Closer look at LeisureNet exposes more than a little muscle
'We pay for the cash flow and the profit stream rather than take a risk on an apparent bargain-buy'
SELDOM is the JSE as polarised about a company than it is about LeisureNet. Its supporters hail it as the next Rank Organisation, its detractors accuse it of issuing more paper than it can service.
Before my meeting with the management this week I tended towards the latter camp. Last week while I was surveying the market for potential performers for my 1997 portfolio, every second person recommended LeisureNet. My reservations were that it appeared to lack focus, seemed to pay enormous premiums for diverse acquisitions, the debtors' book looked outrageously high and I wondered if LeisureNet had the depth of management. When you don't go to gym yourself it is hard to understand the appeal, and how does a company match upfront income on a 40-year contract against all those years of expenses?
But when such weighty institutions as Coronation, Investec and Board of Executors have filled their emerging boots with LeisureNet, there has to be something to it. The progress since listing as Health & Racquets Club three years ago has been mixed: shares issued at 100c dropped to 60c at a time when investors neither knew nor cared about the company. A decision to raise the profile was effected by management presentations to institutions, 11 of whom now own 45% of the equity. The Krok brothers have 15% and management and the public the balance.
Since the low, when the market capitalisation was R46-million, the share price has climbed to 405c and the market cap to R640-million. After the latest acquisition, MacRib for about R19-million, there will be 160-million shares in issue.
For the debt-averse, scrip is the way to pay for acquisitions provided the market likes your paper. LeisureNet started in October 1995 with the R40-million acquisition of Foodgro, comprising the Bulldogs, Black Steer, Flame diners and Max Frango restaurant and food businesses. Foodgro's net asset value was R2-million, it was bought on eight times earnings with LeisureNet shares of 100c. Last May it bought tertiary education group Varsity College for R3,9-million shares of 250c - handsome appreciation in only three months. Varsity came on a forward price: earnings ratio of six. Then came gyms business Ron's and Rands Sports on a p:e of five for R15-million, paid for with scrip at 325c.
After getting progressively cheaper, the acquisitions suddenly became more costly. In August, by issuing shares at 320c, LeisureNet bought 50% of Crawford College for up to R32-million. A month later, LeisureNet announced an effective R60-million programme to develop 34 Health & Racquet clubs within two years - quite a cash call. LeisureNet also raised R34-million through the issue of 10-million shares to Sanlam and BoE to fund its Planet Hollywood theme restaurant venture. The education arm was strengthened in November with the purchase of cram-school Consolidated Colleges, trading as Abbots in Cape Town. This was a R14-million cash deal. The deal that took the biscuit was the R70,6-million purchase of The Pro Shop, a golf supplies business, on 17 times historic earnings.
In only 10 months, LeisureNet bought more than R200-million of businesses and announced plans for almost R100-million of capital expenditure. Mico Smuts, the group's financial director, says in essence you either buy loss-making companies for a song and hope to turn them around, or you pay plenty for well-managed acquisitions that can do more as part of a greater leisure infrastructure. LeisureNet wants the management, so pays the money.
Christo Demetriades is in charge of the food operations - an entity in itself because it is to be listed independently later this year after the education interests are consolidated through Crawford and listed. Demetriades notes that the tendency of hotels is towards contracting out the provision of food and beverage, resulting in a rising demand for places to dine. He prefers to pay goodwill for an established brand than start a greenfields business. "We pay for the cash flow and the profit stream rather than take a risk on an apparent bargain-buy."
The gyms contribute about two-thirds of the group's profits. Smuts says no debentures or long-life memberships have been sold for five years, although schemes of up to five or 10 years are embraced as a marketing tool. "It is better to attract members on a marketing campaign before a new gym opens as it can be a bit daunting to go into a completely empty gym."
There is no doubt that gyms have become a way of life and Health & Racquets is the premier name, especially in the wake of several collapsed operations. The cash-flow of each club branch is treated separately: each must make a profit.
Most of the R112-million debt at June 30 is in Health & Racquets. "I'm glad you asked about that," says Smuts, "because it is at the same time our biggest asset as well as the biggest threat. I am delighted that Rand Merchant Bank has assisted us in securitising the Health & Racquets debt. This will help us chip away at the internal funding and make it more efficient."
Smuts says there is a huge market overseas for the Health & Racquet Club name and concept. Only the US has branded gym clubs - elsewhere it is a largely fragmented business.
Smuts is quick to defend the price paid for the Pro Shop, saying it is about 12 times forward earnings. Plans are to make consolidate the shops into mega-stores with properly trained staff. Import duty on golf clubs has been reduced and should help to cut out the Pro Shop's biggest competitor - people buying clubs on overseas trips.
The first Planet Hollywood merchandise store was opened at the Cape Town Waterfront last month and the restaurant will open in October. Outlets are planned for other centres.
Aimed at the tourist market, the directors expect it to make a lot of profit. (Orlando's Planet Hollywood turns over $50-million a year.)
Shareholders should not expect automatic rights to the food and education companies when they are floated out of LeisureNet. There are 2 800 and it is cumbersome to try and cater for all of them. Most likely is a placement of the new quotations with institutions. "But all shareholders will benefit because we will put the funds raised back into the balance sheet. At the end of 1997 we should have R150-million cash in the balance sheet - three times what we have today. Although we won't turn down a good opportunity, this will be a year of consolidating our acquisitions and building our war chest."
So, to buy or not to buy at 405c? It's cheap on a two-year view and can be bought.