CORPORATE FOCUS — Sports Club Is Pumping Up Too Fast to Attract Investors


As the Sports Club Co. beefs up, Wall Street is responding by kicking sand in the fitness company’s face.

The West Los Angeles-based owner/operator of luxury sports and fitness complexes is in the midst of a major expansion. The Sports Club/LA at Rockefeller Center opened in February and four other clubs will debut later this year and early next year on New York’s Upper East Side, in Washington, D.C., San Francisco and Boston.

Despite potential rewards down the road, the company’s rapid pace of expansion has dragged down its stock price and earnings in recent months.

“We didn’t expect in 2000 or 2001 to make money,” said Rex Licklider, vice chairman and co-CEO. “We knew it wouldn’t bode well on the stock price in the near term.”

The Sports Club’s thinly traded stock was trading at around $3.50 a share last week, closer to its 52-week low of $2.75 than to its 52-week high of $6.13.

Wall Street prefers companies that grow their earnings consistently, quarter after quarter, but the Sports Club’s bottom line has been hurt by development costs. Each club costs about $30 million to build, with the new flagship New York club clocking in at close to $55 million.

So it’s little surprise that the Sports Club posted a net loss of $2.1 million (12 cents per diluted share) for the first quarter ended March 31, vs. net income of $551,000 (3 cents) for the year-earlier quarter. The loss included a charge of $1.47 million to settle litigation, $2.5 million in pre-opening expenses and pre-sales activities at new clubs, and interest expenses related to the $100 million of notes issued last April to finance the expansion.

Revenues were also down in the first quarter, to $16.8 million, more than a 20 percent drop from $21.7 million in the year-earlier period.

The revenue drop stems from the December 1999 sale of the mid-range Spectrum Clubs as part of the company’s decision to focus exclusively on its upper-tier Sports Club outlets. Although the sale generated $50 million in cash, those clubs are no longer contributing revenues.

New development is the only way for the Sports Club to grow, Licklider said, because there are no other comparable clubs or chains for it to buy. Historically, new clubs aren’t profitable until they’ve been operating for at least a year, he said.

But if the company’s existing clubs are any indication, it’s just a matter of time before the new clubs start bolstering the bottom line. The four clubs the company operated last year in West L.A., New York’s Upper West Side, Las Vegas and Irvine produced almost $20 million in cash flow, Licklider said.

“As these new clubs open and ramp up, revenues and profitability should increase rapidly,” Edward Vanacore, an analyst at Sutro & Co., wrote in a recent report. “The Sports Club Co. has the potential for more rapid growth within the next five years than the overall industry, may experience less competitive pressures, and operates in a niche with greater margin potential.”

Even though he is bullish on the stock in the long term, Vanacore currently maintains an “accumulate” rating on the stock, citing investors’ general aversion to risk at this point.

Brett Hendrickson, an analyst at B. Riley & Co., agreed with Vanacore’s long-term bullish outlook.

“Wall Street might not understand the clubs in the short term, but in the longer term (when) they’re producing cash flow, they have a stock that could go back to $8 or more,” Hendrickson said.

Licklider said if all nine clubs perform according to the Sports Club’s forecast, the company would be able to build two more clubs a year out of internally generated funds.

Another factor holding down the stock price is that investors find it “difficult to get a handle on the industry,” Licklider said. There is only one other publicly traded fitness center operator, Bally Total Fitness, and it caters to more of a mainstream mass market, rather than the upscale segment.

Sports Club executives appear to be backing up their bullish talk with money. Licklider and Chairman and Co-CEO D. Michael Talla have together purchased close to 700,000 shares in the past six months.

The company’s board last month amended its shareholder rights plan to allow Talla and Millennium Entertainment Partners (Sports Club/LA’s landlord in several locations) to purchase up to $2 million more common shares each. Millennium owns about 28 percent of shares outstanding, Talla also owns about 28 percent and Licklider 10 percent.

“If Wall Street won’t reward them, they buy the stock themselves. They’re confident in the cash flow they’re going to produce,” analyst Hendrickson said.

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