Description

Life Time Fitness operates 112 large format athletic centers and recently announced intention to explore the formation of a REIT. LTM has a $3.3 enterprise value and real estate worth ~$2.2B – $2.6B, implying the Opco is currently trading for 1.3x – 3.0x EBITDA.

1. While I want to focus this discussion on the value of the real estate, I wanted to briefly present the summary financials for LTM. I am not going to argue that the gym business is great business or that trends are not a little soft right now (comped down 0.9% in Q2 14 against a 3.8% positive comp in Q2 13), but LTM has a differentiated product and has outperformed the industry for a very long time. LTM SSS, margins and EPS growth have been historically very healthy and stable.

2. Now to triangulate the value of the real estate from multiple data points. First, the company has spend $2.6 building the centers since 2001. The real estate has likely appreciated over time and has an in place tenant, suggesting it should be worth more than construction cost. At its last analyst day, management confirm that new centers cost $250 -$300 / ft implying a value of $2.1B – $2.55B. Capex to date

3. In Q2 2014, LTM repurchased two 105K sq. ft. centers for $65M that it entered into sale leaseback transactions in 2003 for $43M. Assuming 32.5M per center * 80 owned properties = $2.6B. While we cannot extrapolate the value of all real estate from two purchases, it is certainly a relevant com and supports the view that the real estate has appreciated 4.2% CAGR over last 10 years.

4. In February 2013, LTM entered into a mortgage for 5 centers for $75M. Again we obviously can extrapolate to the whole estate, but assuming 50%-65% LTV implies each center is worth 23M – 30M or $1.85B - $2.4B.
5. In December 2011, LTM bought back 6 previous leased centers from WP Carey for ~$122M or a 6.7% cap rate. A 6.7% cap rate on 175M rent implies $2.6B EV for the real estate.

6. In August 2008 at the height of the financial crisis, sold 4 gold properties for 25M or $217 / foot each and sold two onyx properties for 30M or $275 / foot…….

7. LTM currently pays $42M in annualized rent for 2.1M sq.ft. and 1M sq. ft. of ground leases. Assuming the 10 ground leases cost $5M / year, implies LTM is currently paying $16.95 per foot. Applying this rent to their 8.5M owned sq. ft. implies ~$150M of rent worth $2.15B at a 7% cap. The leased properties skew older and toward LTM’s lower end Bronze Clubs (where dues are 1/3 the rate of Diamond clubs). (Importantly, 9 of the 32 leased properties were acquired in 2011 from Lifestyle Family Fitness for $70M and had dues levels half the average of LTM). Given the overall club skew mix, I believe the whole chain can support closer to $20 rent per foot or $175M of rent. At $175M rent would be 15% of 2015 sales (compared to 25% at CLUB) . Additionally, 2015 EBITDAR of $450 ($408M EBITDA) would more than adequately cover $217 of rent ($175M new rent to REIT and $42M legacy rent) given the stability of the business.

8. Taking the above all together and assuming the real estate is worth $$2.2B, implies the Opco is trading at 3.3x EBITDA.

9. On the above, assuming the opco trades at an unlevered 12.5x P/E and the REIT has a 95% payout and trades at a very conservative 8% dividend yield, implies the real estate is worth $2.2B and the Opco is worth $1.5B and the combined co is worth $65 or ~40% upside.

Risks

1. Company decides not to pursue the REIT and stock declines to pre-announcement levels. This does not seem likely given the activists in the name and the CEO owns ~$100M of stock.
2. Fundamentals deteriorate from flatish to something worse. This is possible, but I take comfort in the concept’s historical performance. I believe the stock over reacted in Q2 to a -1% comp and 50bps of YTD EBITDA margin erosion.

Catalyst

Annoucement of Opco/Propco