Moody’s Investors Service downgraded 24 Hour Fitness Worldwide, Inc.’s ratings including its Corporate Family Rating (CFR) to Caa1 from B2, Probability of Default Rating to Caa1-PD from B2-PD, first-lien bank credit facilities to B2 from Ba3 and senior unsecured notes to Caa2 from Caa1. The outlook is stable.
The downgrade follows the weaker than expected EBITDA forecasts for the full year 2019 and 2020 as a result of a decrease in new member sales conversion and higher attrition rates. These factors contributed to a sizable decline in membership count and an acceleration in comparable club revenue declines in the third quarter. Moody’s believes competition will make it challenging to quickly restore conversion to levels achieved prior to the EVO implementation, and reduce attrition. Based upon the revised EBITDA expectations, Moody’s now forecasts that funded debt/EBITDA (excluding operating leases) will peak at about 8.2x in the middle of 2020 and EBITA/interest expense (excluding operating leases) will fall to 0.3x. This level of leverage and coverage would make it challenging for 24 Hour Fitness to refinance its existing debt on economic terms barring a material improvement in EBITDA.
The two-notch downgrade to Caa1 acknowledges the significant challenge 24 Hour Fitness faces to improve both EBITDA and credit metrics in the second half of 2020 and in early 2021 when it will need to address approaching maturities. This includes the need to very quickly address the customer service in the clubs, the heightened competition from the budget gym operators and other smaller more local chains as well as the ongoing expense pressures. 24 Hour Fitness operates in the most highly competitive mid-tier price point within the fitness club sector which has felt the most pressure from the budget gym formats and consumers have numerous options from which to choose. Currently, 24 Hour Fitness’ $837 million term loan has a springing maturity to March 2022 from May 2025, three months prior to the June 2022 maturity of its $500 million unsecured notes if more than $100 million of the notes remain outstanding. The two notch downgrade also acknowledges the erosion in 24 Hour Fitness’ liquidity as a result of lower than expected cash balances and a higher reliance on its $120 million revolving credit facility.
Downgrades:
..Issuer: 24 Hour Fitness Worldwide, Inc.
…. Corporate Family Rating, Downgraded to Caa1 from B2
…. Probability of Default Rating, Downgraded to Caa1-PD from B2-PD
….Gtd Senior Secured First Lien Term Loan, Downgraded to B2 (LGD2) from Ba3 (LGD2)
….Gtd Senior Secured First Lien Revolving Credit Facility, Downgraded to B2 (LGD2) from Ba3 (LGD2)
….Senior Unsecured Regular Bond/Debenture, Downgraded to Caa2 (LGD5) from Caa1 (LGD5)
Outlook Actions:
..Issuer: 24 Hour Fitness Worldwide, Inc.
….Outlook, Remains Stable
RATINGS RATIONALE
The Caa1 CFR reflects Moody’s forecasts that 24 Hour Fitness’ EBITDA will decline further resulting in funded debt/EBITDA (excluding operating leases) peaking at 8.2x while EBITA/interest expense (excluding operating leases) will erode to 0.3x. The CFR also acknowledges 24 Hour Fitness’ high regional concentration in expensive labor and rent markets with about 50% of its clubs located in California which has resulted in a continued increase in its operating expense level per club. The CFR is constrained by 24 Hour Fitness concentration in the mid-tier price point which faces the most intense and challenging competitive pressures against the budget clubs and smaller local clubs in the fitness club sector. It also is constrained Moody’s view that the highly fragmented and competitive fitness club sector has high business risk given its low barriers to entry, exposure to cyclical discretionary consumer spending, high attrition rates and the trend towards budget gym memberships.
However, 24 Hour Fitness’ credit profile is supported by its well-recognized brand name in core markets, and adequate liquidity that provides some time to address the weak operating performance. Moody’s also expects a moderate level of industry growth both from economic expansion in the US over the next twelve to eighteen months as well as from longer term trends such as the aging of the US population, the apparent under penetration of fitness clubs and the increased awareness of the importance of fitness.
The stable outlook reflects that the Caa1 CFR already incorporates Moody’s projection for further EBITDA declines through the first two quarters of 2020. The outlook also reflects that 24 Hour Fitness’ adequate liquidity – largely provided by its revolving credit facility and lack of any debt maturities until the earliest of March 2022 — creates some flexibility to execute turnaround strategies.
Given the expectation for further weakness in operating performance, an upgrade is unlikely at the present time. However, ratings could be upgraded should operating metrics meaningfully strengthen including comparable club revenue, new membership conversion and attrition rates. An upgrade would also require EBITDA reaching a level such the EBITA/interest expense is likely to be sustained above 1.0x even after factoring in any higher cost of capital associated with refinancing the 2022 debt maturities.
Ratings could be downgraded should 24 Hour Fitness fail to demonstrate an improvement in new member conversion levels, attrition rates, and earnings. A deterioration in liquidity or increase in the likelihood of a distressed exchange or other default could also lead to a downgrade.
Headquartered in San Ramon, California, 24 Hour Fitness Worldwide, Inc. is a leading operator of fitness centers in the US. As of September 30, 2019, the company operated 448 clubs serving approximately 3.4 million members across 13 states and 23 markets, predominantly in California, Texas and Colorado. For the twelve months ended September 30, 2019, revenue was about $1.5 billion. In May 2014, 24 Hour Fitness was acquired by affiliates of AEA Investors LP, Fitness Capital Partners and Ontario Teachers’ Pension Plan for a total purchase price of approximately $1.8 billion.
