S&P Global Ratings upgraded the debt ratings of Life Time, Inc. due to the operator of upscale health clubs’ planned refinancing and improving metrics.
The rating agency said Life Time intends to refinance its senior secured first-lien term loan B and extend its maturity to 2026 from 2024. Life Time also demonstrated good membership, revenue, and EBITDA trends in the first quarter, which led S&P to raise its base-case assumptions for its 2023 revenue and EBITDA.
S&P raised its issuer credit rating on Life Time, Inc. to ‘B’ from ‘B-‘ and its issue-level ratings on its debt by one notch. At the same time, S&P assigned its ‘BB-‘ issue-level rating and ‘1’ recovery rating (90 percent to 100 percent; rounded estimate: 95 percent) to its proposed first-lien senior secured term loan B.
The positive outlook reflects S&P’s expectation that the company will gradually reduce its revolver balance over the next few quarters, improving its leverage to the mid-5x area by the end of 2023, despite S&P’s expectation for a shallow recession starting in the second half of the year.
S&P said in its analysis, “The upgrade reflects our expectation that Life Time’s leverage will decline to the mid-5x area by the end of 2023. Our base-case forecast assumes the company’s dues and center memberships increase by approximately 10 percent as of year-end 2023, compared with year-end 2022, though its memberships will still be approximately 5 percent below its results as of year-end 2019. We anticipate Life Time will continue to increase its member tally by the mid-single-digit percent range in 2024 and onward. We also expect the company will increase its average monthly dues from paying center memberships to $160-to-$170 per member in 2023. Furthermore, we assume the company’s average prices will increase as it sheds the legacy cohort of members paying lower rates. This is largely in line with our previous base-case forecast; however, we have upwardly revised our EBITDA margin assumption by about 300 basis points in 2023. The high flow-through of incremental revenue to Life Time’s EBITDA, due to the coverage of its fixed-charge base and refined cost structure, has supported an EBITDA margin in-line with its pre-pandemic results, and we expect that it will maintain its margin at this level. We now expect the company will end 2023 with leverage in the mid-5x area and 2024 with leverage in the low-5x area, which compares with the high-6x area as of the end of the first quarter of 2023.
“Life Time plans to develop new clubs and intends to fund about half of the costs with the proceeds from sale-leaseback transactions. We expect the company will use these proceeds to partially finance its growth capital spending over the next several years. We assume Life Time will spend $550 million to $600 million annually on capital expenditure (CAPEX) in 2023 and 2024 to develop approximately 10 clubs per year. We also expect the company will close on approximately $300 million of sale-leasebacks in 2023 and a similar amount in 2024. While we believe Life Time has adequate liquidity to fund its capital spending needs over the next several years, its club development spending typically precedes the closing of its sale-leaseback transactions, which creates incremental financing risk. We do not believe the company has faced difficulty in closing its sale-leaseback transactions, though rising interest rates and recessionary conditions in 2023 could make securing financing more difficult. While the company drew on its revolver in the first quarter of 2023, we expect it will be able to repay its revolver balance during the year with proceeds from its sale-leaseback transactions. Life Time has also stated that to begin funding its new club development with internally generated free cash flow, it would need to achieve about $600 million of EBITDA. We believe the company’s incremental financing risk would be significantly declined if it generates EBITDA at that scale. The company has also indicated a desire to begin using higher levels of landlord financing for its new club development instead of sale-leaseback transactions. We believe that this strategy would support an improvement in its cash flow profile and help reduce the financing risk related to its sale-leaseback strategy. We have yet to see evidence that the company has begun executing this strategy in a material way.
“We believe price increases could partially offset the reduction in its club memberships, relative to historical levels, and the significant inflationary pressure. Life Time has significantly raised its monthly dues for new joiners compared with its pre-pandemic levels, and we believe it will continue to raise prices for new memberships in 2023, which will support increasing annual dues revenue through at least the end of 2023. Therefore, we believe the company could match its pre-pandemic EBITDA levels even with a lower per-club membership base than before the price changes. However, given the significant macroeconomic risk, this strategy could leave Life Time vulnerable amid a recessionary environment characterized by declining consumer spending.
“The positive outlook reflects our expectation that the company will begin to reduce its revolver balance over the next few quarters and could improve its leverage to the mid-5x area by the end of 2023, even after incorporating our expectation for a shallow recession in 2023.”
Photo courtesy Life Time
