Bets grow against Life Time's fitness

Investors in Life Time Fitness Inc. may want to take one of the company's "stress management seminars" before it posts fourth-quarter results Feb. 22.

Membership growth at the Eden Prairie-based company has slowed and its costs for attracting new members have increased -- early indications that its large-format fitness centers are not immune from the contraction in consumer spending, some analysts maintain. And competition is heating up in Life Time's two largest markets: Minnesota and Texas.

Those concerns, as well as the company's debt level and rich stock valuation relative to its peers, have given ammunition to short sellers, who are betting that the company's remarkable run of 14 consecutive quarters of 20 percent-plus earnings gains may come to an end. The company's short interest -- borrowed shares sold by investors who expect the stock to fall -- has risen to about 26 percent of the stock outstanding.

Shares of Life Time's stock trade at 24 times trailing per-share earnings, well above the average multiple of 18 within its fitness-center peer group.

"There is a market belief that membership in a fitness location is discretionary, and that the ability of this company to maintain the same level of member growth will be challenged in an economic climate that is not as strong," said Dana Walker, a portfolio manager at Kalmar Investments Inc., which owns about 900,000 shares of Life Time stock.

Bulls argue that Life Time's rich multiple is justified by its business model, which is based on building huge fitness centers in wealthier suburbs, such as Chanhassen and Scottsdale, Ariz., whose residents are viewed as more insulated against downturns. These centers average 110,000 square feet (three times the size of a Best Buy store) and typically contain swimming pools, basketball courts, child care centers, climbing walls and other amenities. Each center costs about $30 million.

A different experience

A working-Joe gym rat may balk at Life Time's fees -- $59 to $79 a month for an individual membership -- but the company's CEO insists Life Time isn't really interested in those customers anyway.

"LA Fitness, 24 Hour Fitness, Gold's, World's, all those types of facilities offer a basic fitness center experience, like a Hampton Inn does as a hotel," CEO Bakram Akradi said during the company's third-quarter earnings conference call last September. "Frankly, we don't really focus on that customer."

The problem is, the pullback in consumer spending is moving up the income spectrum. Among high-end retailers, Coach, Tiffany & Co., Saks Fifth Avenue and Nordstrom all experienced a holiday season slowdown in sales.

Hedge funds that have been betting against the stock have called attention to a sharp increase in the company's membership origination costs, which are amortized over three years. Those costs rose 22 percent in the third quarter to $15.4 million, from $12.6 million, outpacing the 17 percent growth in deferred revenue.

Suzanne Price, an analyst with ThinkEquity Partners, which has a buy recommendation on the stock, said Life Time's management assured her the higher origination costs were the result of an effort to sign up new members with higher monthly fees. Sales associates earn a higher commission on those memberships, she said.

LA Fitness' rapid expansion also reminds investors of Life Time's lack of geographic diversification, a weakness some may have overlooked. Of its 71 fitness centers, 39 are in Minnesota and Texas.

Lower-cost LA Fitness now has 32 centers in Texas and four in Minnesota, and is planning more in both states.

Bank of America analyst Scott Mushkin downgraded Life Time's stock in October, citing in a research note the company's "overexposure to Minnesota."

Debt is another concern.

To fund its rapid growth, Life Time has relied almost entirely on bank loans and mortgages backed by its real estate. The firm has more than $470 million in long-term debt, and the interest eats up 20 percent of its operating profit. With banks tightening credit, many analysts expect Life Time's borrowing costs to rise in 2008.

Chris Serres • 612-673-4308