Life Time takes a beating

Life Time Fitness Inc., once considered a sure bet for outsize returns, is beginning to resemble a runner on a hyper-pace treadmill.
One missed step, and there's a world of hurt.

The company on Friday confirmed what short-sellers, who have been increasingly betting that the stock would fall, had suspected: That even high-end fitness centers with emporium-size workout rooms and lots of amenities are not insulated from economic reality.

The company, which recently moved its headquarters to Chanhassen from Eden Prairie, forecast 2008 results Friday well below analyst estimates, citing more-cautious consumer spending. Shares plunged 17.5 percent, to a 52-week low of $33.50, a drop that wiped out more than $270 million in stockholder value.

"How is the economy affecting us?" Chairman and CEO Bahram Akradi asked Friday during a conference call with analysts. "It's like biking into a headwind rather than having the wind at your back."

Though Life Time still reported a 35 percent gain in fourth-quarter profit Friday, the company said it expects earnings per share for the year to be $2.05 to $2.08 — up from $1.78 last year, but well below the average analyst estimate of $2.19 a share.

The weaker-than-expected outlook raised questions about the company's aggressive growth plans. It plans to build 11 new centers in 2008 — costing $35 million each — even as its membership growth has slowed and competition is heating up in its largest markets.

Life Time's leveraged balance sheet poses risks that, if the economic downturn intensifies, its rising borrowing costs could squeeze earnings.

Life Time's long-term debt has more than doubled, to $555 million from $258 million in just two years, and interest payments on that debt now eat up 17 percent of operating profit.

At least one analyst believes that the company should suspend its growth plans — and focus on improving returns at existing centers — until the effect of the economic slowdown on fitness clubs becomes more apparent.

"It's like they're putting a third floor on a house when there are signs of cracks in the foundation and a big storm is coming," said Greg Gorbatenko, an analyst with Jackson Securities in Atlanta, which has a "buy" recommendation on Life Time stock. "It might be smarter to sturdy up the basement before you put up more floors," he said.

In an interview Friday, Akradi strongly disagreed with that view, and suggested the market's reaction to the company's 2008 forecast was overdone.

"If we were not making money, or we were making less money than a year before, I would say we've really got to stop and rethink expanding," Akradi said. "But we're still growing our net income more than 20 percent a year. … I asked analysts how many companies are growing 20 percent a year, and they can't name one."

He pointed out that, while membership growth has slowed, much of that decline was the result of price increases designed to boost the company's top line. The strategy, he argued, was a success. Membership at some of the company's older centers declined, while the higher rates helped to push up Life Time's revenue 22.8 percent in the fourth quarter, to $171.1 million.

The price increases were meant to address another problem: overcrowding. Life Time prefers to have about 10,500 members per location, but membership at some of its older locations has crept up to 13,000.

At the Life Time centers in Bloomington and St. Louis Park, parking lots aren't big enough to accommodate the crowds; and shuttle buses run from distant parking lots at peak hours of the day. "You'd hope that a company's worst problem is that its stores are too full," said Suzanne Price, an analyst with ThinkEquity Partners. "Even if they're turning away customers, the important thing here is their revenue is growing. It's a deliberate tradeoff."

Indeed, while retailers report a broad pullback in consumer spending, existing Life Time members have shown no signs of cutting back. Last year, the average Life Time member spent $387 on extra services, such as personal trainers and massages, up 9.1 percent from a year earlier.

Yet in recent quarters, the company has cut enrollment fees at many centers and increased commissions to its sales force — a worrisome sign, analysts say, that the company is having to pay more to attract new members.

Competition may be part of the reason. LA Fitness of Carrollton, Texas, has 32 centers in Texas and Minnesota — Life Time's two largest markets — and is planning more in both states.

And many of Life Time's planned new stores for 2008 are in existing markets such as Houston, Chicago and Atlanta, where the company already has multiple locations and faces tight competition from lower-price operators. Life Time charges $59 to $79 for an individual membership, vs. $45 at LA Fitness.

"The consumers that are getting squeezed are going to become more focused on centers with no frills and no free fluffy towels," said Gorbatenko, referring to Life Time's long-standing policy of offering free towels to its members.

Akradi said he's not worried about LA Fitness, noting that it serves a lower-end customer than does Life Time. "You have to bring your own towels and your own [locker] padlock," he said. "They're more like a Hampton Inn. … For a $20 monthly difference in dues, people don't give up the difference they've had."

Chris Serres • 612-673-4308