Brent R. Rystrom [email protected] (612) 492-8810 Consumer-Retail Life Time Fitness Inc. (LTM - $18.91) July 15, 2009 Initiating Coverage STRONG BUY Financial Summary Key Points: Rev(mil) 2008A 2009E 2010E • We are initiating research coverage of Life Time Fitness (LTM) with a Strong Mar $184.5 $206.4A $219.3E Buy rating and a $28 price target based on our 2010 EPS estimate of $1.88 and a Jun $192.4 $213.7E $226.2E P/E of 15 times. Sep $198.8 $217.0E $233.8E • Life Time Fitness is the clear “category killer” in the health and fitness center Dec $194.0 $209.3E $230.0E industry. LTM’s centers offer the broadest array of services of any national or regional FY $769.6 $846.4E $909.3E chain, and the pricing of these services is extremely competitive. LTM now operates 84 P/Sales 1.0x 0.9x 0.8x centers in 16 states, and should generate 2009 sales of $846 million. • Life Time Fitness stumbled in 2008-2009, as its aggressive growth strategy relying on EPS 2008A 2009E 2010E company-owned real estate ran smack into the recession, financing difficulties, and Mar $0.44 $0.38A $0.40E higher customer attrition. Jun $0.50 $0.42E $0.43E • We believe LTM’s 2009 second quarter results should be inline to better than Sep $0.55 $0.47E $0.53E Dec $0.33 $0.39E $0.48E Street expectations, and in particular the company will start to shift its tone from a focus on survival and crisis management to one that is more confident in regards to FY $1.83 $1.58E $1.88E earnings, cash flows, balance sheet issues, and eventual earnings growth. P/E 10.3x 12.0x 10.0x • Relative results should improve through the reminder of 2009. Specifically, our model provides negative EPS comparisons in 2009’s 2Q and 3Q, and positive Price: $18.91 comparisons starting in the 4Q. We are modeling EPS of $1.58 for 2009, inline with 52-Week Range: $41.50 -$7.07 consensus of $1.61. Target: $28 Rating: Strong Buy • Street estimates for 2010 EPS are too low. We are initiating with a 2010 EPS estimate of $1.88, well above the consensus 2010 EPS estimate of $1.71 and the highest Shares Outstanding: 40.27 mil Mkt. Capitalization: $762 mil current estimate of $1.81. We believe there is significant upside to our new Street-high Ave. Volume: 557,000 estimate. Instit. Ownership: 96% • LTM is about to become a significant cash generator. Management has BV / Share: $16.66 Debt / Tot. Cap.: 51% repositioned LTM to maximize cash flow instead of rapid unit growth. This transition Est. LT EPS Growth: 15% is about complete and should be visible in 2009 3Q results. • Two interesting side stories could provide interesting positive spin. First, LTM is Company Description looking to develop opportunistic real estate at much lower investment levels, which Life Time Fitness is the dominant “category would incrementally lift LTM’s performance. Second, its extensive portfolio of real killer” in the health and fitness center estate implies a significant liquidity opportunity in a healthy economy. industry. It operates 84 centers that • Rising interest rates present an intermediate-term risk. One risks to LTM’s generate an average $10.3 million each in balance sheet and profitability is the company’s revolving credit facility, which is tied to revenues and have contribution margins near LIBOR. If LIBOR rates rise faster than we have modeled, it could reduce earnings 40%, among the highest of all retail and expectations by 3% to 5% depending on the time horizon and magnitude of the change. service companies. The Company is headquartered in Chanhassen, Minnesota INVESTMENT THESIS: and was founded in 1992. Life Time Fitness stumbled in 2008-2009 as its aggressive growth strategy proved unsustainable in the face of the recession, financing difficulties, and higher customer attrition. As a result, LTM has scaled back unit growth and is concentrating efforts on maximizing cash flow. This should result in an improving financial profile the next 12-18 months and position LTM for an acceleration of growth in 2011 and beyond. Our Strong Buy rating and $28 target price reflects an operational turnaround unfolding the remainder of this year and sharply improved EPS next year. Feltl and Company Research Department. Please see important disclosures on pages 14 to 16. 225 South Sixth Street, Suite 4200 Minneapolis, MN 55402 1-866-655-3431 COMPANY OVERVIEW Life Time Fitness has clearly emerged as the category dominant participant in the health and fitness center industry. LTM’s typical centers are bigger than those of any other major competitor, they offer more programs and services, and all of this at very competitive rates. As LTM works to further improve its value proposition with its members and improves cash flows and the balance sheet, the company should be positioned well to start accelerating growth in late 2010 and beyond. Prototype Facility Life Time Fitness’s prototype facility offers a category dominant assortment of programs and services, including large indoor and outdoor recreational pools, climbing walls, basketball and other courts, 400 pieces of cardiovascular and resistance training equipment, extensive health and fitness classes, spas offering massage and beauty services, and cafes. Life Time Fitness Amenities, Services, Activities, and Events Amenities Services Activities and Events Basketball/Volleyball Courts 24-Hour Availability Aquatics Cardiovascular, Resistance, and Fitness Assessments Athletic Leagues Free Weight Equipment Educational Seminars Birthday Parties Cycle Theatres Experience Life Magazine Eastern/Martial Arts Group Fitness Studios Towel Service Kid's Clubs Lap Pool Locker Service Pilates Racquetball/Squash Courts Massage Therapy Group Fitness Classes Child Center Nutritional Products Scuba Lessons Rock Climbing Cavern Personal Training Studio Cycling Saunas T.E.A.M. Programs Sports Training Camps Two-story Waterslides Cardio O2 Run Summer Camps Whirlpool Spas Cardiovascular and Resistance Swimming Lessons Zero-Depth Entry Swimmings Pools Training Yoga LifeStudio Metabolic Testing Educational Camps LifeCafe Nutrition Coaching Dance Classes LifeSpa Endurance Coaching Athletic Events Pool-side Bistro Member Advantage Run Club, Cycle-Club and other Men's Women's and Family Total Health Interest-driven clubs Locker Rooms myLT.com Source: Life Time Fitness 2008 10-K Life Time Fitness’s prototype center averages 113,000 square feet, and is designed to accommodate a targeted capacity of 8,500 to 11,500 memberships. Prototype centers typically employ 200-300, and 75% of these positions are part-time. Approximately 60% of LTM’s centers are of the current model format. Total capital expenditure for a prototype center is $30 to $35 million, sales per prototype center average near $13.7 million (this is the average for the 22 “mature” clubs), and the typically center-level contribution margin of 44.4% provides an attractive 19% ROI on an unlevered center. If debt is used to fund 75% of the center, the equity ROI jumps to 51% - a level virtually unmatched by any other big box retailer. And these numbers should only get better: LTM’s historical data suggests centers will peak at revenues near $17 to $20 million per location. Life Time Fitness Prototype Center Performance Avg. 22 Mature Long-term $ in millions 2009E Centers Goal Revenues/center$ 10.3 $ 13.7 $ 18.5 Center contribution$ 3.9 $ 6.1 $ 9.0 Contribution margin 38.4% 44.4% 48.5% Center investment$ 22.0 $ 32.5 $ 32.5 ROI: 100% equity 17.9% 18.7% 27.6% 75% debt 47.6% 50.9% 86.4% Source: Life Time Fitness and Feltl and Company estimates Page 2 Life Time Fitness Inc. (LTM) 7/15/09 Life Time Fitness presently operates 84 centers in 18 states and 22 major markets. Its most developed areas include its home market of Minneapolis-St. Paul (24 locations, only two of which are the large format, current prototype), greater Chicago (9 units, all current prototype), Dallas-Ft. Worth (8 locations, 7 current prototype), Detroit (5 locations, 3 current prototype), and Houston (5 locations, all current prototype). The long-term opportunity for new centers remains immense. Its penetration in markets like Dallas-Ft. Worth suggests a nationwide opportunity of 500 or more units, roughly one unit for every 450,000 people living in Metropolitan Statistical Areas. The number of units in Minneapolis-St. Paul may be misleadingly high at 24, but the combined 2.0+ million square feet of these units may also prove illustrative of the opportunity. With a population of roughly 3 million, Minneapolis-St. Paul has 0.57 square feet of center space per capita. Cutting this penetration in to 0.30 square feet per capita for the metropolitan population of the U.S. still yields a national opportunity of near 70 million square feet of center space, or roughly 600 total units based on the present prototype size of 113,000 square feet. LTM Positioned as Value and Convenience Leader Life Time Fitness primarily positions its centers to be a value leader. Membership costs of $50 to $80 a month for individuals or $100 to $150 a month for a couple or family membership compares favorably to the membership costs at most other competitors, despite the fact LTM offers a vastly greater array of programs and services. Children under the age of 12 can be added at a nominal cost, and complimentary services include group fitness classes, educational seminars and fitness assessments, towel and locker service, and a subscription to LTM’s magazine, Experience Life. LTM’s centers are typically open 24 hours a day, seven days a week. The breadth and depth of equipment and facilities helps to ensure little or no waiting time for users.