Survival of the Fittest
- South Africa
- Brait, Net Asset Value, Planet Fitness, Rand hedge, Virgin Active
- August 17, 2020
Lockdown Level 2 is here and boets everywhere are rejoicing. It’s time to klap gym again chana, maybe H2O will even be back this summer!
Not so fast chaps. Only 50 people will be allowed in any gym at a time, presumably including the staff and certainly including the skinny folk on the spinning machines. Friends may not let friends skip leg day, but at this rate nobody will find out because your mates can’t be there with you.
Jokes aside, the fitness industry is really important. Not only does it provide thousands of jobs directly and indirectly, but it contributes to a healthier population.
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Market leading heavyweights
For most South Africans, two gym franchises will immediately spring to mind: Virgin Active and Planet Fitness (or Planet Fatness, as I’ve heard it referred to many times).
Planet Fitness started out in Benoni in 1995 and opened a second gym in Springs (stereotypes often exist for a reason). Health and Racquet Club was in the process of going under after selling lifetime gym memberships and running out of cash, only to be rescued by the Virgin Group and renamed Virgin Active.
These companies are now household names in South Africa. Planet Fitness generated R850m turnover in 2016 according to an interview of the founder in Entrepreneur magazine. The company is private, so there isn’t any other information available.
Virgin Active is much larger, generating operating profit of around R2.5bn.
Klapped by Corona
As substantial as these companies are, lockdown has had a massive impact on the industry. The gyms have been among the hardest hit in South Africa, forced to shut for 5 months. Debit orders were put on hold over this period in a bid to retain clients once gyms reopen.
Virgin Active used every trick in the book to decrease cash outflows by two-thirds, deferring rent and cutting staff costs by 20% – 40%. Freelancers like trainers were hardest hit, earning literally nothing over this period unless they managed to sell their services online.
Virgin Active is held 79% by Brait, an investment holding company listed on the JSE. The stake represents 42% of Brait’s net asset value.
Despite these cost saving measures, Brait had to lend almost R350m to Virgin Active to keep the business capitalised. When you consider the extent of this disaster, you can’t help but wonder how Planet Fitness is surviving as a private company, let alone the countless independent gyms across the country.
Is Virgin Active a good business?
Virgin Active has a great annuity cash flow model through monthly memberships and has all the right partnerships in place with the likes of Discovery.
The business is also somewhat of a Rand hedge, operating 243 clubs with 1.1 million members worldwide. However, growth is slower than a granny doing water aerobics, with total membership up only 3% (and South African membership up just 2%).
64% of the membership base is in Southern Africa but only 38% of revenue is generated in the region. The UK generates 28% of revenue and Italy 21% of revenue, with the rest coming from Asia Pacific.
These growth numbers suggest that independent gyms (like CrossFit boxes) have taken the fight to the chains. My peer group would confirm this, even after adjusting for people talking too much about CrossFit.
Virgin Active reports all its financials in GBP as its functional currency. With only 5% revenue growth in constant currency (i.e. assuming no change in the Pound vs. the other countries) and EBITDA growth of 8%, Virgin Active is a mature business.
It’s not a bad business, but there’s little to suggest that it offers compelling growth. Perhaps some supplements would help.
Should Brait have skipped leg day?
Yes, although it’s frightening to consider what the management team might have done with the money instead considering most of the investments have been poor.
Brait paid a 10.2x multiple for its stake in Virgin Active in mid-2015 and now values the business on a 9x multiple, so that’s hardly a win for shareholders.
A total investment of £700m has diminished to £474m (current value plus cash received to date). Even with the assistance of severe depreciation of the Rand, Brait has lost R2.5bn in value for shareholders through the Virgin Active investment.
Brait has numerous other problems (especially the clothing disaster in the UK that is New Look) and the share price is down 97% over 5 years. Yes, you read that correctly.
Brait’s management would have you believe that the portfolio is worth a net asset value (NAV) of R10.9bn. In other words, if they sold everything and settled all debts before shutting shop, it should end with R10.9bn in the bank for shareholders.
The company is only trading on a valuation of R3.8bn, a colossal 65% discount to NAV. With a new management team now in place and a partnership with Ethos Capital (one of the most highly respected private equity firms in South Africa), shareholders may finally see some light at the end of the tunnel.
As for the previous management team, shareholders will be wishing they hadn’t just skipped leg day, but had skipped every day instead.
Taking a punt at Brait would be a gamble of note.
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Workouter
in lockdown, the collapse in commercial activity is far more severe than in previous recessions. The exit path from lockdowns will be precarious, with uneasy consumers, a stop-start rhythm that inhibits efficiency, and tricky new health protocols. And in the long run the firms that survive will have to master a new environment as the crisis and the response to it accelerate three trends: an energising adoption of new technologies, an inevitable retreat from freewheeling global supply chains and a worrying rise in well-connected oligopolies.
Workouter
in lockdown, the collapse in commercial activity is far more severe than in previous recessions. The exit path from lockdowns will be precarious, with uneasy consumers, a stop-start rhythm that inhibits efficiency, and tricky new health protocols. And in the long run the firms that survive will have to master a new environment as the crisis and the response to it accelerate three trends: an energising adoption of new technologies, an inevitable retreat from freewheeling global supply chains and a worrying rise in well-connected oligopolies.