Podcast #90: Vadim Perelman's Basic-Fit thesis $BFIT

Vadim Perelman goes through his thesis on Basic-Fit (BFIT) and why he thinks it could be a >10x in <10 years. Key topics include a detailed walk through the unit economics and why competitors won’t be able to open new gyms once the company “fortresses” their markets. You can find my notes on BFIT here and Vadim’s outstanding write up here.

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Transcript begins below

Andrew Walker: Alright, hello, and welcome to Yet Another Value Podcast. I'm your host, Andrew Walker. And with me today, I'm happy to have Vadim Perelman. He told me he's just a guy. He's an investor I followed for a long time, I really respect him. Vadim, how's it going?

Vadim Perelman: I'm good. How are you?

Andrew: Doing good. Hey, let me start this podcast away the way I do every podcast. First, by reminding everyone, nothing on this podcast is investing advice. Everyone should do their own work. Get their own advice, whatever. Nothing on here is investing advice. The second way, I start every podcast is with a pitch for you, my guest. You know, I was telling you when we're talking for, I followed you for a long time. I remember all of your write-up so well. You had this great write-up on Sears a long time ago, that was saying, "Hey, the short interest is so high. If you just buy it and hold it for a year you're going to make all your money back in short interest." I mean, you're exactly the type of investor I like to follow.

Concentrated does great due diligence, and I think that's going to sign through in this company we're going to talk about today. So I'll just turn it over there. The company is "Basic-Fit". You had a write-up a couple of weeks ago including the show notes that I thought was one of the best write-ups I've seen recently. And it's just a super compelling idea. So I'm excited to talk about it. All out of the way. I'll turn it over to you. What is Basic-Fit? We might call it BFIT. And why are we so interested in it?

Vadim: Sure. Basic-Fit is the leading low-cost fitness provider in Europe. So for viewers, listeners who are more familiar with the US market, think about Planet Fitness. The only real difference is that Planet Fitness is 90% of the franchise, Basic-Fit, owns all the stores. But in terms of the business model, the product itself, it is the Planet Fitness of Europe, if you will.

Andrew: I was just going to say, I love the Planet Fitness illusion because I think people doubted Planet Fitness for the past 10 years and all the doubters have been proven very wrong as they've grown share like crazy, and stuff, but I'm sure you'll get there. But one of the things I want to talk about was the Planet Fitness comparison and how a low cross provider like Planet Fitness or Basic-Fit can take so much share and grow in the market?

Vadim: If you think about the gym as a product, fitness as a product, and let's talk about, sort of, physical locations first, so we can talk about what's happening online, opportunities, etc. But if we take the product of going to the gym itself, there are really two important things in a consumer's mind which are, price and convenience. Now, of course, you have the full spectrum from high-end boutiques. You got equinoxes, you've got the low-cost providers which are still a small, relatively, small part of the industry.

You have this very, very large middle tier of gyms that are neither here, nor there. I call them purgatory gyms because they don't provide you the same bells and whistles that an equinox which is, a much more upscale, called a luxury product. But they have a higher cost structure because most of them have pools and spas, and what facilities, which are very expensive to run. Now, from a consumer perspective. One of the things that people point out as a negative to me is actually a huge positive, which is that it really is sort of a commodity product. Right? And there are important benefits of that, an advantage of that.

But if I am going to sign up for a gym membership, largely a case, I care about price, and I care about location. Every consumer's study, it'll make common sense, as well, people don't want to walk or drive 45 minutes to go to the gym. It's a chore for most people to begin with. There's a mental cost that you have to, sort of, impugning overcome. So people, the vast majority of people, want it to be cheap, they wanted it to be close by. And that's how they, sort of, rationalize themselves that, "Oh, I think I'll go 6 times a month", ultimately, then they end up going twice. But they say, "Okay. Well, if it's $20 a month or €20 a month, then it makes sense."

As the price point moves up, then people tend to, sort of, ask a question, "Is it worth it?" This is why you've seen, to answer your question, low-cost fitness as a category, take meaningful share from everything else. And very importantly, expand the market. So the whole TAM has gone up because of the number of people who can, who will sign up for a gym, one that is priced at $20, €20, whatever it is. The low-cost providers. That's a much bigger number than the people who are willing to spend $40, $50, $60 a month, for a product that is, sort of, they are going to be a customer of, in the first place.

Andrew: Yeah. When I was in my prior life, in private Equity, I cover the gym, so I might give a couple of anecdotes there. But, one of the things Planet Fitness says is, I think they're like 30% or 40% of our members have never been to a gym before. These are the type of people... they work out once or twice a month, they're not going to pay for a $60 gym membership. But as you said, they'll pay for a $10 a month, or $20 a month gym membership, just for the psychological benefit of, "I go once or twice a month, and I can say, I'm a gym member". But we would do work and there were people we find to be like, "Yeah, I paid $20 a month. And the only time I go to Planet Fitness would have pizza Tuesdays." And they'd be like, "The only time I go, is on Pizza Tuesdays. I walk in, I get two slices of pizza, and I walk out", which just always cracks me up. They were using it as a pizza service. Maybe BFIT will get that Domino's multiple. Who knows?

Vadim: Right. Well, I don't think you need that at the price that you pay today. [crosstalk]

Andrew: Go ahead.

Vadim: I was going to say, the number of 30, 40%, so it's 40% both for Planet Fitness and for Basic, is the share of joiners who are first-time, sort of, gym consumers. And you know, the reason for that is that it's a low enough price point that they didn't have access to before, and that's really sort of the story of this segment of the industry and why it's been winning, which is that for a long time people just didn't have a low-cost option. And so, if in whatever radius you draw around their house, around their office, the best you could find was $40, €40, whatever it is. It wasn't very compelling, and as you said exactly, correctly, when there is an offering at $15, €20, all of a sudden the TAM expands substantially. Now, you have a lot of people who go 2-3 times a month and that's okay, right? That already pays for itself. That's their rationale.

Andrew: I've got lots of questions, but I think the majority of the questions all come back to one point, BFIT says, and I think you believe, that their current gyms, we can look at what they were doing in 2020 which they'd say they'd do, they get about 30% return on capital when they open a gym. And if they can continue doing that going forward, obviously this is going to be a huge home run and we can talk valuation and all of that, in a second. But that 30% return on capital number is the key question for me, because, as you said, a gym is a commodity product. If I've got two gyms within a reasonable distance, one's $20 per month, one's 15$ per month, they have basically the same amenities, I'll go to the $15 per month one.

So when I look at that 30% number I say, "How can BFIT with commodity products continue to operate and open stores at 30% margins? Because at some point, doesn't someone come along and say, "Well, why don't we just copy the BFIT model? And we'll lower our price point in a little bit under BFIT, and we'll get 25% returns on capital." And then BFIT would say, "Well, we'll go under them and we get 20%", and you, kind of, have this race to the bottom. We can talk about revenue advantage, cost advantage, whatever. But the overall question is, why is that 30% margin sustainable?

Vadim: Yes. From, first of all, the numbers north of 30, right? Because on a typical €1.2 million investment... I mean, they use, internally, 30% as the bar, but in reality, it's, sort of, something like 35, 37%. [crosstalk]

Andrew: We're value investors.[crosstalk] We're value conservative.

Vadim: Neither you nor me. You would argue, "Why is then the 37 became 4?" Right?

Andrew: Yeah.

Vadim: And so, I think this is the point without taking a closer look, everybody misses, because that is sort of the most intuitive. We're all taught that ARC markets are perfectly competitive, and are there excess returns to be had in commodity-type products? And, by the way, this is why, when I first looked at it, when I first pitch in. I, sort of, said, "You know, valuation sounds interesting, but so what?" And then...

Andrew: It's why Planet Fitness was one of the most popular shorts in the world in 2016, 2017. And we've come through a pandemic, in the stocks, probably, like a 5x since then, despite that.

Vadim: So there's a very logical explanation, that I'll take you through a very economic explanation, for why that ends up not being the case. If you think about it... let's take a typical city in my write-up, I named Limoges, which is a city in France, but let's take 100,000 population city in France as an example, and it's a pretty typical, sort of, case, the national penetration, national gym penetration in France, about 10%. So in that market of population 100,000, you expect 10,000 members to be up for grabs, effectively, right? Now, the average price point, that people pay in Europe is about €40, it's very close in all of the countries. So on average before BFIT comes in, assuming there's no one else that's offering this model, you have an implicit advantage when you come in.

Now, what is the cluster strategy? which I think is key to understanding this thesis. What BFIT will do is, they will come into a city like that and they will plop three clubs at the same time. They will pick the locations that make the most sense. So they won't do, obviously, 3 boxes next to each other. They will try to cover the largest part of the population, wherever that is. And they will look for the best locations, and by the way, that's an important point because as a public company, as by far the best possible credit tenant in this industry, if you're a landlord and you're choosing between, Andrew and Vadim Gym LLC, and basically, you'll probably give it to Basic-Fit, as nice as we look and sound.

So they will build the three boxes to cover the largest percentage of the population using this concept that people want to travel 7 to 10 minutes, max. So they'll obviously think about where they will locate. Okay, so they will open up and they will open up with their standard price point. The price point is the same for every location, so it'll be €20 a month, which is a much better value prop than what is currently available in those markets. Okay?

Now, what happens then, given the scale, and this is one area where scale comes into play, one of the advantages of scale is that they have the marketing band with the dollars, both on a national, a regional, and a local level through online and every channel you can think of, they will be much more effective at getting the message out there with this now better value proposition. So that's not that... that is already meaningful. So they'll basically blast the message that "Hey, Limoges, we have three locations at an incredible price and you should join." Okay?

And so, you know a couple of things will happen; One, they will obviously attract, as we talked about, those members who are first-time users because now it's €20 years a month, and they're blasting out the message across the entire city. Okay, so that makes sense. And when you go on message boards, there are people in these little towns and cities saying, "Oh my God, finally, Basic-Fit is coming." So there's already national, sort of, brand value to Basic-Fit because people don't live in a vacuum, and Basic-Fit is all over the place, online, everywhere. Even in places where Basic-Fit is not currently available, people are, sort of, clamoring for that option.

Okay, so they will have roughly 40% of their joiners come from this bucket of first-time users. They will have, I think on average, 30% that are re-joiners, that's obviously down the road. Right? Right now, it's day one. And the rest will come from sucking up the large fraction of the consumers, the gym-goers, who now have a better price point, that is convenient. And now, by the way, there are three locations plus, all of Europe, and all the free online content. And so, you know, they come in with a really good, really, really good value proposition to the consumers and so, they will add, sort of, maturity, which they call, 24 months into it. They will reach 3,300 members per gym.

Okay. So they've done that, right? And I sort of, draw the parallel between this and other infrastructure-type assets that are expensive to put the capital in the ground. But once you have it, you have it. And so, now, Andrew and Vadim Gym LLC says, "Oh my God, this is an incredible business. I'm finding unsub stack and PowerPoints, that is 35% or 30% return on capital business. Why don't we go into it? We're smart guys. We have access to money." And so, we say, "Okay, let's go and try this. Let's go to Limoges. So, we go to Limoges and we start talking to a landlord, and we find a spot. So, we find a spot, but now we have a really big problem, right? Because if we do the math, then in a city of 100,000, we will have about 10,000 members. Right?

And, of course, now the penetration is not 10% in that city because we added to the total addressable market. But fine, there aren't that many other people for you and me in our new LLC to go and grab, right? And so, you have to think about, "Okay, what is our value prop to the residents of Limoges? So for people who say, "Well, it's really easy, just build a new club, lower the price." Okay. So if we're saying that it's a commodity product, which it's basically is, there's not a whole lot of innovation that you and I, or any mom-and-pop, or even other chains can bring to bear, to this product. And so, if you think about other infrastructure-type assets, let's take cable, so you've got, let's say a charter...

Andrew: I was going to respond and say, "Oh, it reminds me a little of cable. Not, not the same thing. But go ahead. Go ahead.

Vadim: So I'll tell you one key difference, which is at least on that front, in favor of BFIT. I'm not arguing that this is a cable company, right? But it has elements. So if you take a charter market, right? You have big guys like AT&T and Verizon who can try to deploy fiber and they have. Malone talks about how none of them made money, fine. But at least, in that case, Verizon AT&T, when they come in with fiber, they actually have a better product, right? They have faster internet. So there's something to think about as a consumer because now you can say, "Okay. I've got 100MB per second in my charter, but these guys are promising GB, and so, maybe I'll switch." It's not just price.

But here, what are you and I going to do to attract the right number of members where we can actually turn a profit? It's not going to be on convenience, because we just talked about how Basic-Fit has this cluster of three gyms, in this case. You and I can talk about what happens if we try to build three if we have the whatever, €4 million to spend. But if a mom-and-pop want to just replicate the model, then they have to compete on price, right? And they open up one shop and then, you have to think about, "Okay. What is the math for this kamikaze couple, mom-and-pop, or you and me?" What is their return on capital? Because now, we start going through all the line items that you need to, both revenue and cost. On the revenue side, we talked about how they had to drop prices. So maybe instead of 20, it's 15. Okay?

Now, the question is, how many members will we get? Well, it's unreasonable to expect that with one location you will steal all of Basic-Fit's 3,300 in the location that's closest to you. It doesn't happen that way. Because A, it takes time; B, people are relatively sticky, within reason, right? So if somebody comes in with a much lower price point, over time you will take their members, which is why Basic-Fit takes the members of guys who are charging 40. But if somebody comes in, 15 versus 20, and I'm already a member and I'm going that often, probably takes me some time to get there, and not everyone will do it, anyway.

Andrew: I'll probably mention, New York Sports called a couple of times in this. But again, when I was in my prior life, I would go to the gym and there'd be a New York Sports Club on one block and we'll be charged $100 per month or something. I'm in New York City, so the prices weren't played, and New York Sports Club is the biggest rip-off in the history of the world. But, there'll be a New York Sports Club on one block, $100 a month, and there'd be like a Crunch Fitness, basically, across the street, which would be $60 per month. And if you went into both of them, the Crunch Fitness was newer, nicer amenities, more stuff, less crowded, it beat the New York Sports Club on every single dimension. And yet, the New York Sports Club had more members because, once you start paying, it's really damn sticky. New York Sports Club also, like refuse... you had to basically send them a certified letter to get out of your contract and stuff, but it's really sticky. [crosstalk]

Vadim: Yeah, I know. They do those things and all of that. But, you see that it's not as if consumer response is immediate, people are not robots, it takes time. And if you're not going that often, anyway, you say, "Whatever the hell with it", and you rationalize it, because you and I have one gym, but these guys have 1,000 in Europe and you'll say, "Well, I'm going to Paris next month. I'll work out there. And so, let's say that best case, you and I, with our lower price point, steal half of Basic-Fit's, sort of, local members, so half of the 3,300. And actually what you get to, if you assume that, is you're getting to roughly the number of members per gym that is the average today in Europe, like 1,500 to 1,600, in the 63,000 gyms that are in Europe, right? So these independent gyms they get to, whatever, that's roughly the number, 1,500 to 1,600 members.

Okay. So now you do the math, 1,600 x €15 per month or year. Okay, so that's one. So now, revenue is, whatever, 40%, less than 40%, of what Basic-Fit is, right? And, you still have the cost. Now, on the cost front, that's an important point, that you alluded to in your notes, that obviously, we should talk about. Because you have a couple of different, you and I building our own are going to have a somewhat different cost structure versus a Basic-Fit. So one is the capital outlay required to go and build it. So Basic-Fit has big discounts on the equipment that they get. They are, by far, the largest customer in Europe, with 1,000 existing gyms, plus the 250-300 that they're opening every year. They are, by far, the biggest. So they have a discount.

Andrew: Let me ask that, and we can go line by line through the cost because there are some costs, and I agree they're going to have some advantages. But I'm just, kind of, been thinking of it, "All right, you have 1,000 stores. You're buying equipment." Yes, you're going to get a little bit of a price discount, but fitness equipment is a commodity. They're probably already operating at pretty thin margins and capital returns. How big of a discount or cost, on average, can you really get buying equipment with a thousand, versus one mom-and-pop store?

Vadim: So they get 30% to 40% less or lower, a third out of the price, that is 30% to 40% lower than a mom-and-pop. Bigger scale gyms will be somewhere between... I'm sure, they'll, kind of, get prices that are no worse, right? Probably better. But they bring so much volume and they play the two guys off each other, that to me, they feed the two main manufacturers, that the discount ends up being, they say, 30% to 40%, somewhere there. Right? Now, the equipment, the actual fitness equipment of the 1.2 million upfront investment, that's like 350, between 300 and 400 thousand, of actual equipment that they get out of discount.

Andrew: So, right there, you're saving $100,000 versus a random mom-and-pop competitor, on just the equipment, if I'm doing the math right in my head.

Vadim: Yeah. But the other stuff... you're definitely not getting 30% to 40% off the concrete, things like that. You are getting some discount, right? Because you're building three at the same time. You've got the architect. It won't be masses, right? So it will cost you, I mean more, right? But it won't be an order of magnitude more, obviously, but it starts to add up. So it'll cost us more than 1.2. Let's just, sort of, work with that. Let's even call 1.3 and now we have the Apex.

Before we get into the Apex... because we are ramping a slower and be into fewer members. We also have a meaningful amount of cash that we're going to need to burn before we get where we're going. That's one of the big advantages for Basic-Fit, which is, it takes 4 months to get to a cash flow breakeven and be profitable, right? Takes 24 months to maturity to get to their target profitability, but it takes roughly 4 months to get to the point where you are now cash-flow profitable. So that window, where you're consuming capital, burning cash, as you ramp up and do all of your marketing, it's pretty short. And so, we should come back to it, because that's an important point that also drives, sort of, their ability to grow versus anyone else's ability to grow. Anyone else will need a lot more cash to go and absorb the ramp-up of the stores that they just built. There's a big cash requirement.

So on the Apex, there are three big buckets, basically, there's labor, right? So one of the big advantages of Basic-Fit is, there's a lot of automation. They spend years developing to bring the FTEs per store down and they're working hard to bring it down meaningfully further. The other thing is you get leverage from having three stores in that city versus just one. So you have the benefit of... your outsourced guys are cleaning three gyms, but you do get some benefit there. And so, you and I are doing it, assuming that we don't want to live in the gym and clean toilets, and rack weights. We will have more labor intensity in the store. So that's why.

Andrew: And when you didn't mention three gyms in the market versus one, you're going to get scale on your marketing costs, as well, right? So it's going to be harder for somebody opening one gym to steal your members because they're spending marketing for one gym. You can actually spend twice as much and it's half as much on a per gym basis because you have three gyms in that market rate.

Vadim: Yeah, I don't mention... It's very important and I'm glad you brought it up. It's not in the four-wall number. I'm getting to the... [crosstalk]

Andrew: Oh! Good point, good point. [crosstalk] I was just trying to build it for you.

Vadim: No, no, no. No, but you're exactly right. Because as we ramp up during that cash burn period, we have, you and I, are going to have to go and find those members. We need to put the same billboard up that they put up for three, we need to compete and now put up one. The cost is the same, but they're getting it over three gyms, you and I don't have the same scale. You're exactly right. Okay, so there's labor, and we'll get into labor when we talk about the things that they're doing to drive value going forward.

The second bucket. Let's talk about rent. So, their rent per meter will be lower than you and I entering, it won't be an order of magnitude lower. But the landlords want Basic-Fit and they've given preferential rates because, with that credit of the tenant, the value of the real estate is actually much higher, right? Because of a completely different risk profile and very different cap rate when you put in a Basic-Fit versus an unknown operator. They'll have some advantage there.

Andrew: And if I could add two more things; that A, you mentioned that because if they're the first mover in the market, which we're going to come back to that point, but if they're the first mover, they're going to get the prime location. So, our secondary location will be one street over, it's not going to be quite as ideal. And then; B, because Basic-Fit has proved it out. Landlords want tenants that drive traffic. 20 years ago, I think, they didn't want gyms, but now, they want 10 that drives traffic. And if BFIT can say, "Hey! The average gym has 1,000 members, ours is 3,000 members." Then, they're probably going to nudge towards Basic-Fit, a little, just because the extra traffic increases the value of everything else that they they have around it.

Vadim: By the way, that is the story of Sears, right? Why did Sears end up owning all that real estate? I definitely don't want to get into Sears. But why did they end up with all this real estate? Because people gave them free rent, in the malls of the unknown, because that's back in the day, whatever hundred years ago, or 20 years ago, that brought the traffic to the mall. So they anchor it. So there's an advantage. So, basically, you and I are going to have a simple choice, either we want the same rent as Basic-Fit, but we have to take an inferior location; or we have to pay up for having locations that are of comparable quality to base. Okay? And it won't change math dramatically. But that's an important consideration. So that is rent. And you definitely don't want to be in a location without parking, for example. But, even if you and I find something that's a great location across the street. We still have a big problem, which you'll see. Okay, so that's rent.

The third bucket, which is, sort of, "other its" utilities, it's cleaning. And I think there's going to be some advantage, but I don't want to overstate... You and I will not have a massive disadvantage on cleaning because if we want to outsource it we can hire an outsourcer. And yes, basically, we'll have an advantage because they're amortizing over three, so they can have a cleaning crew that goes around the city and does it. But you don't need it, you don't need to believe any of the stuff, to see where I'm going.

Okay, so what's going to end up happening? If you actually do the math, you're going to see that you and I will make no money, we'll probably lose a bunch, right? Because you're already working with a revenue base that is less than half, right? And with a revenue base that's less than half, even if you have the exact same cost structure as Basic, keep in mind four-wall margins of 50%, right? So, take $100 of revenue, 50 or cost. You and I already starting with 40 of revenue, so that's tough.

This goes to the very heart of once you have these clusters, why it's so hard for somebody to build a competing cable network that's in our market, for you and I to do it and open our box of the same product, the same thing? Very, very difficult to make the math work. We have to count on price as a differentiator, right? So lower the price, fine; get the message out, that's expensive, as you said; and then, depending on how far we drop the price, now, we have to play for a big share of one Basic-Fit location's members. So if we get half of them, which is already quite good. But you can work with 70%, which is hard to do because a lot don't go, right? So if they're not going, they don't really care. It's hard to get them. And so, you're going to have a cost structure in reality that is much higher than Basic-Fit.

I'll give you one interesting data point. So Gym Group, which I don't know if you've looked at, but it's one of the two major UK-based operators. Low-cost operators, right? So there's Pure Gym, and there's Gym Group. Publicly traded in London. Smaller, about 200 stores, gyms, and they have the same size, 1,500 square meters, roughly, 15,000 to 16,000 feet. Their cost per unit is 60% higher than Basic-Fit, right? So if Basic-Fit costs... four-wall basis, again. Let's call it €420,000, these guys are at 670. That's a big difference. Basic-Fit... [crosstalk]

Andrew: How much of that is the rent? How much of that are rent and materials? Because I would just imagine rent and materials is higher in England versus all of Europe, just because England's on an island and you got to ship things on, and it's a lot smaller, or am I misimagining that?

Vadim: It's not that meaningful because in the secondary, tertiary cities, go outside of London, it's not it... I think one bias that people have, also on anything about [inaudible], or things like that. People basing California, not... The entire world doesn't look like that, right? Same in Europe. It's not just Paris, we've got... Yes, you have a lot of gyms in Paris. You go to Limoges, there's nothing. I was there, for visiting family. There are three Basic-Fit gyms and a bunch of small stuff. So everybody's at Basic-Fit. So my point in saying that is, that it's very, very optimistic and unrealistic to say that, people express this, "How could it be that unit costs are different?" Because you can hire employees. I can hire employees. Well, it turns out that through automation, Basic-Fit needs fewer employees, and they're working to reduce that further.

Andrew: Let's put a pin in automation because I want to come back to that. Because I do think that is an interesting aspect, but I don't think that's the most interesting driver here if that makes sense. One quick off the top of my head thing, your argument for why Basic-Fit has an advantage with gym... I was going to say, isn't this an argument for why we work, should have worked, but that's just so different. It's not even working. [crosstalk] Let me go back. So when you started describing, why Basic-Fit has this fortress strategy, why it works. And then, you went through all the unique mix of why you and I couldn't go into a BFIT market that's already built out and compete with them. Right? But the key assumption in there was, assuming there's no one else offering this model, right?

So basically, it's going into a market where there are no low-cost gyms that are already broken out. And I think at today's share price, you know, as we're talking. I think we fit at 42 or 43 per share, you could debate if the current store base where they've already got the franchise and stuff are worth 50% or 75% of the enterprise value, or whatever. But there's no doubt, this thing has to grow for it to work, I think. So, I guess my question would be, assuming there's no one else offering this model, why isn't this massive land sure grab? Where Pure Gym in England is moving into every market that BFIT isn't, and you and I are going and say, "Oh my God, 30% returns on capital. Let's go to every market that BFIT isn't in right now and let's fortress it before BFIT gets in there." Like, why isn't there just been this land rush that's going to prevent BFIT from... There are a thousand stores right now. They want to be 3,000 stores by 2030. Why can't you and I beat them to that?

Vadim: Yeah, so I think that goes to the heart of the growth aspect of this. By the way, I disagree with a comment that, you need a lot of growth to make the math work on the existing stores, you're just not paying a big multiple on stable stores, right? I think the entire enterprise value is basically in the earnings power of the existing stores, right? So that's one point where I would, sort of, contend.

Andrew: I might have been a little... I was just kind of looking at it. I think it's about 3.5 billion EV at the current share price, and they're projecting 24...

Vadim: 33

Andrew: Say that again.

Vadim: It's 33.

Andrew: 33. And then, they're projecting 240 in 2022 EBITDA, which will include a little bit of growth. Now, all the stores, as you said, won't be fully mature at that point, but I was just kind of looking at it and saying, "Oh, you know, I'd probably pay 8 to 10 for a mature stable business like this, and it's trading." I just thought you've got to get a little bit of growth from there to justify the share price.

Vadim: So, that number right? Well, I'm looking at this as the earnings power. The reason I'm looking at '23 and also in the math that I put out, although I have all the years, but '23, I think is a much more relevant earnings power year to check. Because first of all, the growth that's coming, that's gone on until now, those will be fully ramped up by '23. Because 2020 is a weird year, a lot of closures. And so, that maturation process really hasn't happened. But so, I'm looking at '23, and on my map, I have '23 earnings power of over 500.

Andrew: Over 500. Yes. And how many stores you have opened, then?

Vadim: So I've got... In '23, I've got a 1,400 on average.

Andrew: I don't want to get caught up in that area. But right now, it's about a thousand clubs in your 23s, 1,400 clubs and probably, all those aren't mature at that point. But I do think...[crosstalk]

Vadim: Hold on. If we talk factually, right? They said they're going to open 250 to 300 per year.

Andrew: Yup.

Vadim: Right. So 1,250 by the end of '22, right? Assuming they are at the low end of the 250 to 300, there at 1,500 by the end of '23. So the average number of clubs for 2023 is exactly there. Right? That's just the math of it. [crosstalk]

Andrew: But again, I still think that's coming back to you. You need a little growth from the current store base to justify the share price, but I don't want to get bogged down on that because I think the more interesting question is, why is this not a land rush, where you and I are going, we're just going, everyone's going to go and get to it and BFIT's not going to be able to get to 3,000 because they're only going to be able to build out two more years of markets before everyone saturates or something?

Vadim: Yeah. So I think that's the more important question than the one that, I think, people do get bogged down in which is, it was very simplistic and just without running the map, as people say it. Well, why can't people go into their existing markets? Because I think the existing markets are deeply entrenched and they build a moat when they do. [crosstalk]

Andrew: So I'm pretty convinced on that though. I will talk, a little bit longer term, in a second, but I'm reasonably convinced on that, at this point.

Vadim: Sure. So let's talk about that growth. Now, what does the landscape look like right now? You have 63,000, I think, which is the number that I saw for Europe, in terms of the number of gyms. Of those, the top six players are still tiny, right? So basically being by far, the largest, with a thousand of those, right? And then you get down to 400 to 300 pretty fast, right? So the number, I think is 2,500 to 3,000 in the top 5 players, right? So it's still largely a mom-and-pop market and the question is, okay, who is going to go and build the number of clubs that you need to actually go and saturate these markets with this low-cost model?

Basic-Fit is going to add a supply of 250 to 300, roughly, which is the size of more than Gym Group per year. Right? And when you look at, for example, McFit, I saw somebody asked about McFit in the comments on Twitter, McFit is very, very cash constraint. A lot of these guys are lever. They're highly levered, right? COVID didn't help. And so, the access to capital and the internal cash flow isn't there for people to go and build out thousands of clubs. That's the reality of the existing scale players. And so, I think you're totally right if all of a sudden people rushed in and build these clusters, using the low cost and soaked up the available, sort of, members up for grabs. They would have a cable network that we would have a hard time competing with.

But you look at the pace of openings of everyone else, and Basic-Fit just dwarfs everyone else combined in terms of how many clubs they build relative to all of the other big players in the industry. We're not talking, yet, about guys also dying, which is happening, obviously. It happened in the US, by the way, it hasn't really happened in Europe, yet. Because during COVID, you might know this, the government subsidized pretty heavily, which they didn't do so much in the US, right? So you've seen supply shrink, I think, like Planet talks about 22%, we talked about it yesterday, of gyms by account, but most are smaller, right? But still, it takes capacity out of the market. You haven't seen that in Europe and the larger operators think that you'll see that, but whatever.

But to answer your question, I think it comes down to, that capital needs to come from somewhere, right? You don't see Blackstone funding a Basic-Fit competitor. People, by the way, have also really not wanting to get into Basic-Fit's Market because René is known as an absolute...this is for public consumption. I'll leave it at that, but you understand. So he's a very, very competitive guy, and fiercely, fiercely so.

Andrew: Strategically, I think, it's out... This is a land rush model, right? You want to be the first to franchise a... Sorry, not. It's a fortress in an area. I think we've agreed on that. And you just laid out a compelling case for why the other people who might even try to fortress it, are probably pretty capital constrained. And BFIT's got... we'll talk about the FTEs. But BFIT's even got some capital advantages over them, even without that. It does strike me that Planet was so successful because they went with a franchise model, right? And a franchise model, lets you leverage other people's capital to really go out and expand very quickly. And when I look at BFIT, my first question was, why don't they just franchise so that they could...? If they really opened up franchising, then you get to 3,000 stores by 2025, if they had some really aggressive franchisees or something. So why haven't they pursued a franchising model?

Vadim: It's a great question, one that, when I first looked at it, I sort of had the exact same reaction. I've spent time with René talking about franchising, getting his thoughts. By the way, one of the reasons I love this thing is, the guy is literally thinking 10, 15, 20 years out of what this looks like. And I think that's the biggest driver of why he hasn't wanted to franchise. Franchising creates... Yes, it accelerates the go-to-market, for sure, you've seen that with Planet. But it has two, at least two, pretty negative side effects, I would say, or conflicts. One; when we talk about, let's say, the omnichannel, which is starting to happen. And by the way, another benefit of scale is Basic-Fit's able to offer now the Peloton solution, they'll have many others.

There's just a job post yesterday that I saw of a product manager, to develop other things in addition to their buy, fine. So they're able to do that with scale. But when you have a franchise model, you immediately... It works pretty well, until now, you have an omnichannel, right? Because if you have, let's say a franchisee in some city or some region in France. Well, now Basic-Fit wants to offer a bike, a thread, etc., may be other ancillary stuff, online subscription, whatever. Now, you have a very uncomfortable need to somehow share the economics and that's very, very tough to resolve in Paris.

Andrew: You've seen it with the broadcasters... Again, sorry for the messy focus.

Vadim: It's fine.

Andrew: CBS doesn't own the New Orleans CBS station, that's often owned by an X star[?]. And then, when CBS says, "Hey, the future is not in the cable bundle, the future is in the direct consumer." Well, you've got a really awkward conversation with someone who's paying you literally millions of dollars of year to be your CBS franchise in New Orleans and you're going to go to them and say, "Hey, we don't need you anymore, we're going direct to consumer." And they're going to say, "Well, you sure need us now because we still pay you millions of dollars, and that's going down, but it's not going anywhere for the next 5 years, so you better cut me in on to that direct-to-consumer thing, even though I don't provide a lot of value to it."

Vadim: Right. Exactly, right. I don't think this is the biggest thing, because obviously, 5 years ago, nobody could have foreseen that there would be attention in the business, nobody was talking about omnichannel back then. But, I think, a more meaningful component is, Basic-Fit is absolutely obsessed with driving down unit costs. They are under no illusion that this is a commodity-like product and you need to be a low-cost guy because it's what drives your unit economics, it's what drives down your break-even point in terms of, what you have to charge members per month and still get high margins, right?

So another interesting data point, slight tangent, but an important one, for independent guys, the break-even is like €28 a month, as a membership fee. And you need to, obviously, charge more than that because you have CAPEX needs and the UNICAP, some profit. For Basic-Fit, it's like 10 per member, per month, per member. For Basic-Fit, 10, independent guy, 28. That's why, basically, they can price at a 20 and still have 50 percent margins. The other guys have to be higher. Smaller space, higher cost, etcetera, etcetera, right? And so, the obsession with cost control is something that you can really only do effectively from their point of view, and I agree with that.

If you truly have control of your costs, which you do not do, if you've got franchisees, it's really hard to control the quality, the cost. Now, you might argue. "It's sort of their cost structure, what do you care?" But, in the long-term, you do care, right? And so, having all of the cash flow, 100% of the stack, gives you the ability to reinvest it, etcetera. I mean, you look at Planet's EBITDA, it's actually not that high, because they're only charging 7% of the top line. Now, they're, by the way, interestingly, reacquiring their best franchisee. But I think it's a one-off, I don't think it's a trend that Planet will become asset-heavy, but I thought it was interesting yesterday.

But anyway, those two things are important; having control of cost, and obviously product quality consistency. And by the way, if one believes it as I really do, that they are able to redeploy capital at a pre-tax north of 30% return on capital, I, sort of, want all of that to myself, like, why would I, in the long run, want to give up those excess returns to a bunch of franchisees, who themselves are going to earn outsized returns? I'm much happier to... [crosstalk]

Andrew: It's the classic franchise argument, though, I do think there is something to... Well, if you're getting a 30% return, you slap a franchise fee on it, your franchisees will get 20% returns on capital because 10% of it is with you. And you're getting infinite returns because you don't really have to invest anything, and you grow a lot faster.

Vadim: Sure, sure. But the flip side is, you don't capture... you're giving up a big chunk of the total dollars earned to someone else, right? Because I don't think people are going to be super excited by a 14% return on capital, to do this. Now, I will say, because this returning capital keeps coming up and it's important. I'm going to say something incendiary.

Andrew: There we go.

Vadim: But not in poem form, in prose. I actually think those returns on capital are likely to go higher over time, not lower. And I'll tell you why, if we draw the analogy, just for the sake of a mental model, of an infrastructure-type asset, like a cable company. Think about cable or cable internet, let's say, 20 years ago. So you have the cable, but the market comes to you over time, right? So today, when they lay a cable and they build these clusters, they're building it in countries with, take France, as their biggest market, 10% penetration, which they will move up. But, I believe that over time... And, by the way, you don't need to believe any of this because it's really not in my mind. But, I do think that's the way that things will play out from here. I think that penetration is likely to head higher, to get closer to where, let's say, the US is today, over time.

Andrew: Isn't the argument there... I don't think... You can tell me if I'm wrong and we don't have to get bogged down in the point because this is just a Super Bowl case, right? But if penetration goes higher, I don't think the returns on capital will go up materially, though, they might get some more scale that lets them drop their costs more, especially, if the FTE reduction comes in. But it would just be a market that used to be able to support three BFITs, now that penetration's higher, it can support five BFITs, which by the way, you will get... it doesn't affect your four-wall return, but it will affect your overall returns because you'll get a little bit more leverage on SGNA, the marketing, and all of that.

Vadim: We're talking about two different things. So you're talking about, prospectively on new markets that there's yet to penetrate. I'm talking about, let's take the city where they today lay the cable. They built the 3 stores, right? As you know, the demand for gyms goes up in those cities, they are going to be the outside's beneficiary of the incremental gym membership. So, for example, somebody turning 18 today is different from somebody who turned 18, 20 years ago, in their pensively to join a gym. Again, don't need to get crazy here, but, I think that the gap between where Europe is, and where the US is, should narrow over time. And by the way, if the US is still heading higher and it builds more and more.

Andrew: One more push back on that, just because I think it's interesting, not because I'm trying to contest the point too much, but isn't your argument there, as penetration goes higher, they get more members at their current installed base? So are you suggesting that their current gyms could support a lot more members? Because I, kind of, thought their current gyms, not that they were overflowing, but they were already pretty close to... There's a clause, where, if you get, I think, it's like 3 members per square foot, the gym's going to be pretty crowded at peak times, and people might be unhappy and you can't go. Aren't they pretty close to, kind of, the limits of what these gyms can support?

Vadim: No, not at all. So, I would say, if you ask them the question, and I'll give you the data that I think will make sense of it, they would say that up to 4,000 members per gym, is very comfortable. Now, let's take Planet, which has 6, 7, 8 thousand, depending on the box...[crosstalk]

Andrew: And it depends on the size of the gym, right? It's a big, kind of, criteria. [crosstalk]

Vadim: You're right. I'm sorry, I'm looking at per square meter. The way I'm thinking that is per square meter. [crosstalk]

Andrew: Okay. Perfect, perfect.

Vadim: We can bring it back to the size of a box. But, Gym Group's average, I think, is around 5,000 members? Same sized box, right? And so, that's not to say that 5,000 is the ideal size because at 5,000 it gets crowded, right? But 4,000 is not a crazy number and I think internally that's, sort of, where they think this should go. Again, not in my numbers, but given, sort of, other boxes with higher density, it's not crazy to think that at 4,000 is still fine. And then, maybe you build a fourth box. Either way, you become the beneficiary as the market comes to you, you capture more, and, of course, in markets that are going higher and penetration where you're not there. And you're exactly right, you have to build more boxes.

Andrew: I have a lot more questions, and this is the problem, it sounds crazy. We've been talking about an idea for an hour, especially, good ideas. You can really run up on the hour, real quickly. But, before I ask any more questions, realizing we're coming up on an hour, I think you lay out such a great bull case. People go read his pitch, it's going to be included in the share notes. You lay such a great bull case. Is there anything I haven't mentioned, so far, on the barer side, that, kind of, keeps you up at night here? Because I know you run a concentrated portfolio, which means you really have to think through all the bull cases and all the barricades to make sure one of them is not going to kill you. So is there anything on the bare case we haven't mentioned, that we should be talking about, or thinking about?

Vadim: I can tell you what I think about it. I can also tell you, why it doesn't keep me up at night? But longer-term, you, sort of, alluded, maybe that's, sort of, where you were going because you made a comment, that there are things you worry about longer-term. But the thing that would worry me, if I went into the future and saw a future state of the world, is if somehow human behavior changes. Right? And that's happened in the past. If somebody invents a pill, I mean, just crazy examples, but maybe not so crazy at some point. Somebody invents a fat pill, where you don't need to go to the gym. The reality is most people should go to the gym for health reasons, but most people do go to the. gym for... [crosstalk]

Andrew: For the pizza, that my friend was getting every Tuesday.

Vadim: Well, that guy's doing not a lot for his health or his appearance. But, yes.
Most people do go for the sake of vanity or appearance. If people are spending all their life in the metaverse with avatars that are skinny, and they themselves are 250 pounds, like that, and doesn't matter anymore, right? It sounds crazy, but the world does change, right?

Andrew: So the pill is, it is a far out there risk, though, it is not inconceivable. You hear a lot of people believe that the average person today will live to 150, 200. It's not crazy to think we're gonna have a pill that's going to give everybody the 8-pack they've always dreamed of. Maybe, a more feasible one in the next 5 to 7 years... not Peloton, I don't think... there can be some substitution for the Peloton's all-access pass versus this, but I think the more pressing one would be something like Oculus, right? You buy an Oculus, you put on the headset, you get the Oculus box in. I've heard lots of people love that. And if you imagine AR, you run it forward, 5 years, and you think how much better games and stuff are today than they were 5 years ago, you could imagine a fully metaverse world, where it kind of like, Ready Player One-style, you're running on a treadmill while you're dodging bullets and stuff, and that's going to be a lot more entertaining than going to the gym. A lot more fun and probably cheaper, because you could do it all over software in your own home.

Vadim: Yeah. If you told me that you went to the future, you saw it, and nobody goes to the gym, I would say, not a whole lot of sense in owning physical gyms. People have a workout at home option now. Basic-Fit is, obviously now, developing products that targeted, I think, the best position to increase penetration into that, if we're talking about actual equipment. But they're not going to do anything on the Oculus. They're not needed. But to the extent that people use strength to the extent that people want cardio that's not just running outside, then you do need physical gyms.

And again, I would be a lot more about the middle tier, of gyms, that are higher priced. They're not giving you any better of a product. But yeah, if you tell me that human behavior changes in a meaningful way, for whatever reason, whatever the driver ends up being, fat pill, nobody cares, etcetera. Then I would say, yeah, then this is not good. I think that the runway... People have been talking about driverless cars and that's been the bearer thesis on Copart or AutoZone. But at some point, one of those will hit and I just think it's a higher risk. I think it's whatever. If it's 20 years, you'll make all the money back in cash and then some.

Andrew: I hear you, though I do think that the metaverse workout in your home is probably closer than driverless cars taking over the world but I completely agree with everything you said. Let me... [crosstalk]

Vadim: Sorry, just to add one little bit. On the home stuff, I mean, you can pull up a YouTube video, you can work out at home. You don't even need, arguably, the... maybe the Oculus makes it more fun. I did it. I played ping-pong and I played all sorts of things. Gives me a headache. At some point, that will get better. I don't think that's a real reason not to go to the gym. I think, also a lot of people want to be at a gym because it's a social place. One reason I go. I mean, I can do stuff outside, you too. But I like being among other people and that's a big driver.

Andrew: And look. I love my Peloton. I love it all. But there is something that, you said yourself, it makes more sense to rent a gym, than own a gym, right? So for some people buying the Peloton bike, I love it. Peloton is a completely different thing though. But if you want to get every different workout type, it makes more sense to pay $20 to BFIT than to build a squat rack, get a treadmill, and all of that type of stuff. One other risk I wanted to ask right. Right now, the store base is really new, but this has come up both in some expert interviews and in the charter throat, I said, I worry about the maintenance cutbacks that they allow. I think they said in their most recent presentation, $55,000 a year to start and it goes up to 70,000 per year, which there are expert interviews that say, "I think your gym is 100,000 to 120,000 per club."

I don't know how Pure Gym's clubs compared to Basic-Fit. There was an expert interview that said, that even 75k, they thought it was going to be too low. I said it again, I used to cover gyms for private equity and you don't really notice it until you go to a store, go to a gym that is 7 years old, and then go to a gym across the street that's newer, and even if the gym's been relatively upkept, it's just crazy how much better a newer gym is. So, I worry, right now, these gyms seemed great and... Its CAPEX is an issue that sneaks up on you and then all of a sudden, it's boom, it's there, and your gyms are really tired and really old. So do you worry at all about the maintenance CAPEX or what these gyms look like 5 years from now?

Vadim: Yes. Specifically for that reason, in my math, I build it up, literally, with a full CAPEX schedule for gym-by-age, and then the average that you see that's printed out in the model is the sum of all those. So I'm not using a €55,000 number because they've said so, that number is artificially lowered today because so much of the estate is newer. But in my math, I literally say, "Okay, you're a 6, we have to replace the cardio year 9, we'll replace all the weights. You're 12, we'll have a whole overhaul of the thing." And by the way, one thing that people may don't really appreciate, all big chunk of that 1.2 is structural reinforcement of the building that you don't need to do, at all, again, right? It can last for decades.

But yeah, specifically to avoid that, I know that it's just transcript and directionally, of course, is true. That 55,000 is not the ultimate number. It does tend to go to 70, 80. And by the way, that's what the company said in their capital markets day. They said that over time. It goes, I forget the number, but it was like 70 or 75. In my math, which I actually have, sort of, very aggressive, conservative the way you would think about them. I assume that they will have to spend a lot of capital at year 12 to refresh the whole thing, etc. And by the way, people maybe don't know that there is a CAPEX component that is expensed every year for things like showers, etc. It shows up in the other bucket of cost. It's really in the capital, but because it happens all the time they are expensive. And so, in my math, to get to my answer. I literally do, at year 6, for this gym, we have to overhaul the equipment, I build that on the ground up, to specifically kind of create visibility on that issue.

Andrew: We're over an hour. The one thing we haven't talked about, so far, the one thing we've alluded to, but we haven't talked about is the full-time employees and how they can use, kind of, capital to bring that down over time, which I think creates a huge moat. If you've got time, I'd love to talk about it. But if you've got something else, we can hop and save that for another day.

Vadim: No, no, we can talk about it. Let me get something... [crosstalk]

Andrew: Go ahead. Yeah.

Vadim: Yeah, it's something that they have been working out. It's not the only line item, obviously, they work on basically everything. They are meticulous about the software, for example, they use to plan all the store openings, to manage that process. Maybe you saw the investor day get least of the slides from the investor day, but they... keep in mind, not that long ago, they were opening a hundred gyms, you could do that more manually. But now, when you're doing 250, 300, creating one-and-a-half gym groups every single year, we probably don't think about that as investors, but operationally that's actually very complex. It's happening all over Europe and I can see it being a pain.

Andrew: How many times have you seen a retailer go from 100 to 200, to 300 stores? And then, after they get to 300 they say, "Ooo-oh, our supply chain is completely insane. We need to stop just so we can catch up."

Vadim: What I say is that, to me, René, the CEO, he's like the anti-Ron Johnson. So Ron Johnson had an amazing idea and he said, "Let's blow up JCPenney because let's try this idea." And so, Basic-Fit is the exact opposite of that. They are very, very thoughtful long-term in their planning of this business. Because they think, by the way, that even the 3000, 3500, which is a 10-year target, they think that's still very low and they have a lot of reasons for why, ultimately, the number should be much higher than that. But they are thoughtful, but, "Okay. Well, how do we go from 100 to 150, to 200, to 300, and then how do we scale this business, so that we can build a lot more than that per year?" It's just an example of how measured, and thoughtful, and pre-scientific they are about that.

And along the same lines, they work in every part of the operations and I was in their security control center and you need 3 eye scans, a urine sample, and a proctologist in order to get in. It's like trying to get into the NSA. And so, they have a room in a building, that is actually separate, that is looking at every one of the thousand clubs they have with sound meters, with motion detectors to see if somebody is not moving, or not breathing, or screaming, or whatever, or trying to break in. Literally, somebody tried to break in while I was there, at some Belgian Club. They call security, etc.

But all those things, allow them to centralize more of the costs instead of just having, whatever the independent average, I think is about 6 FTEs, by the way, or 6 people on an average mom-and-pop, which should come down because people have to try to stay competitive. But, just to give you a sense of where BFIT is, and where they're ultimately going, which, I think, they've already run tests with one FTE and they'll run tests that are below that. But the goal is, and the approach is, complete obsession with cost and so... [crosstalk] Go ahead.

Andrew: Oh! I'll just hammer it at home for listeners. You go from six full-time employees to one full-time employee. That's a lot of Apex that's coming out of the business. Now, some of it is going to the centralized cost but your hope is that it scales way, way more and all in, including the centralized cost. Maybe you're running two or two and a half full-time employees versus the mom-and-pop at six and guess what, the mom-and-pop at six, they can't get down to your one or two, or two and a half because they can't afford that centralized overhead. So that would be the ultimate scale benefit on cost is what I would say.

Vadim: Just to keep it simple for people in terms of, just numbers, right? If an average store, just to make it really easy, 420,000 of cost, 420,000 of margin, right? 50% margin. One FTE, you're gonna pay somebody with benefits, €40,000, €50,000, right? That's a meaningful, meaningful reduction. You're not talking about a box that does 5 million of four-wall margin and you're reducing a person, or you're adding a couple of percent to the bottom line. This is a major structural change in the cost structure of the business by adding one person because each individual box doesn't have that many dollars or euros running through it.

So these things really matter, and they really matter because A... first of all, you have two options, if you do that, one; you can pass that savings down as price, make it even harder to compete, right? Expand the market further, right? Or you can retain that margin if you are the only guy with that advantage. There's gonna be some window of opportunity, right? And so, it does help you either improve your economics because your costs are lower; or improve your economics because you have more members with a lower price, but still maintain margin. So it's very important, and that is something that they've been working on. Well, they already have a big advantage over the mom-and-pop, but getting it down from two and a half to one, adds quite a bit to margin.

Andrew: Perfect. Well, hey, anything else you want to talk about before we wrap this up?

Vadim: I'm good.

Andrew: Perfect. Well, hey. Look, again, I read this thesis. I've seen it before and every time I see it, I'm like, "Wow, this is interesting." But, your write-up, which is, again, included in the show's links. Everybody should go check it out. It was incredible. Everybody should go follow you on Twitter because you are now Finch wits[?], the greatest slam poet. I've loved the recent poems. They're just unbelievable. But Vadim, thank you so much for coming on and looking forward [crosstalk] to having you on in the future.

Vadim: Thank you. Thanks, I appreciate it.

[END]