LA Fitness Versus Life Time Fitness

LA Fitness Versus Life Time Fitness

The California company is making inroads in Life Time’s headquarters market and adding clubs faster. But Life Time CEO Bahram Akradi believes his slow-growth strategy will ultimately win out.

A major battle in the multibillion dollar fitness industry is underway in Minnesota, with ringside seats in the Uptown neighborhood of Minneapolis.

LA Fitness has opened 12 centers in the Minneapolis–St. Paul metro area since entering the Twin Cities in 2007. The privately held Irvine, California, company plans to open three more facilities in this market in 2011, right in the backyard of Chanhassen-based Life Time Fitness. The most recent LA Fitness to open locally, last April, is on the second floor of the refurbished Calhoun Square shopping center, a gleaming space with machines and yoga studios, but absent the swimming pool and basketball and racquetball courts of the company’s larger suburban sites.

Less than 200 hundred yards away, Life Time Fitness (NYSE: LTM) followed suit, taking over a vacant former public library on Hennepin Avenue. Life Time opened a yoga and Pilates studio in the Beaux Arts revival building last August, a standalone version of the LifePower yoga studios it operates in its larger fitness facilities. Standing nearly nose-to-nose, the two clubs seem to form a line in the sand.

But Life Time Fitness founder and CEO Bahram Akradi appears unconcerned. The competition is “all good for the gym business,” he says. “It brings in more entry level customers.” Akradi says that if anyone is likely to be hurt by the expansion of LA Fitness, it will be workout chains like Snap Fitness, Gold’s Gym, or Anytime Fitness rather than his own.

 

Two “Very Different Business Models”

To say the health and fitness club business is fragmented and highly competitive is an understatement. In total, the industry generated revenue of $23.6 billion in 2009. The top five players accounted for $4.5 billion of that; the rest was spread across 29,000 separate business entities, according to Los Angeles–based research firm IBISWorld.

LA Fitness and Life Time Fitness are both in that top five. LA Fitness, notoriously closed-mouth about its operations, declined an interview with Twin Cities Business for this story. But Stuart Goldman, managing editor of Club Industry, a trade publication in the fitness sector, estimates that LA Fitness generated approximately $1 billion in revenue in 2009. That makes it the second-largest health and fitness chain behind (also private) California-based 24 Hour Fitness, at an estimated $1.4 billion. Life Time reported $837 million in revenue in 2009, making it number three.

Life Time has 24 clubs in the Twin Cities area, twice what LA Fitness has here. But LA Fitness has more than 340 clubs spread across 22 states and Canada, a substantially larger footprint overall than Life Time’s 90 clubs in 19 states. And LA Fitness is adding clubs faster.

Paul Swinand, a stock analyst at Morningstar, suggests that footprints and head-to-head battles aren’t the clearest way to look at these two companies, however. Swinand, who has belonged to both clubs in the past, describes Life Time and LA Fitness as offering two “very different business models, very different products.” He recently upped his valuation of Life Time, though he gives the stock only two stars out of a possible five for investment timeliness and attractiveness, primarily because the stock ran up so much in 2010, he says.

LA Fitness is an “in-and-out gym and exercise club,” Swinand says, while Life Time is more of a “country club” where members spend more time and money after their workout on amenities such as the in-store café or a massage.

Life Time’s mainstream clubs, “super centers” that average 95,000 or 113,000 square feet, have facilities for a wide variety of activities, from running and cycling to swimming, tennis, and yoga. Usually located in the suburbs and appointed in granite and hardwoods, the clubs strive to attract families. Swinand says that despite the upscale look of the facilities, members are “teachers, firefighters, computer programmers . . . people with regular jobs.” Life Time succeeds in generating revenue by selling them add-on services: personal training, tennis and swim lessons, golf swing analysis, kid camps, clothing and equipment sales, and power-boost smoothies.

The contrast with LA Fitness is clear to Swinand: “The name says it all. LA Fitness is selling the sizzle.” Members there are young, urban, and single—“muscle heads and young cuties,” he says. The clubs tend to be smaller than Life Time’s and they don’t have the same degree of high-end detailing or in-club amenities.

Because of that, Swinand reaches a conclusion similar to Akradi’s: LA Fitness is as much a competitor to Snap Fitness or 24 Hour Fitness as it is to Life Time.

“I don’t really like the LA Fitness model,” Swinand says, because the firm is caught between Life Time’s super center model and the “simple center” model of chains that offer small, no-frills, low-fee, work-out sites. LA Fitness carries much of the cost of having big facilities, he adds, but it lacks the amenities that bring along ancillary revenue.

Industry journalist Goldman is more sanguine: “Because of their track records,” he believes the two companies “will find a way to coexist, whether [in the Twin Cities] or in any market. They’ve proved they know what they’re doing and have the respect of others in the industry.”

Attrition Peaks with the Recession

Health clubs historically have experienced a member attrition rate of 33 to 35 percent per year. That meant one in three members had to be replaced just to stay even, requiring constant sales and marketing efforts. It’s one reason the industry has a reputation for aggressive—and some say deceptive—sales practices. (Consumer complaints about health clubs nationwide rose nearly 36 percent from 2007 to 2009—from 5,268 to 7,139—according to the Better Business Bureau, ranking the industry 20th for number of complaints, up from 31st.)

On the other hand, once a club reaches and maintains its steady-state membership level, cash flow in this business can be reliable and substantial. Monthly membership fees constitute two-thirds of revenues for Life Time Fitness and more than 70 percent of the company’s operating profit.

Akradi says that in the current economic environment, however, with unemployment above 9 percent, Life Time has “never had to work harder to attract and retain members.” Attrition peaked for Life Time at 42.7 percent in the first quarter of 2009. It’s still a point or two above the company’s near-term goal of 36 percent, but moving in the right direction. Memberships stand at 623,000, compared with 578,900 a year ago.

Life Time has been periodically lowering its enrollment fees and offering “value pricing” across its range of add-ons while keeping its basic monthly fee structure intact. The idea, Akradi says, is to keep members engaged: “If they use the club,” rather than simply carrying a membership card around in their pockets, “they’re less likely to leave.”

Competitor LA Fitness is also following a tack of heavy promotion and discounted enrollment fees, while positioning its monthly fee below Life Time’s. LA’s monthly membership fees range from $30 for an individual to $80 for a family. Life Time’s range from $50 for an individual to as much as $250 for a premier “Onyx” level family membership. But LA Fitness imposes additional “enrollment” charges when members sign up for fee-based services, such as personal training, and prices shift, making a direct comparison difficult here and for consumers who are shopping around.

 

Akradi: “Not Interested in the Gym Business”

More than adjusting fees, Akradi has been adjusting his company’s position in the marketplace. He says he’s “not interested in the gym business,” and over the past year, he has refashioned Life Time as a “healthy way of life company,” the brand’s new tagline. Akradi has restructured to create 19 separate businesses, one around each activity the company offers—cycling, running, yoga, and so on.

“Two years ago, if you went to Life Time, like everybody else, we had spin classes,” he says. “Today, we have a cycling company.” That includes outdoor cycling clubs, cycling events, specialized coaches, cycling gear, and other products. Since the mid-1990s, Life Time has produced running and cycling events. It launched the Life Time Triathlon in the Twin Cities in 2002. Last year, Akradi bought the Chicago Triathlon, the largest such event in the country, and the Leadville Trail 100 Series of mountain biking and running events in Colorado.

“We have transformed something as simple as spinning to a really comprehensive sport,” he says. “We have several million dollars a year in revenue from cycling events . . . . From the consumer side, we have literally thousands of people who go to our cycling events—some members, many nonmembers.” Akradi says he expects to make more acquisitions, and he believes that cycling alone could become a $50 million to $100 million business for Life Time.

Each of his 19 newly established units has its own business plan, business leader, and employee group dedicated solely to one sport.

“We’re marketing to the 2 percent leaders in an interest group and the 13, 14 percent early adopters behind them” who’ll be “pollinators” to the rest of the market over time, Akradi says. “You cannot do that with a department mentality. You have to have separate businesses where that’s all they do. They wake up in the morning and all they do is yoga.”

The strategy seems to be working. Life Time Fitness generated on average $9.8 million in revenue per club last year, compared with $3.1 million for LA Fitness. (On the more meaningful measure of revenue per square foot, however, analyst Swinand believes the two companies are more comparable, given Life Time’s larger footprint per club.)

Life Time’s total revenue had swelled 27.6 percent from pre-recession 2007 through 2009, fueled by new club openings. But same-store sales at mature clubs (those open more than three years) had fallen nearly 10 percent, and revenue per member inched up only about 4 percent (from $1,360 to $1,414), over that same period. Life Time’s operating profit margin also declined, from 21 percent to 17.8 percent.

In 2010, the numbers began moving in the right direction again. Same-store sales at mature clubs were up slightly (1.8 percent) in the second quarter. In both the second and third quarters, in-store revenue per member hit an all-time, per-quarter high of $112, up nearly 12 percent from a year earlier, and operating profit margins had edged up by Q3 to 18.3 percent year to date. (Year-end earnings will be reported just after this story goes to press.)

Slower and Stickier Wins the Game?

For most of the past decade, Life Time Fitness was adding clubs at $20 million or more a pop, and growing its square footage at more than 10 percent a year. New clubs enabled Life Time to post nearly 21 percent membership growth and 32 percent revenue growth compounded annually from 2000 to 2007. But when the economy hit the skids in 2008, Akradi put the brakes on club growth. Capital spending dropped from more than $400 million a year to less than $100 million; cash is up from $56 million two years ago to $121 million today.

While the company’s long-term debt is down from more than $700 million a couple of years ago, it still stood above $550 million at the end of Q3 2010. Total debt is now three times cash earnings (EBITDA, or earnings before income taxes, depreciation, and amortization). Life Time has told Wall St. that it will consider hitting the accelerator on club growth again when its debt ratio falls below 2.5, probably in 2012.

LA Fitness, by contrast, continues to add locations aggressively. Trade journalist Goldman says he’s seen the normally reserved company issue a press release on a new club opening “every couple of weeks, it seems.” In some cases, LA Fitness is growing without building expensive new space, Goldman says, by taking over abandoned club space in strip malls “at low rates maybe they couldn’t get three or four years ago.”

Akradi’s slow-growth approach has critics and naysayers. When LTM stock hit $40 last spring, up 60 percent in just a few months, it attracted short sellers, traders who bet on the stock dropping in the future.

One of them, Andrew Parlin in Boston, criticized Life Time’s slow-growth model for delivering only near-term earnings and boosting the stock. In a Barron’s interview last April, Parlin said Akradi would either have to scale up capital spending or stay trapped in slow-revenue-growth mode, and that either move would compress future earnings and bring the stock back to earth.

But apparently, Parlin didn’t count on Akradi being able to pull more revenue out of existing clubs and members. As it exited 2010, LTM still hovered around $40, about where it peaked last April. Contacted recently by TCB, Parlin says he is “not current on” the Life Time story, and so is unwilling to comment.

Negative sentiment persists, however, with short interest at about 20 percent of LTM’s shares outstanding at year end. Morningstar’s Swinand calls the persistent heavy short interest “a side bet, because the stock is way overvalued . . . . because they have been so successful.” He adds, “It doesn’t impact what they do” in running the business.

After the most recent (Q3) earnings report, Swinand wrote that Life Time’s move to what he calls a “fitness services and lifestyle” strategy is preferable to its earlier “fitness club building” strategy, because it’s “stickier with customers, harder for competitors to copy, and obviously less capital intensive.”

Akradi sees lots of growth ahead as he targets the 15 percent of the market that he believes will most enthusiastically embrace Life Time’s approach.

And LA Fitness? He’ll let them compete with other “gyms” for the remainder. He expects to see them in every major metropolitan area across the U.S. over the next decade. He’s gearing up for a marathon, not a sprint.

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