Interview Transcript

Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

Could you explain when and why you joined PureGym, how that came about, and what the state of the business was when you first joined PureGym?

I joined the company in 2012 when it was still in its early stages. The first gyms had opened in 2009 and by the time I came on board, there were about 25 gyms. They had made reasonable progress in growing the estate, but it was still relatively small. The turnover in the previous year was less than 20 million, which made me question whether this was a large enough business for me. I had been a CFO in a couple of larger businesses before that. However, I was really drawn to the gym industry and the business model. The economics were great, the format was simple, and I saw potential for growth in the market. I also thought highly of the team, including the founder, Peter Roberts, and the COO, Jacques de Bruin.

When you joined, there were 25 units. How did you choose locations for additional units as you scaled the business?

Looking back, there has been a lot of growth and sophistication in how we select locations for new units. Even back then, we had a lot of data on demographics and traffic flows for potential sites. Peter, the founder, had a background in property and understood the importance of choosing the right location. These decisions are crucial because they involve significant capital expenditure and long-term leases. We spent a lot of time analyzing demographic data. When people choose a gym, convenience and price are two of the biggest factors. The low-cost model addresses the price concern. As for convenience, most people want a gym within 10 minutes of their commute, home, or children's school. We would look at our potential customer base within a 10-minute radius, whether they were students, workers, or residents.

How many households did you typically target for each new location?

In the UK, approximately 15% of the population are gym members. For a gym to be viable, it typically needs around 5,000 members, which means you need a catchment area of around 30,000 to 40,000 people. However, not all of these will be members of PureGym, so you need a larger population to ensure a good share. The location of the gym is also important. Some gyms are located next to universities or office blocks, which provide a ready-made membership base. Proximity to transport hubs, such as tube stations in London, is also beneficial. In suburban areas, sufficient car parking for members is crucial.

Why is the target set at 5,000 members?

That's a typical membership number for a large, low-cost gym. Different formats now have different membership levels, but 5,000 is a common target.

The original format was 16,000 square feet, correct?

Yes, for a gym of around 15,000 to 20,000 square feet, you'd be looking for at least 5,000 members. Other factors to consider include ease of access and transport links. The age of the population is also relevant.

What is the average age of gym members?

Gym membership generally starts to decline as people age. For low-cost gyms, the core age bracket is from 16 to 35.

That would include students and university populations?

Yes, exactly.

The Gym Group reports that 30% of their members are new to gym use. How does that compare to PureGym?  

The figures are fairly similar. Both businesses have reported similar statistics in the past. However, these figures are likely to change over time. Because these gyms cater to a younger market, they attract a higher proportion of first-time gym users. For example, there are not many first-time gym users at David Lloyd due to the higher cost. So, you find a disproportionate number of new members at low-cost gyms. The membership tends to be divided into thirds; it's roughly kind of a third of new members, a third of people coming back who were previously members and are rejoining again, and a third of people that come from other gyms to join.

As discount gyms penetrated the market, did you observe a change in the mix over time?

Yes, there has been a change over time, but not significantly. There's still a healthy pipeline of new people. Currently, only 15% of the population, about 10 million people, are gym members. Excluding children and the very elderly who aren't likely to join a gym, there's still a considerable number of people in this country who aren't gym members.

I understand that PureGym is more skewed towards London than The Gym Group. Could you tell me what percentage of your units were in London or what you would classify as commuter units?

The percentage changed over time. The LA Fitness acquisition was aimed at increasing our presence in city center areas versus commuter areas. In the early days, we tried to secure prime locations in city centers like Manchester, Edinburgh, Leeds, and then started expanding into good residential locations. However, I can't provide a precise split.

How did you and the founder think about The Gym Group's positioning when opening new plots?

In the early days, there was a lot of white space. For instance, in a city like Manchester, there were no low-cost gyms. We would open one, and The Gym Group would open another in fairly separate locations. We tried to avoid being too close because the low-cost gym model was still developing and wasn't a significant part of the UK gym scene. We were trying to prove that people wanted low-cost gyms. As the market matured and we understood that a city could support multiple low-cost gyms, provided it had a large enough catchment area, we became more confident about building closer to The Gym Group, although not on the same high street.

I noticed one in Brighton where you're literally 50 meters away from each other.

Yes, the one on London Road.

How did that happen?

There are a few instances like that, but they are the exception. Between the two chains, we have over 600 gyms, and only a handful are that close to each other. We generally avoid such situations.

Even though the London Road location is very close, does it still have a different catchment area? 

I believe both gyms were in development simultaneously. Normally, if we knew another gym was opening in a location, we would choose a different location to avoid competition. However, I think both gyms are doing well. In a place like Brighton, there are enough gym-goers to support multiple low-cost gyms, even in close proximity. If they weren't successful, I expect one of them would have closed by now. Those gyms have been around for quite a long time.

It's quite remarkable to have two gyms so close together, both successful and offering similar services.

Considering the population of Brighton is about 250,000, with a high student population and a young demographic, there are probably 50,000 gym-goers in Brighton. That's quite a lot of gyms, even if they are relatively close. However, I wouldn't get too fixated on that, because only a small number of gyms are that close. Most of them are more distanced apart.

So, you would check their planning, like if someone had planning permission in a certain area, you wouldn't build next door, but find a different catchment area.

Exactly. You wouldn't intentionally build next to each other, as there is a level at which you are targeting the same catchment area.

Why did PureGym purchase LA Fitness?

LA Fitness was once a significant mid-market chain with over 100 gyms. However, they suffered due to the growth of low-cost gyms and a lack of investment in their facilities. By the time we considered purchasing them, they were down to approximately 40 gyms. They had sold or closed many of their tertiary gyms and had gone through an administration process.

What attracted us to LA Fitness was that three-quarters of their gyms were in locations we were interested in, particularly in central London. They had prime sites in the West End, the City, and Canary Wharf, all on good lease terms and at rents that were attractive to us. We had previously struggled to establish a presence in central London due to the fragmented UK property market.

Acquiring LA Fitness offered us the opportunity to secure a number of sites in excellent locations all at once. Besides London, they had other desirable sites in Brighton and Oxford. We were interested in about 30 of their sites. We sold the remaining sites to other mid-market operators and converted the ones we kept into PureGym.

What was the average capital expenditure per unit for LA Fitness? What changes did you have to make to fit the PureGym format?

The cost was substantial, in the range of several hundred thousand. This includes the purchase cost.

Did LA Fitness gyms have swimming pools?

Yes, almost all of them had a swimming pool. If you go to some of them, you’ll see a weights area in a sort of indented area in the gym, which is the legacy of where the pool used to be. We knew about these costs when we bought the gyms. We were committed to doing a good job because we weren't going to buy sites in central London and then do a half-hearted job. That's against the philosophy of our business, which is to invest properly.

Why was it difficult to get access to leases in the City?  

We acquired LA Fitness in 2015, when we already had 100 gyms.

And you still struggled to get access to leases in the City?

Yes, at good prices and terms that we were satisfied with. Landlords can be selective about their tenants, especially if they're unfamiliar with the brand. At that time in central London, we had acquired some sites, including one in the Oval and Wandsworth. We had some zone two or three sites in total, but not many in zone one. That was our challenge.

Could you elaborate on the differences in terms LA had versus Pure Gym at that time?  

LA Fitness had attractive leases with good headline rents that we believed we could profit from. We also knew that we could charge more in those locations than we could outside London. So we knew that we could make good returns on capital from those sites. The returns wouldn't be as high as with a brand new site because we had to purchase LA Fitness initially. But it made strategic sense to add those sites. It significantly bolstered our portfolio all at once. We continued our organic opening program that year, so we experienced a boost in growth and acquired some really good sites that we wanted. That's why we made the decision.

Looking back, how would you evaluate that acquisition?

It was very successful. It required a lot of work from many people to complete and integrate, but I was very pleased with the results. It gave us a significant boost in growth in excellent locations. It opened the door for us to open many more sites in central London.

Who initiated that acquisition?  

Humphrey joined as the acquisition was taking place. It had been initiated earlier by Peter and the management team.

Did Peter fully sell out to Humphrey and the PE fund?

No, when Humphrey joined, it wasn't a new PE firm at that point. We sold to CCMP in 2013. Humphrey then joined in 2015. We made the last sale in 2017 to Leonard Green. So it wasn't a sale, it was a change of leadership with Humphrey taking over and Peter stepping down.

Does Peter still own equity?

He sold, I believe, 100% in the last transaction.

Regarding these leases, what is the average lease term structure that you typically have for a discount gym?

When referring to a typical large box gym, about 15,000 to 20,000 square feet outside of London, the ideal rate is £8 to £10 per square foot. In London, due to the higher price, it's more flexible, but you can charge customers a higher price. So, it's typically £10 to £20 per square foot in London. As for the lease term, a good typical lease would be 15 years with an option to break at 10 years. However, all leases are different. There's always a trade-off between getting incentives from landlords, such as rent-free periods or capital contributions to the lease, and the lease term. Landlords are more likely to offer these incentives for longer leases.

John mentioned that capital contributions have largely disappeared and it's more about rent-free periods now. How have you seen lease incentives change over time?

Capital contributions haven't completely disappeared, but they are more challenging to obtain, especially from individual landlords as opposed to institutions. They typically don't have the funds, particularly post-Covid. Post-Covid, it's been harder to secure capital contributions and rent-free periods have become more common. So, there has been a shift, but it's not impossible to get capital contributions.

What's the average rent-free period you typically get?

I'm not involved in the business anymore, so I can't say what the current situation is, but typically, you would aim for a year.

So, it's a 15-year lease with a potential break at 10 years. What's the typical inflation rate or price increase per year?

Peter managed this aspect well early on. Many leases have an open market value clause that reassesses the rent every five years. However, this can lead to disputes with landlords who argue for significant rent increases based on evidence of rising rents elsewhere. We had most of our leases locked in on an inflationary basis, with a cap and a collar, so increases wouldn't go above 3% per annum or below 1% per annum. This provided a good degree of certainty regarding the rent increases every five years.

You mentioned that the rent per square foot in London is significantly higher than outside London. How does the EBITDA margin or underlying economics compare between London and outside London? Given that you can charge more in London but also pay more, what's the end difference?

Indeed, there are different Londons, so to speak. For instance, outside of London, they might charge around £25 to £30 a month. In areas like the City of London or Canary Wharf, the price might be £40 to £50. If you manage it correctly and have 5,000 members paying an extra £10 a month, that's a significant yield increase, even after VAT. If you do the math, you'll see that with that many members and a few extra pounds a month over a year, that's about £300,000. If the rent increases by £10 a foot, that's another £150,000, plus more rates, plus a bit of labor cost. In theory, you should be able to make more money in London.

So, the pound value is higher, but is the margin the same, or does it also increase?

The margin could be higher as well, and you'd be making more revenue. So, your top line is increasing too. It could be either or both.

How does capex per unit differ in London vs outside London?

The only factor that could make it higher in London would be labor, which is typically more expensive. For instance, if you've had any work done on your house, you'd know that labor costs more. Also, sometimes access to the sites is more difficult. For example, we had a site in Lower Regent Street where we only had limited access hours, and there was no yard around the back. That made the fit-out quite difficult and more costly.

So, it's not clear that it's higher margin, but it's a higher pound EBITDA?

Yes, you're going to get exactly that in terms of EBITDA. As long as you maintain discipline on rent, which was the point about LA Fitness, you can get sites at a flexible rent. In multi-site businesses, it's easy to lose discipline on rent. People might say it's an amazing site and make exceptions to pay more for that site. Often, that approach doesn't work out.

Who managed the rent at PureGym when you were there? Did Peter handle the rental negotiations? ,

Yes, there's a team that handles it. We have an internal property team that manages it. The team is divided into people who find the sites, people who develop the sites and spend the capital expenditure on it, and people who manage the ongoing property relationships, rent reviews, service charges, and so on. It's divided among those three areas, and we also employ external specialists as needed.

Where do you think things go wrong with these leases?

Generally speaking, losing rent discipline is probably the worst thing. If you start with a site that's highly rented, your feasibility for that site means you have to achieve very high sales just to get the same profit you'd expect elsewhere. There's no room for error or slight miscalculations. In my view, the worst thing is stepping outside of your rent parameters. Aside from that, agreeing to burdensome increase clauses can also be problematic. We have to be very careful about having these cap and collar agreements, but you can get unpleasant surprises with open market rent reviews sometimes.

Even with a cap and collar, do you have an open market rent review?

No, those are two different types of structures.

Right, exactly.

In the past, I've worked with retailers and have seen open market rent reviews where rents have doubled or even tripled.

Why doesn't everyone use a cap and collar structure?

It has become more common and popular over the last few years. However, in certain frothy markets, people have to agree to the landlord's terms. We're probably not in that kind of market at the moment, to be honest.

Because the landlord would prefer an open market review?

Yes, in some cases. In some cases, they could settle for nothing. So it's not all bad. It can work for you sometimes, but there's no certainty. It never decreases, that's for sure.

Looking towards the latter end of your time there, when PureGym and The Gym Group had a much larger estate, how did you see competition evolve, if at all, from the 2012 days that you mentioned?

We were obviously the two market leaders of low-cost from relatively early days in the low-cost market. We were going to merge with The Gym Group in 2014, but that was stopped by the Competition and Market Authority. We did quite a lot of work with them before that was halted. They had about 40 sites, we had about 60 at the time. We knew each other's business very well. Other low-cost competitors came along, of course. During that period, probably the largest low-cost competitor was a company called Xercise4Less, which tended to be in larger sites, like 30,000 to 40,000 square feet sites in relatively low rent areas. They were obviously aiming for higher memberships. They got to about 50 or 60 sites, but they ran into trouble and went through some kind of process.

What happened?

They were sold to JD Gyms in the end.

Why did they run into trouble?

The financials were not working for them. They seemed to struggle to attract enough members at a high enough price to justify their large sites. If you observe the market trends, the average size of sites has actually become smaller due to increased site density. Therefore, large sites are not necessary in every location, and their sites were probably too large, I would say.

They were a significant competitor. There were also smaller competitors, like EasyGym, which shares the same logo as the EasyJet brand. There were various small competitors that managed to open five to 10 sites, but did not expand much further.

Why do they seem to reach 10 to 20 sites and then falter?

I believe they struggle to gain traction on site and to reach a large enough scale to make it viable. In some cases, it was due to poor site selection, in others, poor management. There were a variety of reasons, really, as there were quite a few of these chains. We examined quite a lot of them as we grew ourselves.

Like Anytime Fitness, now Énergie Fitness. There are a few, yes, they're all still operating.

Anytime Fitness, although they are a large chain with relatively small sites and a franchise model, I wouldn't classify them as low-cost because their membership is around £35 a month. Énergie Fitness is predominantly a franchise model as well, with smaller sites. The closest one to PureGym and The Gym Group would probably be JD Gyms. They have about 80 sites and a similar kind of offer, similar price point to the main chains.

Who did you respect the most as a competitor when you were at PureGym?

That's a good question. We had a lot of respect for The Gym Group. I believe there was quite a lot of mutual respect there. Of course, we wanted to be the best gym chain, but we didn't want them to fail. We wanted them to do well. If they're doing well, then the whole sector is doing well because we were trying to build a low-cost gym sector, not just our chain. I have a lot of respect for JD Gyms. I think what they've done is quite impressive. Their sites are well fitted out, they look good, they feel good, they're very appealing.

I've never been to a JD Gym. What's their strategic vision? 

I'm not sure. I'm sure they've articulated it at some point, but I don't know. You're right, their gyms are a very small element of a much larger PLC. But the gyms themselves, I think, are quite impressive. So, yes, I respect them.

Are their sites larger in terms of square footage?

Yes, they tend to be on the larger side. They also acquired Xercise4Less, which had larger gyms, so their average gym size is probably larger than that of PureGym and The Gym Group.

You mentioned the interesting event in 2014 when your merger with PureGym Group was blocked by the CMA. PureGym is a much larger business now in terms of units. Why do you think that is? 

Our perspective was that once we had established that there was a significant market for these gyms, we collaborated with OC&C to validate the market potential. Having a third party confirm and verify this was crucial as we were progressing.

PwC has also done the same for Gym Group. They estimated around a thousand discount gyms, I believe, around 1027, 1028.

Yes, a thousand was their estimated target.

And that was the same as the OC&C estimate you had.

We had different studies done at different times. What we've noticed is that each time a study is conducted, the number increases. Initially, we aimed to reach 100 gyms, which now, in hindsight, seems like a very low figure.

How many discount gyms, like the PureGym model or The Gym Group, do you think you can establish by 2030? 

Low-cost gyms currently make up about 30% of the 10 million total members. That's approximately three million people. I don't see why low-cost gyms shouldn't comprise the majority of UK gym memberships. Gym membership penetration was increasing steadily in the UK until Covid. The highest proportion globally is around 20% in the US and some Nordic countries. Over time, the UK should be able to exceed 15%. Low-cost gyms should be a larger proportion of that. So, why couldn't we increase from three million to, say, six million members? Roughly speaking, I believe we could double the current number to reach that level.  

You mentioned the capital structure and corporate structure. How do you compare that to going public, for example?

We attempted an IPO for PureGym in 2016, so we were not opposed to that idea. It's an exit and liquidity event for the private equity company, which is part of their model. However, there are differences when you're a public company. I serve on a few public company boards, not in the gym sector, but in leisure and consumer businesses. You are more constrained in terms of leverage in public markets, and strategically, you are more limited because you answer to multiple external shareholders rather than a single private equity house. If the private equity house supports you and believes in your vision, they will let you proceed. Being in the public markets can be more restrictive. This has probably helped PureGym grow faster. Before The Gym Group listed, it was already growing faster. We were more adventurous and aggressive in growing the business. As for why they chose their strategy, you would have to ask them. We believed in the potential of the market, as long as we could secure good sites.

It was like a land grab?

Yes, but a sensible one, as long as you can secure the right sites at the right rents.

I'm curious about mature gyms. You mentioned in 2012 there was a lot of white space and you wouldn't enter the same markets as The Gym Group. Did that ever change?  

We've always been rational, and I believe The Gym Group has been too. We didn't abandon rationality. As we opened more gyms, we learned more about customer behavior, how far they are willing to travel to a gym, and what catchment area you need. When you've only opened a few gyms, you don't have that information. As we opened more, we realized that opening a gym drives demand. As John mentioned earlier, you generate new memberships just by opening a gym. If the only option before a low-cost gym opened was a mid-market gym with a 12-month contract costing £50 a month, that excludes many people. But when you open a low-cost gym, suddenly many more people can afford to go. Also, being open 24 hours allows people who finish late shifts, like in restaurants or hospitals, to go to the gym at midnight.

How did you approach clustering?

As we began opening more sites in a city, we noticed a beneficial effect of having gyms near people's homes as well as in city centers. We discovered that we could attract enough members for both locations. This strategy developed strongly after the initial phase of opening a single gym, for example, in Edinburgh. If you look at the current map, you'll see that PureGym has five locations in Bristol.

A good example abroad is Basic-Fit, which has been very strong on clustering from the beginning. They've been successful in opening 100 gyms a year in France, in clusters in major cities, and that works very well for them. We've learned from their example about the strength of clustering in particular cities.

What are the risks associated with clustering?

The main risk is that if you open too many gyms in a short time without proper calculation, you may not get an optimum return on capital.

How did you consider single units versus clustered markets?

We looked at the catchment area. For instance, in Bristol, we considered the city's population, the number of commuters, and the number of students. We then determined how many gyms we should have in the city and where we wanted them to be. However, getting the property you want when you want it isn't always possible. So, some of it is about waiting for the right units to become available or actively seeking out the right units.

Let's say you have a mature gym with 4,000 members. Can you give an example of what happens when a competitor moves into your catchment area. What would you expect to happen to that unit's membership growth?

In the short term, if a competitor opens nearby, there will be an impact. A few years ago, we had a gym in Milton Keynes in a warehouse. We occupied a portion of the warehouse and then found out that Xercise4Less was opening in the remaining part of the same building.

We had a very successful gym. When they opened their gym, they offered extremely low prices, aiming to attract our members. We experienced a short-term hit, but it wasn't as severe as one might expect. In fact, it wasn't particularly bad at all.

So, was it a churn of around 20% on day one or higher?

Not even that. This is indicative of how these situations unfold. You don't necessarily lose a significant portion of your member base because new members are constantly joining. These new members could be completely new to the gym scene or coming from other gyms. I can't fully explain why this happens. Logically, you'd think you'd lose many members in such a scenario, but that's never been the case.

What was their price compared to yours at that time?

For instance, it was something like £5 a month. It was incredibly low.

That's similar to the one-time pre-opening offer that you typically provide.

Yes, something along those lines. Join now and get a low offer. It was something like £5 a month, if I remember correctly. We likely lowered our price a bit to compete, but not to that extent. We didn't have contracts, so members could leave anytime they wanted. That's part of our model.

How does that work? You lower your price, but only for new members. Do you see people leaving and rejoining at the lower rate?  

Typically, existing members continue with their current plans. Some people do leave and rejoin, and that's part of the model. We accept that. And it works the other way as well. If you increase the price for new members, the existing members can stay, leave, and come back. It works both ways.

That's interesting. Let's say a competitor offers a lower price, and for whatever reason, I don't want to join that gym. But if you lower your price, why don't some people change their membership? Logically, you'd think everyone would cancel and then rejoin at the £5 a month rate to save money.

Well, they either don't notice or aren't bothered. I'm sure if any of us scrutinized our own bank statements, look at things and say, actually, if I left Netflix and rejoined, or if I left this subscription and rejoined, it's just the way people behave. Nobody is stopping them from doing it. It's not wrong. It's just that they don't do it in large numbers. I'm sure some do.

So in that scenario, when Xercise4Less came in with heavy discounts, you lost approximately 10% of your members. What happened after that? How did it perform six months to a year later?

Typically, your membership starts to rebuild over time. In regards to mature gyms, they generally fare well. Although the landscape has changed significantly since the first gym you opened in Manchester or Leeds 15 years ago, a good gym in a good location remains that way. If you're in a prime transport location or next to a university, those factors don't change. As more people gravitate towards low-cost gyms, you'll find that your gym fills up again over time. This hasn't been the issue that people once thought it would be.

If you hypothetically lose 10% of your members on the first day of Xercise4Less, are you regaining those who left or are you gaining new members?

Over the next 12 months, you're getting a mix. Some people return because they prefer what you were offering compared to the new gym. You also get new people coming in, possibly because the gym is less crowded. Or, you might promote more heavily because you have some capacity. You can promote very specifically to a local area if you want more memberships in a particular gym.

How do you see marketing expenses as a percentage of revenue changing for mature gyms over time, given that churn is fairly high?

Yes, churn is high, but many people misunderstand the churn in these businesses. It's often the same people coming and going in a particular period of time. For example, students often cancel over the summer and return later. The population attracted to low-cost gyms is quite young and transient. They're leaving home, going to university, starting a new job, but they're being replaced by other people. So churn is a factor of the type of people that go to these gyms.

Initially, you would spend quite a lot on marketing to bring people in and raise awareness of the gym, whether that's physical marketing or online marketing. As the gym matures, you should be spending less. You still need to keep it ticking over, but you should be spending less.

What do you think is the biggest risk to mature gym EBITDA?

At a unit level, it could be that a gym has reached its membership capacity. If a gym has been successful for a few years, it may reach a point where it is consistently busy. However, gyms are peak time capacity businesses, with most people preferring to go at specific times, like 6:00PM. So you're actually managing capacity over a few hours a week. And if the gym gets too busy and people start to get cheesed off because they can't get on equipment or they can't get the weights they want, they start leaving.

There are a few ways to address this. One option is to increase the membership fee to discourage new members. This is a blunt tool, but it can help manage capacity and increase yield. Another option is to assess which equipment is being used most heavily and adjust accordingly. For example, you might need to reduce the cardio section and add more weights.

A longer-term solution could be to expand the site if you believe it could accommodate more members. These are just a few strategies to manage capacity if a gym becomes too busy. In terms of risks, one of the biggest for a mature gym would be reaching capacity. Short-term competition could also pose a risk, but I don't see that as the primary issue in the long run.

Looking at PureGym, it was earning roughly 80 million in EBITDA in 2018. The Gym Group is probably at a similar stage, but the market doesn't seem to believe it. What do you think people misunderstand about these businesses and their durability?  

That's a good point. There is a significant amount of negative sentiment about consumer-facing businesses in the UK.

The multiples for these types of businesses are not as great as they were five years ago. I don't believe this is specifically targeted at the gym market, but rather it's a broader issue. For instance, I serve on the board of a restaurant chain and recently left the board of a tenpin bowling chain, which we sold off to the PLC markets. Both businesses, in my opinion, are relatively lowly rated in terms of enterprise value and multiple of EBITDA by historical standards.

It seems to be a general perception that something negative is going to impact the UK consumer market, whether it's a reduction in spending, disposable income, or the effects of interest rate rises on mortgage repayments. There's always a reason why consumers might start being negative, such as the war in Ukraine. However, I agree that the value in these businesses is not being recognized. Analysts covering The Gym Group, for example, believe there will be a correction based on their reports and projections for the share price. But that might take a while, and it's uncertain how long.

These companies are reporting in the same way, looking at mature gym EBITDA. Looking out for the next 10 years, if the mature gym EBITDA turns out to be a fraction of what was expected, what do you think could be the main reason?

A structural change in the market would have to occur for that to happen. One potential cause, although I'm not suggesting it's likely, could be a significant impact on consumer spending. In my view, this would have to be quite substantial to affect gyms, as they represent relatively low expenditure for most people.

We've conducted surveys in the past that indicate people would be reluctant to cancel their gym memberships. For many, especially those in their teens, twenties, and thirties, gym membership is a core part of their life. Another potential cause could be the entrance of a major competitor who disrupts the market. For instance, Planet Fitness or Basic-Fit, although the latter is less likely as their model is similar to PureGym.

Planet Fitness, with thousands of gyms and a starting price of $10 a month in the US, could potentially disrupt the UK market. However, I think that's unlikely. They've experienced substantial growth in their core market, with over 60 million Americans being gym members. So, why would they want to complicate things by entering a much smaller market? That would be the first consideration. Additionally, the UK market is quite different. Franchise gyms haven't really taken off here to the same extent.

Let's consider a scenario where Planet Fitness enters the market. Could they offer the same for £10 a month and make economics really work?

The first thing to note about their offer is that a significant proportion of their members pay a higher fee. They have this higher tier membership, called the black card, I believe. The headline rate is $10, but many people pay considerably more. They rely on high membership numbers, which is more feasible in the States due to the population and the common use of cars. There are several structural factors that might make it less attractive for them, but I don't have any further information.

Is there anything else where we might be underestimating the fragility of the mature gym market over time?

What are the variables in that? There's revenue, which depends on the number of members and average yield. Factors like consumer spending could cause the number of members to drop.

And competition.

Yes, competition as well. As for the average yield, if there was a serious recession, prices might have to be lowered slightly. However, these are not expensive. The average yield is in the 20s, so I don't see that as a significant risk. As for costs, would there be significant increases? A large portion of your costs are property-related. As I've mentioned before, there's a fairly predictable growth in those. We've had energy cost shocks and labor price increases. These are smaller proportions for gyms than they are for businesses like restaurants and other consumer businesses. So while gyms are not completely insulated from these, they're not the major cost factors that they are in other consumer businesses. These factors could play a role, but I believe they're manageable.

Looking at the economics now, how do you conceptualize the unit economics? IFRS 16 has somewhat complicated the financial statements. How do you view it at a high level?

If you look at a typical unit, both PureGym and The Gym Group have shared quite a lot of information on this. In their investment, you're typically looking at spending about 1.3 million on a large box site. From that, you'd probably get around 5,000 members. You'd be making revenue of approximately 1.1 million a year from those 5,000 members, most of which comes from membership fees. They do get some joining fees and other ancillary revenue, but the majority comes from the monthly membership fee. So you've got 1.1 million. Your cost base is about 600k of that. A significant portion of that is rents, rates, and service charges, maybe 40%, perhaps a bit higher in a London location.

Rent rates, service charges, salaries, energy, and maintenance costs are all part of the expenses. One of the advantages I had as CFO of PureGym was the predictability of the cost base. When assessing the feasibility of a site, I could predict the operating costs. I knew the property costs and what we could charge based on evidence from other locations. The only variable was the number of members we would attract. An EBITDA of 400k to 500k, which is a 30% or slightly higher return on capital employed, was the target. Both PureGym and The Gym Group aim for a 30% return.

What is included in the pre-opening costs? How do you account for that?

Marketing and salaries are probably the two largest costs. You need a substantial budget for marketing the site because both PureGym and The Gym Group aim to have a high number of members when the gym opens or within the first month. That's part of the model.

Let's say you've got a new location and you start fitting it out today. How would it work?

If we have a new location and start fitting it out today, we would begin recruiting the manager, assistant manager, and some personal trainers beforehand. They might be there a month or two before the gym opens. They're being trained, learning the ropes, and likely doing face-to-face marketing in the town center to raise awareness about the gym's opening. The marketing effort, whether it's through them, online marketing, radio adverts, or leaflet distribution, starts a month or two before the gym opens. Typically, we give people an offer for joining at that point.

So they get the first few months at a reduced price? Is it for a year?

No, we don't offer a lifetime discount. We offer the first year at a reduced price, provided they sign up at that point. This gives us certainty about our memberships. From there, we grow, and new members pay higher rates. This churn then starts to increase our yield.

Could you provide an estimate of the pre-opening cost per unit?

I'm not certain about their current spending, but it could be around 50,000 to 100,000. I'm not sure what they disclose now, but I would assume it's in that range.

I have a figure here of approximately 120,000 from The Gym Group. This is deducted from the adjusted number because it's not earning any revenue, effectively acting as a capital expenditure. Could you briefly discuss the fair maintenance capital expenditure per unit?

It's crucial to maintain the gyms' appearance and functionality, whether that's the site's fabric or the gym equipment. If a treadmill is out of action, it affects several members and looks unprofessional. So, you could spend about 3% of revenue on ongoing site maintenance. A similar amount could be spent on maintenance capital expenditure, which involves replacing items that break and need replacement. This seems sensible to me. That is annual; you need to maintain the site's appearance and functionality. Every few years, a significant refurbishment of the site is necessary, which involves replacing the equipment and refurbishing the site more broadly, possibly changing the configuration. This refurbishment is a separate, significant capital expenditure.

I think The Gym Group mentioned that the cost of new equipment for a unit is approximately 360,000. Considering depreciation over five years, do you think this estimate could change? Could we be overestimating, or could the equipment last longer?

It's more likely to last longer. As you own more facilities and learn how to use and maintain the equipment, it should last longer. Some of this equipment can also be refurbished. Over time, the proportion of cardiovascular equipment like treadmills and bikes has decreased, while functional fitness areas and weights have increased. These last longer, require less maintenance, and are cheaper to replace. This trend is favorable for gyms and helps offset some of the capital expenditure challenges they face in other areas.

It's impressive that these facilities yield 30% cash on cash returns. Why do you think people underestimate these businesses, including Basic-Fit, not just in the UK?

There are two factors to consider. One is the lingering doubt in people's minds about the resilience of the consumer. The situation has been exacerbated by Covid. Other factors such as geopolitical instability and rising interest rates have not helped either. Interestingly, I was discussing this with someone yesterday. I mentioned that I've been working in multi-site businesses for 35 years, and there's never been a time when everyone was optimistic about the coming year.

It's never been the case. However, the current climate feels a bit more pessimistic than usual. That's one aspect. Secondly, many people, who have long memories, had negative experiences with mid-market gyms in the past. These gyms didn't meet their expectations and they lost money. I've had investors tell me that no matter how good the proposition is, they would never invest in a gym chain again due to their past losses.

Why is this different? That's the question. Why do you think this time is different? That phrase is often the famous last words.

Many of the points we've discussed suggest that we've created, along with others like The Gym Group and Basic-Fit, an affordable and accessible gym model that appeals to the majority of the population. The investment cycle is also affordable. Many mid-market gyms faced issues because reinvesting in facilities like swimming pools and cafes was too expensive.

How much does it cost to fit out a business like LA Fitness? Is it around two to three million?


And then you have to maintain it.

You have to refit it. Those areas can start looking run-down quite quickly.


I believe that our model works better from a reinvestment perspective. It appeals to a larger customer base, so we're not reliant on a small number of high-spending customers who are more vulnerable to economic downturns. Interestingly, at the moment, some high-end gyms are doing quite well because their customers don't seem to be affected by the market conditions. However, the mid-market has been a challenging space.

There are also businesses like Barry's and bootcamps, which charge around £20 per session, and they're doing really well. It seems like there's a bifurcation in the market.

I agree. There are many parallels in other industries as well. If you look at airlines, hotels, supermarkets, and fashion, you'll see a similar trend. For instance, there must have been a time when people questioned whether Premier Inn would survive. Despite their challenges with Covid, businesses like EasyJet seem to be recovering. It's always risky to predict that everything will always be great, and I'm not suggesting that. However, I do believe these are sustainable long-term models. They've already achieved significant scale.

I believe the PE Fund purchased at approximately 10 times the forward EBITDA, which I think was the valuation Leonard Green used.  If you were to value them, how would you go about it?

If you were an impartial observer, rather than someone like me who believes in the industry, you'd start by looking at the public market valuation for gyms. You'd examine The Gym Group and Basic-Fit and see that it's currently somewhat less than 10. I would estimate it's somewhere between six and eight. I don't have their numbers in front of me, but I'm sure it's around that multiple, because that's what public markets are valuing these types of businesses at currently. But I don't have the exact figures.

I have the numbers here.

Three and a half would be incredibly low, wouldn't it? Let me check.

The point here is, The Gym Group isn't reporting mature gym EBITDA numbers similar to what you were. That's the question. And another tricky thing is how you interpret the income statement given IFRS.

It does make it more confusing for people to understand a real EBITDA number, pre-IFRS, although most people are still telling you what that is. I'm just looking at their last year's EBITDA to give a more accurate view. Their last year's numbers, which are obviously different now, showed 38 million of what they're calling EBITDA after rent. I've referred to their slides from their last year-end presentation. In 2019, the year before Covid, they reported an adjusted EBITDA, not IFRS 16, of 32%. In 2022, it was 22%. So, their EBITDA margin has decreased significantly.

They went from 48 to 38 million, despite higher revenue. The margin was clearly affected by Covid, but they are rebuilding. Both PureGym and they are still in the rebuilding phase. Their membership base is close to 90%, although I can't confirm their exact status at the moment.

They've also faced cost inflation and have opened new sites which, in the short term, don't contribute to profit at the same margin. They are lower margin while they're opening. If you consider that they made 38 million and their market cap is a couple of hundred million at the moment, that's five times, which is very low. But that's the market.

That's the UK market for you.

It's sentiment about these kinds of businesses. They've reported some challenges in the past few weeks, so people are not feeling optimistic. In the public markets, good news in the consumer sector doesn't usually lead to a significant rise in the share price. Bad news, on the other hand, is taken very badly because people are currently looking for bad news.