Crunching Town Sports Internationals Surprise Fourth Quarter & 2015 Profit

Jordan S. Terry
March 8, 2016
Town Sports International
Price (3/8/2016)
Shares Out (1,000's)
Market Cap (1,000's)
LT Debt
Less: Cash
Enterprise Value
P/E (core)
EV/EBITDA (core)

1.86
25,000
46,500
266,189
98,011
214,678
NM
NM

Target Price
Return to Target
Action
Rating
Rationale

(NASDAQ: CLUB)
0.00
-100%
Reiterate
N/A
Worse than expected, deteriorating
operating performance, ratings
downgrade, restructuring watch

In our January report on the New York Sports Club parent, and again in February, we said, and affirm:
We reiterate our belief that CLUB equity is worth zero, though weve been bearish for years1.
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. Significant involvement of activist hedge funds
introduces an additional source and degree of risk to the terminal short case.
Take this one with an extra dose of CAVEAT EMPTOR!
On Monday, Town Sports International (NASDAQ: CLUB) reported $21.6 million net income and $0.84 in
diluted EPS for full-year 2015, a massive surprise, sending the stock soaring about 60% on the day.
Where is this surprise profit coming from?
Always, Always Read Past the Headline
Unfortunately for those buying hand-over-fist on the news, the only surprise in that earnings number
was that it included the huge impact of a last-minute wind-down of the companys sale-leaseback
1

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

CRUNCHING TOWN SPORTS INTERNATIONALS SURPRISE FOURTH QUARTER & 2015 PROFIT

transaction for the 86th street location in NYC, which it sold, and received cash proceeds from in 2014.
Backing-out this one-time item, which is an accounting issue, unrelated to the companys actual
operating performance, CLUB would have actually lost around $60 million, which still includes the $14
million tax benefit claimed for the year. Instead of the company delivering 2015 EPS of +0.84, core EPS
would actually be a loss of $2.35!
To be clear: Town Sports is not actually making money, let alone the enormous piles of it the headline
would have you believe.
Membership Jumps, Revenue Sinks
Revenue from membership dues was down 10% over 2014, and total revenue was down 6.5% from
$453.8 million to $424.3 million, despite membership increasing by 12%. I dont blame the company and
bullish traders/investors for anchoring onto the record membership numbers and big membership
growth, but the problem is that to get these new members, the company is charging low fees, more
than offsetting the benefit from the new memberships. Average monthly revenue/member went down
16.4% from $78 in 2014 to $65 in 2015, and monthly membership fees/member were down 19.4% from
$59 to $48. Both of these will fall even more for the foreseeable future. By our generous estimates,
average monthly fee revenue will drop another 6-9% to $61 and ~$43 in 2016 alone!
STONE STREET ADVISORS LLC
Town Sports International (CLUB)
3/9/2016
Case: Bull
Membership Dues
Membership Dues Growth
Initiation & Processing Fees
Ancillary Non-Training Club Revenue
Other Revenue
Fee Revenue
% Change
Personal Training Revenue
Total Revenue
Revengue Growth
Actual v SSA Estimate
Total Members
Membership % Change
Actual v SSA Estimate
Change in Members/Avg # of Locations
Total Revenue/member/month
Monthly Revenue/Member % Change
Actual v SSA Estimate
Membership Fee Revenue/member/month
Monthly membership fee/member % Change

Historical
2013
358,761

Estimated

14,392
24,720
5,985
403,858

2014
343,185
-4.3%
12,044
22,304
5,971
383,504

66,367
470,225
-1.8%

70,338
453,842
-3.5%

497,000
-2.5%

484,000
-2.6%

78.8

-83
78.1
-0.9%

60.2

59.1
-1.8%

Actual

2015E
2015A
333,280 309,096
-2.9%
-9.9%
20,000
13,644
22,400
22,138
5,917
6,254
381,597 351,132
-8.4%
78,300
73,191
459,897 424,323
1.3%
-6.5%
-7.7%
540,000 541,000
12%
12%
0.2%
368
376
71.0
65.4
-16.4%
-8%
51.4
47.6
-19.4%

Estimated
2016
281,880
-15.4%
10,000
20,000
5,000
316,880

2017
272,830
-3.2%
20,000
5,000
297,830

2018
280,041
2.6%
20,000
5,000
305,041

78,300
395,180
-14.1%

82,215
380,045
-3.8%

86,326
391,367
3.0%

540,000
0.0%

567,000
5.0%

595,350
5.0%

0
61.0
-6.7%

180
55.9
-8.4%

189
54.8
-1.9%

43.5
-8.6%

40.1
-7.8%

39.2
-2.2%

CRUNCHING TOWN SPORTS INTERNATIONALS SURPRISE FOURTH QUARTER & 2015 PROFIT

We explained how this would play out last May, again in our January report, and again in our February
update; it isnt rocket science! Due to more and stronger competition from the likes of Planet Fitness
and its $10/month memberships, and high-end ones like Equinox or Lifetime (both >$100/month), midrange gyms like New York Sports Club are stuck between a rock and a hard place, losing members to
both. Their solution was to try to compete on price, lowering their monthly membership fees
substantially. This allowed new members to join at a rate drastically lower than what existing members
were paying, but allowed current members to drastically lower their membership fees and switch from
annual to monthly contracts. THIS is why membership is growing and why attrition is fallingfor now.
Where Did the Profit Come From?
CLUB rents all of its locations, though until late 2014, it owned a building on 86th street in NYC. They sold
this building on September 12, 2014, receiving proceeds of $85.6 million, and committed both to leasing
the space back from the new owner, and to leasing space in the new high-rise building that will go up in
its place. CLUB got the money, the cash, in 2014; its right there in the financial statements.

For accounting purposes (not really economic ones), this transaction is classified as a sale-leaseback,
so on paper, it doesnt look quite like a simple asset sale, which is why I think many observers are so
confused with this years results. Lucky for us, theyve gone ahead and explained it in their 10-k:

With a week left in 2015, CLUB decided to walk away from the future lease commitments. As a result,
the accounting treatment of the transaction dictates they have to record it in a certain way, in this case,
as a gain on the sale of the building.
The gain on sale of building they booked in 2015 that led to the huge profit is just accounting!
Theres not actually new money coming in the door!
CRUNCHING TOWN SPORTS INTERNATIONALS SURPRISE FOURTH QUARTER & 2015 PROFIT

Getting Down to Business

Im sure the company, the activist investors running it, and most bulls (especially new ones) will
disagree, but we prefer to look at firms core operating results. Management adjusts to its benefit, we
go the other way and adjust for how a long-term fundamental investor should look at the results. How is
the core, operating business doing, absent the effects of financing/accounting effects and non-recurring
items? Now that CLUB has sold and accounted for all of its remaining hard assets (the 86th street
building), weve gone ahead and adjusted CLUBs reported results for 2015 by stripping out the effects
of the sale-leaseback wind-down to get to core operating results. We have left the gain on the debt
repurchase, however, as we see that as recurring, even though we think debt repurchases are, for lack
of a better word, extremely stupid. Why burn cash you desperately need to retire debt thats not due
until 2020, AND destroy whats left of your credit rating in the process? Far better to hoard as much
cash as possible, for the very rainy days ahead!
As you can see, the picture changes drastically. A relatively huge profit is actually, on a sustainable,
economic basis, a huge loss.

CRUNCHING TOWN SPORTS INTERNATIONALS SURPRISE FOURTH QUARTER & 2015 PROFIT

STONE STREET ADVISORS LLC

Town Sports International (CLUB)
3/9/2016
Case: Bull
Membership Dues
Membership Dues Growth
Initiation & Processing Fees
Ancillary Non-Training Club Revenue
Other Revenue
Fee Revenue
% Change
Personal Training Revenue
Total Revenue
Operating Expenses
Payroll & Related
Per location
% Sales
Club Operating
Per location
% Sales
G&A
% Sales
Impairment
% Sales
D&A
% Sales
Other & Non-Recurring Expenses (Gain)
Total OpEx - Reported
OpEx % Sales
Total OpEx - Core
Core OpEx % Sales
Operating Income - Reported
Operating Margin
% Change
Operating Income - Core
Core Operating Margin
% Change
(Gain) loss on extinguishment of debt
Interest expense
Equity in the earnings of investees and rental
income
EBT - Reported
EBT - Core
Tax Rate
Tax provision
Net Income - Reported
Net Income Margin
Net Income - Core
Core Net Margin
% Change
EPS - Reported
EPS - Core

Historical
2013
358,761

Estimated

Actual

Estimated

14,392
24,720
5,985
403,858

2014
343,185
-4.3%
12,044
22,304
5,971
383,504

66,367
470,225

70,338
453,842

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%
431,817

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%
453,090

38,408
8.2%
-9.4%
38,408
8.2%
-9.4%

752
0.2%
-98.0%
752
0.2%
-98.0%

181,127
1,184
39.4%
199,206
1,302
43.3%
30,859
6.7%
46,129
10.0%
46,000
10.0%
503,320
109.4%
503,320
109.4%
(43,423)
-9.4%
-5874.4%
(43,423)
-9.4%
-5874.4%

750
22,617

493
19,039

19,000

(17,911)
20,579

18,550

18,000

18,000

(2,459)
19,691
19,691
37.4%
7,367
12,324
2.6%
12,324
2.6%
3%

(2,402)
(16,378)
(16,378)

(62,423)
(62,423)
35.0%
(62,423)
-13.6%
(62,423)
-13.6%
-9.5%
(2.50)

(2,361)
6,807
(73,306)
-210.8%
(14,351)
21,158
5.0%
(58,955)
-13.9%
-14.5%
0.84
(2.35)

(59,339)
(59,339)
35.0%
(59,339)
-15.0%
(59,339)
-15.0%
0.7%
(2.37)

(65,502)
(65,502)
35.0%
(65,502)
-17.2%
(65,502)
-17.2%
10.4%
(2.62)

(49,799)
(49,799)
35.0%
(49,799)
-12.7%
(49,799)
-12.7%
-24.0%
(1.99)

52,611
(68,989)
-15.2%
(68,989)
-15.2%
-660%
(2.84)

2015E
2015A
333,280 309,096
-2.9%
-9.9%
20,000
13,644
22,400
22,138
5,917
6,254
381,597 351,132
-8.4%
78,300
73,191
459,897 424,323

2016
281,880
-15.4%
10,000
20,000
5,000
316,880

2017
272,830
-3.2%
20,000
5,000
297,830

2018
280,041
2.6%
20,000
5,000
305,041

78,300
395,180

82,215
380,045

86,326
391,367

175,898
1,157
41.5%
196,725
1,294
46.4%
30,683
7.2%
46,129
10.9%
47,887
11.3%
(80,113)
417,209
98.3%
497,322
117.2%
7,114
1.7%
846.0%
(72,999)
-17.2%
-9807.3%

167,219
1,115
42.3%
195,750
1,305
49.5%
28,000
7.1%
0.0%
45,000
11.4%
435,969
110.3%
435,969

161,547
1,077
42.5%
193,500
1,290
50.9%
27,500
7.2%
0.0%
45,000
11.8%
427,547
112.5%
427,547

159,916
1,066
40.9%
191,250
1,275
48.9%
27,000
6.9%
0.0%
45,000
11.5%
423,166
108.1%
423,166

(40,789)
-10.3%
-673.4%
(40,789)
-10.3%
-44.1%

(47,502)
-12.5%
16.5%
(47,502)
-12.5%
16.5%

(31,799)
-8.1%
-33.1%
(31,799)
-8.1%
-33.1%

CRUNCHING TOWN SPORTS INTERNATIONALS SURPRISE FOURTH QUARTER & 2015 PROFIT

Note in the top left of these charts that the projections for 2016-2018 utilize my bull case assumptions,
for example, growing membership another 10% and cutting payroll significantly, both of which I think
are pretty optimistic. My base-case assumptions are just a tad less generous, but, its 70 degrees in NYC
in early March, so Im feeling generous. Unfortunately, the numbers speak for themselves, and they are
less forgiving:
Town Sports International (CLUB)
3/9/2016
Case: Bull
CLUB Cash Flows
Net Income - Core
D&A
Capex
% of Revenue
Capex/club
Financing
Impairment
Working Capital
Debt Issuance
Preferred Dividend
Common Dividend
Debt Repayment/Repurchase
Asset Sale
Change in Cash*
Beginning Cash
Ending Cash*

Historical
Estimated
9 months
2014
2015
2015E
2014 9 months 2015
2015E
(68,989) (65,838) (62,423)
47,307
36,042
46,000
42,054
24,073
32,193
9.3%
7.4%
7.0%
279
157
210
4,706
46,129
46,129
(20,994)
(10,000)
2,954
83,400
19,854
(5,166)
4,559
73,598
93,452
93,452
93,452
88,286
98,011

Actual
2015A
(58,955)
47,887
30,471
7.2%

46,129
9,185

13,985
(17,235)
93,452
76,217

Estimated
2016
2016
(59,339)
45,000
27,663
7.0%
184
(5,000)
17,924
(54,926)
98,011
43,085

2017
2017
(65,502)
45,000
26,603
7.0%
177
(5,000)
12,895
(55,000)
43,085
(11,915)

2018
2018
(49,799)
45,000
27,396
7.0%
183
(5,000)
12,866
(40,061)
(11,915)
(51,976)

Cooldown
When CLUB earnings came out Monday evening, I was actually walking into the New York Sports Club
location on Mercer Street in Manhattan. As usual, I talked about the company with the employees on
my way in. Apparently the current plan is to upsell all of the new members in the $20-45/month singlelocation (or regional) membership plans to the $60-$70/month Passport plans. In the former, you use
your home gym, and if you want to use another, you pay a fee, around $13/visit. I agree, thats
ridiculous. They also agree, and think that by pricing that fee so high, they can more easily convince
single-location members that it makes sense to get the Passport plan. If youre going to another
location twice per month, you actually save money with the more expensive plan! Which is true,
though I question how many people are going to buy that pitch, given how many existing members have
downgraded and how many new members were attracted by the low-price, single-location membership
plan.
CRUNCHING TOWN SPORTS INTERNATIONALS SURPRISE FOURTH QUARTER & 2015 PROFIT

While I understand the rationale, Im not so sure this strategy is going to play out as theyre
hoping/expecting, just as I predicted correctly that the original high value, low price strategy
introduced in late 2014 would fail.
Most people do not appreciate a bait & switch, regardless of whether the economics make sense.
Again:
We reiterate our belief that CLUB equity is worth zero, though weve been bearish for years2.
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. Significant involvement of activist hedge funds
introduces an additional source and degree of risk to the terminal short case.
Take this one with an extra dose of CAVEAT EMPTOR!

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.

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

CRUNCHING TOWN SPORTS INTERNATIONALS SURPRISE FOURTH QUARTER & 2015 PROFIT