Bally's Business in Better Shape, but Shareholders Still in a Sweat


Nationwide gym operator Bally Total Fitness Holding Corp. is whipping its business into better shape, but that's nothing compared with its stock's calisthenics this year.

Bally's shares tripled in price between mid-1997 and mid-July of this year in response to the company's improvement, then dropped like dead weight during the last two months, plunging 48% since July 20. The stock closed Friday at $19.19 a share, up 6 cents on the day, in New York Stock Exchange composite trading.

The sell-off is blamed largely on Wall Street deciding that Bally's price had climbed much too high relative to the company's outlook, even though that outlook is improving. The Chicago-based firm is the nation's largest fitness center chain, with 4 million members using 325 centers in 27 states and Canada. Most of its 40 California sites are in Los Angeles and Orange counties.

Some Bally bears also have raised questions about whether the chain's recent earnings gains partly reflect accounting methods that might not leave the company with sufficient cash reserves. But Bally's chief executive, Lee S. Hillman, called those concerns "open-ended nonsense" and said Bally's accounting is "the most conservative" in any membership business.

Finally, Bally's stock swings also are blamed on "momentum" traders who pounce on stocks moving up. That helps propel a stock even higher but, once the price stalls, those traders bail out and exacerbate the price's drop.

Regardless, Bally's remaining stockholders aren't the only ones sweating the shares' retreat. So is the company's closest rival, Fitness Holdings Inc., because it's preparing its initial public stock offering.

Fitness Holdings, based in Pleasanton, Calif., operates 24-Hour Fitness facilities in California and other Western states, with 1.6 million members at its 173 clubs.

Last month, the company announced plans to raise about $75 million with its stock sale, but the plunge in Bally's price--and in the stock market generally--isn't the kind of advertising to help pump up interest in Fitness Holdings' shares.

Nonetheless, Fitness Holdings continues to pursue the offering, said Gilbert Freeman, its chief financial officer. He declined to elaborate, citing the "quiet period" that executives observe while their company's IPO is in registration before the Securities and Exchange Commission.

The fitness club industry, with 13,800 centers run by mostly small firms, generates about $9 billion in annual revenue and is growing. Memberships surged to 22.5 million in 1997, from 13.8 million a decade earlier, according to the research firm American Sports Data Inc. in Hartsdale, N.Y.


But for each operator, growth is a constant battle because fitness fans move around. Clubs on average lose one-third of their members every year--although Bally says its attrition rate is less than 25%--meaning they must recruit that many new customers just to keep their membership rolls even.

Even so, Bally and Fitness Holdings plan to open more gyms and are looking for smaller operators to buy. Bally also has been upgrading its facilities with new equipment and decor, and it's shifting the type of memberships it peddles to boost earnings.

During the last four years, Bally lost more than $100 million. But in the six months ended June 30, Bally earned $4 million on revenue of $365 million, and analysts expect the company to post a profit for all of 1998.

"The response from our members [to the changes] has been tremendous," Hillman said in a telephone interview. "Our referral business has gone up dramatically, and customer-satisfaction levels are up as well."

Bally has always let members pay their initiation fees upfront and in full with cash, or over time with an installment loan from Bally. But between 1991 and 1996, when Bally Total Fitness was part of the old Bally Entertainment gaming empire, the club emphasized the upfront plans to generate quick cash.

Since it wanted more members to pay cash, Bally also focused on selling "single-club" memberships that were more affordable--and provided thinner profit margins--than those allowing members to use any Bally outlet. The result: Bally's performance suffered.

Now Hillman has Bally again emphasizing more expensive "full-club" memberships that Bally will finance at 16% to 18% interest. Last year, the average price of its memberships jumped 18%, to $970, with members making an average down payment of $81. (Their members' monthly dues average just under $8.)

The push is "to convert those highly discounted cash memberships to higher-margin, financed memberships," said Andrew Zarnett, an analyst at Ladenburg Thalmann & Co., which helped underwrite a Bally stock offering in May.

The new arrangement not only helps Bally's earnings, it also helps reduce attrition because the full-club membership "is the most popular one we offer," Hillman said. About 85% of Bally's new memberships are now financed, he added.

Fitness Holdings operates differently. It doesn't make loans to members and typically charges lower initiation fees than Bally's ($49 to $299), but higher monthly dues (from $19 to $35).

Regardless, Fitness Holdings has struggled, too. It earned a profit only once in the last five years, and in 1998 lost $17 million on revenue of $262 million, according to its IPO prospectus.

To be sure, Fitness Holdings notes in its prospectus that it's been busy making acquisitions, which have added to its debt load and typically require the company to incur noncash charges that lower its earnings.

But the company says it has strong cash flow to service the debt and continue its expansion, and that it will become more profitable as it continues spreading its costs over a greater number of facilities.

Bally and Fitness Holdings have another major asset that could help boost their earnings and stock prices--their bulk. Because the fitness market is largely composed of little operators, it's a market ripe for consolidation at the hands of those two giants, analysts said.



After soaring early this year, Bally Total Fitness' stock has plummeted amid Wall Street sentiment that the price was too high relative to the fitness chain's outlook. Weekly closes and latest on the New York Stock Exchange:

Friday, Sept: $19.19

* Source: Bloomberg News

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