Fit to drop?

News of a potential MBO at Holmes Place shows the top health and fitness clubs are sweating harder in the face of tough competition. So are some chains running hard to keep still? Madeleine Dyer A year ago, health and fitness was hailed as the growth phenomenon of the new century, offering investment returns as solid as a personal trainer’s pecs. But now investors are beginning to fear that the chains have been putting on too much muscle too fast, causing a chronic oversupply of fitness facilities which could seriously damage the health of their investments. Since the spring, three of the leading UK operators have issued profit warnings and at least two are the subject of takeover bids. This week, Holmes Place announced that it was considering a management buyout led by chief executive Allan Fisher and finance director Lee Ginsberg. The fifth-placed fitness chain warned in May that tougher competition was hitting its profits. Last week, the UK’s leading operator, Fitness First, saw its share price fall by 10% to a three-year low as it reported a £900,000 loss on its French division. Reporting its interim results, Fitness First chief executive Mike Balfour blamed losses on building delays in Europe. Since floating in 1996 with six clubs, Fitness First has expanded to 270 clubs with 632,000 members in 14 countries. But expansion at a rate of 80 clubs a year costs £100m pa, and analysts are beginning to question the sustainability of such an aggressive programme. Last year saw a record number of new clubs opening in the UK. According to Strutt & Parker’s Spring Leisure Report, 2001 saw a 20% increase in the number of clubs run by the leading UK operators. A further 120 are set to open this year, followed by a similar number in 2003. Expansion in Europe is also continuing at an unprecedented level. The nine UK-based operators already have 150 clubs overseas and plan to double that number by 2003. Now market analysts are waiting to see if Holmes Place’s MBO plans affect its expansion into Portugal, Germany and Austria, or whether the firm, which runs 51 health clubs in the UK, will consolidate. They certainly question whether the chain’s target to open 15 new clubs in Europe in 2003 will materialise. “We suspect that this timetable could slip if the UK operations remain under pressure, because that level of European openings would require substantial start-up losses to take in one go,” says Greg Feehely, leisure analyst at Old Mutual Securities. Meanwhile, Esporta – ranked fourth in the UK with 41 clubs – is being stalked by venture capitalist Duke Street Capital Leisure Investments. Esporta’s chief executive, Maurice Kelly, says the Duke Street bid which values the group at £133m is based on results for the year to last December and not on current trading performance. Revenue for the first five months of this year is up 26%, and like-for-like revenue is up 7%. Esporta hopes to make a pretax profit of £9.9m in the current year, rising to £13.6m in 2003. However, Duke Street hopes that uncertainty caused by a falling stock market could convince shareholders to take the money now, and leisure analysts say that 85p per share might be accepted. Very aggressive market Like its rivals, Esporta has expanded rapidly. FPDSavills has acquired eight sites for Esporta over the past 18 months in a very aggressive market. “Some of the sites have been incredibly successful,” says Andrew McGregor, FPDSavills’ director of commercial leisure. Esporta is paying rents of between £8 and £11 per sq ft in locations such as Chelmsford, the Romford Brewery, and Xscape in Milton Keynes. But fierce competition and rising rents have deterred at least one operator. Scandinavian chain Fitness Only recently pulled out of a deal for a unit in London’s Holborn because it was unhappy about the level of competition in the area. “It was an interesting insight into the central London market,” says Charles Maxlow-Tomlinson, leisure specialist at ATIS Real Weatheralls, who was acting for the building’s owner. “They thought the market was wrong for them.” Oversupply in key areas such as the City of London means clubs might find themselves squeezed between high rents and falling memberships. Maxlow-Tomlinson believes that rents will come under pressure. Rents currently represent 17-20% of sales. “Rental levels will stabilise, they won’t stay as high as £18 per sq ft, except in prime spots,” he says. Observers also wonder if all the decent sites in the South East for health clubs have been taken. “It is increasingly difficult to find sites,” says Maxlow-Tomlinson. “Operators are desperate to acquire sites, but they also want ample parking facilities as the customer wants to drive to the club. This is often difficult to provide, particularly in mixed-use schemes, where residential parking takes priority. Operators are going to have to become more imaginative.” He says operators should look at sites on top of supermarkets, such as the one at Sainsbury’s in Vauxhall in London, or on the first and second floors of retail sites. The key factors for health clubs are location and catchment area. They need a minimum of 5,000 potential members who can get to the club in 15 minutes. The trouble is, the more attractive the catchment area, the greater the competition for the site. Mark Churchouse, a director of Chesterton’s licensed and leisure department, is not convinced that saturation has been reached. “In certain pockets, yes, but not nationwide, because there is a limit on the number of clubs these groups can roll out. They can’t develop quickly enough for the money they’ve got to spend.” So whose money is likely to run out first? This all depends on membership. Members who go every day for half an hour to keep themselves healthy are likely to go on paying so long as they keep their jobs. For this reason, Churchouse thinks there will be steady growth in fitness club membership in the UK but that the growth rate will not reach that of the US. “The UK growth rate is 5.5-6%. In the US it is 14%,” he says. “There is always a danger that we think we can catch up with the US. A reasonable target for the UK is 8-9% growth of the sector in two years.” According to David Stapleton, head of property at Fitness First, what the fitness sector needs is a shift from being seen as a leisure product to being seen as a health product. “I’m sure in years to come, just as we are seeing in the US, there will be tax relief for treating obesity in the UK,” he says. He also thinks that at some point life assurance and health insurance will be cheaper for people who have healthy lifestyles. He expects there to be tax breaks for employers who provide health and fitness facilities through club memberships and for the staff who use them. Such factors help to explain why operators’ optimism remains undimmed. LA Fitness, ranked eighth in the UK with 40 clubs, is not anxious about saturation, and hopes to add 30 clubs by the end of 2003. “We opened at Golders Green in 1997, then Holmes Place opened at Hendon and Cricklewood, and we opened in Finchley and Highgate,” explains David Turner, LA’s property director. “Then Cannons opened in Brondesbury, and they are all full.” Top 10 groups of health and fitness clubs in the UK Investors fear that chains have been putting on too much muscle too fast, causing a chronic oversupply Company/brand UK members UK Clubs Opening in 2002 Total by end 2003 1 Whitbread David Lloyd Leisure Curzons Hotel-based facilities 286,492 51,000 48 12 50 6 – 0 72 50 2 Fitness First 250,000 101 25-30 155+ 3 Cannons Group Cannons Health Clubs Courtneys 170,000 47 15 13 – 84 4 Esporta 169,500 37 3-4 46 5 Holmes Place Holmes Place (H/LA) 150,000 40 11 3 1 59 12 6 Hilton Group LivingWell Health Clubs Hilton Hotel Health Clubs 118,000 25 59 3 – 87 7 De Vere Group Greens Health & Fitness Village Leisure Clubs De Vere Leisure Clubs 110,000 11 19 13 4 0 1 15 19 16 8 LA Fitness 97,816 40 20 70 9 Crown Sports 60,000 22 10-15 52+ 10 Invicta Leisure 49,000 11 6 24 Others 241,639 108 35 183+ Total 1,753,593 669 126-141 944+ Source: Strutt & Parker Research 2002 Notes: Ranking by number of members. UK memberships and number of health clubs as at 1 January 2002. H/LA designates those Holmes Place outlets managed by hotels or local authorities.