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Stone Street Advisors LLC

Town Sports International & the Sound of Inevitability


Jordan S. Terry
February 4, 2016 (Updated from January 27, 2016 Original)
Town Sports International
Price (1/27/2016)
Shares Out

1.20 Target Price


25,000 Return to Target

Market Cap
LT Debt
Less: Cash

30,000 Action
295,394 Rating
95,478 Rationale

Enterprise Value

229,916

(NASDAQ: CLUB)
0.00
-100%
Reiterate
N/A
Restructuring watch,
hires advisors

Clarification/correction 2/4/2016:
Below and in the original version of this document, we cite an S&P LCD report that
Town Sports has hired Rothschild as financial advisors. We have confirmed that this is
NOT a reference to Rothschild Investment Corporation, rather to an unaffiliated
entity/firm. Please note this very important correction/clarification.
Gym & fitness center operator Town Sports International (NASDAQ: CLUB) revenue will
collapse almost 30% from 2015e-2018e in our base case due to intense membership fee
pressure, membership attrition, and membership type downgrades.
High, inflexible costs from Company-operated, leased facilities subject to high northeast U.S.
metro rent. Marginal improvement possible from headcount related cost cutting.
Less money in the door and the same or more money out means cash flow will be severely
negative for 2016-onlward. CLUB will run out of cash by 2017q3.
The Firms largely untapped and 75% unavailable $45m revolver matures in 2018q4, while its
$325m term loan ($295m out) matures 2020q4. The runway is not as long as it seems from the
air.
With the stock at all-time lows, down ~90% in two years, we do not expect the company will
be able to raise cash through the equity markets. The firms existing senior debt is trading at
distressed levels around 37; there is too much debt to service let alone repay, leaving further
debt issuance or a simple refinancing transaction out of the question.
We expect some sort of restructuring to be announced and underway by year-end 2016. Best
case scenario for equity holders is severe dilution related to equity options/warrants granted as
part of a distressed exchange.
Due to the above, we reiterate our $0 price target for the stock with no rating.
Town Sports and its creditors have reportedly already hired investment banks to advise on
potential restructuring (Rothschild and PJT Partners, respectively).
Neither the company nor the activist hedge funds controlling the company have disclosed the
engagement of financial advisors or refuted reports. This may not be a direct violation of
securities regulations but it is an intentional failure to report material (non-public) information
to investors in the spirit of securities laws. Hell hath no fury like an investor in a money-losing
company scorned.

TOWN SPORTS INTERNATIONAL & THE SOUND OF INEVITABILITY

Stone Street Advisors LLC

Introduction & Background


One of my favorite films, The Matrix, has some good lessons for corporate managers. The premise of
the film is that we are living in a world largely outside our control, a world in which we can choose to
live in the comfort of the familiar or accept a less than pleasant reality. In the former, we go through life
blissfully ignorant; the world we see is not the world as it actually exists. Most people cannot and do not
want to see the world as it really is; Its cold, unforgiving, and requires constant adaptation just to
survive. As the antagonist says to the main character, facing certain imminent death, that is the sound
of inevitability (Note: YouTube clip)

Town Sports, owner of gyms including New York Sports Club, is now facing that same sound, the sound
of inevitability. As I explained in my previous post on the company, management has been living in an
alternate reality for the past decade-plus, blissfully unaware of whats actually happened around them,
indifferent to the ever-changing landscape. In that article I explained how the industry changed and how
CLUB got into the unenviable situation in which it finds itself. Here, Im going to talk more about the
future and how I expect it to play out.
In keeping with the theme, absent remarkable strategic and financial transformation, the following
happenings are inevitable:
Declining Membership Fees
In 2014, Town Sports brought in about $78 per member per month in revenue, or $59/month in
membership fees. Planet Fitness (PLNT) charges $10/month, with their Black Card membership
TOWN SPORTS INTERNATIONAL & THE SOUND OF INEVITABILITY

Stone Street Advisors LLC


running at $20. This is equal to the cheapest membership option at Town Sports gyms, and even then
its only available at 20% of system-wide locations.1 Planet Fitness has grown from 389 locations in 2010
to 1,040 locations as of 2015q3 and has been aggressively expanding into CLUBs northeast metro home
turf. With the promise of no lunks and not dissimilar facilities/amenities as CLUB locations, CLUB
membership fees are guaranteed to drop. We estimate that revenue/member/month will drop from
$78 in 2014 to $71 for 2015, dropping further to $55 by 2018. This works out to monthly membership
fees dropping from $59 in 2014 to $51 in 2015, settling around $39 in 2018. Considering the biggest
player in the industry is already at half of our 2018 estimate and competition is only heating up, this
decline may be even swifter than weve projected.
Declining Membership
Historically fitness clubs have catered topeople who wanted to get and stay fit, the ~15% of the U.S.
population that has a gym membership, many of whom are relatively inactive. Sometime around the
turn of the millennium, Planet Fitness realized the 85% was a bigger addressable market (why this
arithmetic took so long is a bit of a mystery), and if you make a gym membership cheap enough, almost
no one will ever cancel. You can even serve free pizza at the gym and people will still line up to pay you
to help them get skinny, while you make them fat(ter). Planet Fitness actually does this.
By maximizing inactive or less-active members rather than trying to convince everyone they can get
rippling muscles, PLNT is able to run at 2x the members per location as CLUB and 2x the members per
square foot. So long as most of the inactive/seldom-active members stay that way and PLNT can keep
selling franchises, the business can scale to the moon. PLNT membership fees should approximate a
growing perpetual annuity. Does it get any better than that?2
CLUB management (now controlled by smart money hedge fund activists) has not only rejected the
math behind the Planet Fitness approach (and broader industry trends), but theyve recently dug-in,
eliminating the grand 2015 experiment that was HVLP, High-Value, Low-Price, $20/month
memberships. Theyve also rolled out a new ad campaign, #ibuiltthis3, for those members with rippling
muscles to show them off on social media.
Entrenchment, thy name is Town Sports.
We estimate that CLUB membership will decrease from 540,000 at year-end 2015 to 480,000 by 2018, a
decline of less than 8.5% or ~3%/year. You may wonder, given our generally bearish outlook, why these
numbers arent more catastrophic. First, this is our base case in which the company continues as a going

Source: Stone Street Advisors LLC analysis of 90 NYSC, BSC, WSC, and PSC membership options per
mysportsclubs.com, 2015q4.
2
We are NOT suggesting or even discussing whether to invest in PLNT. We reference it as CLUBs only public &
most important competitor.
3
The campaign calls for selfie stations/mirror clings in gyms so people can snap pics while theyre still pumped. We
can only hope this idea never takes off, for everyones sake. http://www.prnewswire.com/news-releases/newyork-sports-clubs-builds-a-new-ad-campaign-i-built-this-marks-new-era-in-speaking-to-consumers300196366.html

TOWN SPORTS INTERNATIONAL & THE SOUND OF INEVITABILITY

Stone Street Advisors LLC


concern without any substantial reorganization/restructuring. Second, we dont expect a mass exodus
or a huge spike in attrition, not yet, at least. Our model assumes less than 100 members per club on
average leave each year for the next three years. With over 3,000 members per gym, the change may
not even be noticeable to anyone except management, if they even notice at all. Third, its going to take
PLNT and similar competitors a while to get their low-price NYC locations up and membership ranks full.
New York Sports Clubs in and around NYC have a lot of solid locations. Theyre unspectacular, but for the
most part perfectly adequate for all but the most snobbish gym-goers. For now, the important thing is
location, location, location, and CLUB has A LOT of locations in NYC, especially in Manhattan.

Left: New York Sports Clubs in/around Manhattan, NYC


Right: Planet Fitness locations in the same area

For most, sticking with the status quo is easier than switching. The question is how long will it take
people to switch once PLNT penetrates CLUBs territory and offers the same or better for to 1/3rd the
price?
Ive been a CLUB member (New York Sports Club) for most of the past 6 years. Im pretty close to the
epitome of their target market; an early 30s, white-collar, metropolitan-area fitness buff. As such, Im
TOWN SPORTS INTERNATIONAL & THE SOUND OF INEVITABILITY

Stone Street Advisors LLC


routinely curious about (read: angry at) the sheer number of people meandering around the gym, more
interested in Snapchatting than actually breaking a sweat. If CLUB management has its way, these
people will flock to Planet Fitness ASAP, and Ill be wearing a big smile on my face when I no longer have
to wait around for the 2 guys hogging 12 sets of dumbbells.
Membership Downgrades
There was a time in the not so distant past when CLUB could charge people (many employer-subsidized)
$100+/month for a Global Passport membership. I was paying around $85 when I had this in 2009-2011,
and if memory serves, it was more like $120 without the subsidy. Fast forward a few years and the same
type of membership is $60 or $70/month (annual v. month-to-month). With the old, annual
memberships, you could only realistically switch to a lower/cheaper level once a year (or two!). With
current month-to-month contracts you can effectively downgrade whenever you want. Increasing ease
of switching should enable a lot of switching!
As for sales mix, Passport v. Premier memberships, how many people use more than one location more
than once or twice a month? My guess is very few. Sure, its nice if you travel the Amtrak Acela corridor
for your job, or if youre a social butterfly often working out with friends all over the city, but with the
standard (ahem, Premier) membership the price at $30/month, we believe even most corporate
memberships will downgrade from Passport to Premier. Use of another location besides your home gym
runs $12.95 for NYSC locations, though a Regional Passport membership exists for certain areas like
Hoboken/Jersey City, where $40/month gets you unlimited access to two Hoboken and one Jersey City
gyms v. $20 for just one. Even here, I suspect only a few people will use the two non-home locations
more than 1-2x/month, so even those few will likely opt for the lower-price membership and pay
additionally (which they dont tell you about when you check in, in my experience) if visiting other
locations.
For 2015 we estimate the split between Passport and Premier will be 60/40%, resulting in average
monthly membership fees decreasing from $59 in 2014 to $51 in 2015. We project the membership split
settles at 30% Passport/70% Premier in 2018, with monthly membership fees dropping 9% a year (24.4%
total) to $39. We do not see any realistic way CLUB can do much, if anything, about the sales mix trend.
We also think were being rather generous assuming almost a third of members will still pay $60/month
three years hence with the way things in the industry and consumer preferences are moving.
Cash Hemorrhaging
Many blind CLUB bulls and other species of defenders have told us that CLUBs cash burn is under
control; slow enough that the 2018 and 2020 debt maturities are not even worth thinking about. We
politely disagree.
Weve already explained, as clearly as possible, that theres going to be less money coming in the door.
The only way to avoid running through cash is to embark on aggressive cost management.
Unfortunately, they cant.
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CLUB has very, very little control over OpEx, and can only cut CapEx so much before the clubs start to fall
apart. With no owned locations anymore and higher/rising rents (as existing ones roll-off), club
operating costs are unlikely to fall; quite the contrary, most likely. The clubs are not particularly highlystaffed4, so we dont see too much cost flexibility in payroll & related, either. In-line with company
announcements, we have modeled some OpEx reduction in 2016 and onward including full- and parttime headcount reductions. These account for $16m of $17.5m of projected cost savings in 2016-on v.
2015, with club operating expense increasing $2.6m and G&A falling $2.9m.
STONE STREET ADVISORS LLC
Town Sports International (CLUB)

Case
P&L
4
Base

9mos

Membership Type & Breakdown


Passport
Passport
Passport
60.0%
45.0%
33.0%
Premier
Premier
Premier
40.0%
55.0%
67.0%

Historical
Case: Base
Membership Dues
Revenue Growth
Initiation & Processing Fees
Ancillary Non-Training Club Revenue
Other Revenue
Fee Revenue
Personal Training Revenue
Total Revenue
Revengue Growth y/y
Total Members
Membership % change
Change in members/avg # of locations
Revenue/member/month
Fee Revenue/member/month
Operating Expenses
Payroll & Related
Per location
% Sales
Club Operating
Per location
% Sales
G&A
% Sales
Impairment
% Sales
D&A
% Sales
Total OpEx
OpEx % Sales
Operating Income
EBITDA
Interest expense
EBT
Tax Rate
Tax provision
Net Income
EPS

2013
358,761
14,392
24,720
5,985
403,858
66,367
470,225
-1.8%
497,000
-2.5%
78.8

174,894
1,080
37.2%
179,683
1,109
38.2%
28,431
6.0%
714
0.2%
49,099
10.4%
431,817
91.8%
38,408
87,507
22,617
19,691
37.4%
7,367
12,324

Passport
30.0%
Premier
70.0%

Estimated

9 months
2014
2015
343,185
230,964
-4.3%
12,044
15,000
22,304
17,468
5,971
4,736
383,504
318,748
70,338
55,316
453,842
323,484
-3.5%
484,000
534,000
-2.6%
-83
78.1
59.1

177,009
1,172
39.0%
192,716
1,276
42.5%
31,352
6.9%
4,706
1.0%
47,307
10.4%
453,090
99.8%
752
48,059
19,039
(16,378)

135,866

52,611
(68,989)
(2.84)

(17,066)
(65,838)
(2.67)

42.0%
151,386
46.8%
23,144
7.2%
46,129
14.3%
36,042
11.1%
392,587
121.4%
(69,103)
(33,061)
15,562
(82,904)

2015
333,280
-2.9%
20,000
22,400
5,917
381,597
78,300
459,897
1.3%
540,000
12%
368
71.0
51.4

2016
273,300
-18.0%
10,000
20,000
5,000
308,300
76,125
384,425
-16.4%
525,000
-2.8%
-97
61.0
43.4

2017
243,438
-10.9%
20,000
5,000
268,438
73,950
342,388
-10.9%
510,000
-2.9%
-97
55.9
39.8

2018
230,910
-5.1%
20,000
5,000
255,910
71,775
327,685
-4.3%
495,000
-2.9%
-97
55.2
38.9

181,127
1,184
39.4%
199,206
1,302
43.3%
30,859
6.7%
46,129
10.0%
46,000
10.0%
505,807
110.0%
(45,910)
90
19,000
(64,910)
35.0%
(64,910)
(2.60)

165,175
1,066
43.0%
201,810
1,302
52.5%
28,000
7.3%
0.0%
46,000
12.0%
440,985
114.7%
(56,560)
(10,560)
19,000
(75,560)
35.0%
(75,560)
(3.02)

165,175
1,066
48.2%
201,810
1,302
58.9%
27,500
8.0%
0.0%
46,000
13.4%
440,485
128.7%
(98,097)
(52,097)
19,000
(117,097)
35.0%
(117,097)
(4.68)

165,175
1,066
50.4%
201,810
1,302
61.6%
27,000
8.2%
0.0%
46,000
14.0%
439,985
134.3%
(112,300)
(66,300)
19,000
(131,300)
35.0%
(131,300)
(5.25)

CAGR 2014- % Change CAGR 2015- % Change


2018e
2014-2018e
2018e
2015-2018e
-9.4%
-32.7%
-11.5%
-30.7%

-7.8%

-27.8%

-10.7%

-28.7%

0.6%

2.3%

-2.9%

-8.3%

-8.3%
-9.9%

-29.4%
-34.2%

-8.1%
-8.9%

-22.3%
-24.4%

-1.7%

-6.7%

-3.0%

-8.8%

1.2%

4.7%

0.4%

1.3%

-3.7%

-13.9%

-4.4%

-12.5%

-0.7%

-2.9%

-4.5%

-13.0%

NM
NM

NM
NM

NM
NM

NM
NM

NM

NM

NM

NM

We assume that headcount reduction to minimal levels is accomplished in 2016. We have kept club
operating costs level due to our lack of visibility on rent prices in each of CLUBs metro areas, but absent
recession, we expect our projections to underestimate actual lease expense and thereby club operating
expenses going forward.

To get an idea for what I mean by not highly staffed, try getting a staff member, trainers included, to give you a
spot lifting, even when theyre just hanging around in a mostly empty gym.

TOWN SPORTS INTERNATIONAL & THE SOUND OF INEVITABILITY

Stone Street Advisors LLC


As you might imagine from the income statement, our projected cash flows arent exactly pretty
STONE STREET ADVISORS LLC
Town Sports International (CLUB)
Historical
Case: Base
CLUB Cash Flows
Net Income
D&A
Capex
% of Revenue
Capex/club
Financing

2013

Estimated
9 months
2014
2015

(68,989)
47,307
42,054
9.3%
279

(65,838)
36,042
24,073
7.4%
157

19,854
73,598
93,452

(5,166)
93,452
88,286

Impairment
Working Capital
Debt Issuance
Preferred Dividend
Common Dividend
Debt Repayment
Asset Sale
Change in Cash
Beginning Cash
Ending Cash

2015

2016

2017

2018

(64,910)
46,000
32,193
7.0%
210
46,129
(10,000)
3,000
2,026
93,452
95,478

(75,560)
46,000
26,910
7.0%
174
(5,000)
2,970
(54,439)
95,478
41,039

(117,097)
46,000
23,967
7.0%
155
(5,000)
2,940
(93,004)
41,039
(51,965)

(131,300)
46,000
22,938
7.0%
148
(5,000)
2,911
(106,148)
(51,965)
(158,113)

CLUB doesnt have a lot of big moving parts on the balance sheet or in financing so weve simplified the
cash flow statement similarly to calculating FCF. We havent added back stock-based comp or similar
since we dont believe it makes a material difference and doesnt alter the conclusion. We see CLUB
turning in a slight cash increase of $2m for 2015, but 2016 will be a long year of pain & suffering absent
some unexpected good fortune, as we project the company will go through $54.4m of cash in 2016.
2017 is going to be so unspeakably terrible itll make management and investors (if theres any left by
then) beg for the only horrible days of 2016. Unless weve made a major judgement error about the
stickiness of members in the face of increasing competition, it seems unlikely that CLUB gets through
2017 without reorganization, either in or out of court. Allowing for a few miracles, CLUB makes it into
2018, but by then the goose is cooked.

We believe the equity is worth zero, though weve been bearish for years5. Anyone considering
shorting this stock into the ground would be well-served to remember the adage, markets can stay
irrational longer than you can stay solvent. Low-priced micro-caps can see huge price swings on little
or no new information, so while were confident of the outcome, we are not so confident of the path.

E.g. 2/20/2014: For those still long $CLUB think it through. There is zero chance this co can turn it around without
an unpleasant restructuring/makeover. https://twitter.com/The_Analyst/status/436551614418014208?lang=en

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The involvement of activist hedge funds introduces an additional source and degree of risk. Take an
extra dose of caveat emptor with this one.
Restructuring
Absent a series of miracles, CLUB is going bankrupt within the next 2.5 years, probably sooner. The
company seems to have a year and a half, maybe two if theyre lucky, before theyre out of cash with a
semi-useless revolving credit facility maturing in 2018q4. You cant amend & extend your way out of a
liquidity problem like this, and no bank is going to roll a facility when break-even EBITDA takes some
fancy Excel goal-seeking. There is simply too much debt and not enough cash flow or value to service it.
It is not unusual for firms to pursue restructuring well ahead of an anticipated bankruptcy. Sometimes,
its smarter to hoard cash and face the music sooner rather than hoping for the best and facing scrutiny
later. The question here is not when does the board hire advisors?, but rather whether or not they
already have.
The December 11, 2015 issue of S&P Capital IQ/Leveraged Commentary & Datas Distressed Weekly
listed CLUB on the Restructuring Watch List, showing that on 12/1/2015, CLUB had reportedly hired
Rothschild and its creditors had retained PJT Partners as financial advisors. The next weeks issue
removed the word reportedly, and the item has been listed in subsequent issues as well as the 2016
Distressed Outlook.
This is disturbing.
LCD is a very reputable leveraged finance industry resource. If its repeatedly mentioned in there, its
very likely true. The board (controlled by the activist investors) has a duty to all shareholders to disclose
material information in a timely manner. If CLUB has already engaged financial advisors to explore
strategic alternatives as the saying goes, this should have been disclosed weeks ago. Normally, wed
see this on a press release6 filed with the SEC in an 8-k a few days after it happened7.
One would be hard-pressed to argue that hiring an investment bank to advise the board on strategic and
financial options is immaterial or otherwise not important enough to communicate with shareholders.
Alas, I have seen no such disclosure, and repeated calls/emails to CLUB investor relations seeking
comment have been futile. At best, the company is violating the spirit, nay, the essence, of our securities
laws by actively keeping important information away from investors. Im not a lawyer so all Im going to
say is this situation has some of the markings of less-credible breach of duty and similar lawsuits Ive
seen.

A favorite example: Ryerson hires UBS, buried at the end of a press release attached to one of two 8-ks filed on
the same day: https://www.sec.gov/Archives/edgar/data/790528/000119312507030493/dex991.htm
7
To be clear, issuers are not required to report hiring an investment bank on form 8-k, but section 8.01 is explicitly
reserved for (emphasis ours) events that are not specifically called for by Form 8-K, that the registrant considers
to be of importance to security holders. See: https://www.sec.gov/answers/form8k.htm

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That aside for now, CLUB needs to reduce its debt and cut expenses in the face of almost certainly
irreparable revenue declines. Easy fix, right? Just work the sales staff harder and bring in more
members! Sounds great in theory, but theyd have to do it while cutting costs, and theyd have to add
over 100,000 members by 2018. Fortunately for the company, theres an easier way: Just close some
poorly-performing clubs. Maybe more than just some; a lot. Like 50 or 60 out of the 154 current
locations a lot. Theyd need to somehow do this while keeping the same prices and membership levels I
discussed above. Theyd need to transition members of to-be-closed clubs to nearby ones or make up
any difference with new members. If they can pull that off, the company can probably restructure its
almost ~$300m in LT debt to a maybe serviceable ~$100m, which of course would wipe-out the existing
equity. Closing down locations when youre suffering from pricing pressure and declining demand is an
exercise in cutting off ones nose to spite ones face; youre fixing the cost problem by making the
revenue problem even worse.
I havent modeled it, but a better alternative, and one I think lenders and Wall Street more broadly
would like to see is for CLUB to franchise at least part of its locations. They get to shift the costs to
franchisees without throwing a few 100,000 memberships out the window like they probably would by
closing locations alone. Of course this is not as easy as it sounds, but its something Id hope the firms
directors and advisors are considering.
Concluding Thoughts

Given the choice of taking the red pill or the blue, CLUB management long-ago reached for the blue pill
and went about living their days under blue skies and rainbows, or so they thought. The end result of
their inability and indifference to adapt to a rapidly changing industry and consumer preferences has the
firm running on borrowed time. The smart-money activist investors took the red pill and have been

TOWN SPORTS INTERNATIONAL & THE SOUND OF INEVITABILITY

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trying to right the ship for almost a year and a half with little luck. Perhaps they regret choosing the
harsh reality of the fitness industry, or perhaps theyre willing to hold on until the very end.
One thing is certain though:
Absent material strategic and financial restructuring, CLUB is facing an inevitable bankruptcy.

Disclosure: The opinions presented herein are solely those of Stone Street Advisors LLC. Neither Stone
Street Advisors LLC nor any of its members has a position in CLUB or CLUB derivatives, nor any plans to
initiate a position. Nothing contained herein shall constitute a solicitation, recommendation or
endorsement to buy or sell any security or other financial instrument. Stone Street Advisors LLC makes
no representation or warranty as to the accuracy, completeness or timeliness of the information
contained herein, and disclaims all liability arising from errors or omissions contained in this
presentation. This document is presented for informational purposes only and does not constitute
investment advice. Stone Street Advisors LLC is not an Investment Advisor.

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