment advice. Guests or the host may have positions in any of the stocks mentioned during this podcast. Please do your own work and consult a financial advisor. Thanks.