The Gym Group
revisited...
I’ve always liked The Gym Group. I was a shareholder for some time and then I sold my shares. I would like to say that I was able to foresee this huge drop, but no. I just thought I had found a better investment idea.
The Annual Report came out this week so I think this is a good time to look at The Gym Group again.
I’ve written about the company here and here. The last time I wrote about it, the share price was £2,5 (or 250 pence sterling) and now the share price £1,35 (or 135 pence sterling) which means a 46% decline.
Right now, things are difficult for gym owners. Gyms all across Europe have been forced to close doors, subscriptions have been frozen and no one really knows when things will get back to normal. Because of this, investors are fleeing gym stocks. And do you know what this means? It means that this is the perfect setting for the intelligent investor to look for hidden gems.
On my previous analyses, I’ve concluded that The Gym Group was a great company, with solid growth prospects and that you could buy it at a reasonable price. What more could one ask for?
But right now the company is facing a different reality. What was true yesterday, might not be true today. That’s why the prudent investor‘s focus should be on the company’s liquidity position and the company’s ability to survive. It’s no worth to project future growth if there won’t be a company anymore or if the company comes out of this with a walking stick, barely able to move.
I’ve been stress-testing several companies in the last couple of weeks and I feel I should write a post explaining how I go about it. For now, let’s just take The Gym’s example:
Sources of Cash
First of all, I’ll want to know which are the “sources” of cash that the company has at its disposal. The first one is the cash it has in the bank. According to the management team, the company had £28,6 million in cash on March 18. We can forget about the inventory and receivables for now and I also think we should picture a scenario of ZERO revenue for the coming 12 months.
On top of this cash, the company also has an accordion for £30 million. An accordion is the ability to raise more debt from the bank (don’t mix it up with the musical instrument). If we add up the cash and the accordion, the company has about £59 million available.
Uses of Cash
Second, I’ll want to know what the “uses” of cash will be in the coming 12 months. Last year, the cash administrative expenses were about £85 million and the interest expense on the debt was £2 million. These would make around £7.5 million per month in cash costs. So those £59 million in cash should be enough to survive for about 8 months (59 ÷ 7,5 = 7.8 months).
HARD NEGOTIATIONS
By now, you might be asking: the administrative expenses can be reduced, right? Right. And the company can probably raise more debt if it needs to, right? Right. And the government is helping everyone by lending more money, foregoing taxes and offering to pay for a great part of the workers salaries, right? Right.
But I still don’t have a full understanding of how that will impact the company.
The company has stated that it’s currently in negotiations with its landlords and with the banks. You see, the company’s gyms are pretty big (1400m2 each). An European football field is 6.000m2. The company typically leases them for periods of 10+ years and it usually gets the first year for free. There aren’t that many tenants leasing these huge places. If they’re evicted, to whom will the landlords lease these places? That’s right, it will be hard for them to do it, especially when everyone is in lockdown.
On the other hand, many of these landlords are probably funds or subsidiaries of funds who are highly leveraged (i.e. they have a lot of debt) and because of that, they will also be in a hard situation themselves, making the negotiations even tougher. This is like a house of cards.
The £30 million accordion is also subject to the Banks’ consent. I have no doubts that the banks are going to lend this money and they will probably lend more, if needed. The thing is, what will they ask in return?
They will be holding both the knife and the cheese in their hands. There are accounts of banks requiring the issuance of new shares in parallel to the loan they are handing out. This would mean that the existing shareholders would see their ownership being diluted (imagine that, for the rest of your life you had the right to 50% of a crispy pizza every week. If new shares are issued to new hungry fellows, they will also have the right to some of that pizza. You’ll have to let go of a part of those perpetual 50% if you want to save your pizzeria and keep eating some pizza).
The importance of a founder
To those investors who don’t really care if their companies are still managed by the founder, think about this: if the company is still managed by the founder and if this founder and his or her family’s lives are dependant on the business, you can be sure that they will negotiate with landlords and banks as if their life was dependant on it… because… it actually is.
In this case, John the founder, isn’t the CEO anymore, but he’s still a director and he still owns a pretty decent share of the pizzeria (3,5%) which I think is enough to make him negotiate hard.
Valuation and conclusion
The investors that are buying The Gym right now have good chances of making good money. The company is trading at a Price-to-Free-Cash-Flow of 3!!! And if we go back one week, it was selling for half the price. This is SUPER CHEAP. This is… I don’t even know how to say this… this is C-R-A-Z-Y. I’m almost sure we will never again be able to buy such a great business for this price. Yes, I know. This year, the company won’t produce any cash. But it’s very cheap nonetheless.
BUT, I’m still not convinced. We still don’t have visibility for how long this will last. That’s why I prefer to follow it a little longer and gain more visibility on all of these matters. The Gym is probably going to weather this storm and come out of it alive, but at what cost? It will probably be a bagger (a stock that has gone up several times its initial price). It has already gone up by 77% from its last week lows and I will probably miss some of the upside with my indecision, but as always, I prefer to make errors of omission rather than errors of commission. I don’t mind leaving some money on the table if the other option is to not be able to sleep well at night.
I will be waiting for Basic Fit’s earnings release in mid-April and I’ll keep following The Gym Group very closely.
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