BasicFit - A Cliché Unit Economics Thesis... But not wrong

This post will discuss some of the misconceptions around BasicFit and why the company will likely end up as the winner of fitness growth in Europe. As always, none of this is financial advice.

Introduction

BasicFit are a low cost gym operator in Europe. It has basically become a meme to pitch a low cost gym operator as a Value Investor and that’s not really what this post will be doing. There are plenty of high quality write ups you can read modelling out the cash flow generation possibilities of the company going forward. Gym businesses in particular lend themselves to this sort of analysis due to the fixed costs associated with their operation such as rent, equipment capex etc, allowing investors to predict their average earnings per gym. The issue however is that what you input into a spreadsheet often does not occur in reality. I like to invest with a wide margin of safety and this post will explain why your focus investing in this company should be not on the projected numbers you will often see modelled out over the next 10 years, but on the dynamics of the gym industry which in my opinion very much favor BasicFit continuing to be the dominant player in a number of EU nations.

What is the Pitch?

The general thesis behind BasicFit if you are unfamiliar is as follows. The company offer gym services at a super low cost price of around €25, beating out local competition easily which is often made up of mid market offerings in the €50/60 range. In addition to these mid market operations, BasicFit also undercut the larger players in the low cost gym space through a highly automated model which also incorporates the cannibalisations of their own gyms. A city which the company enters will often have 3 gyms open in one go, offering the consumer a cheap, convenient and functional gym experience at multiple local gyms. This strategy is most effective in areas where the existing gym’s are more up market locations and consumers realise they can get access to multiple gyms, closer to their home or place of work for a cheaper price than their existing membership. Once embedded in a city, these gyms are protected going forward as there are not enough members for a new gym to be viable for a competitor as BasicFit have enough locations to fully meet demand in the city and are also offering the lowest price. BasicFit also have an industry low break even member number of around 1400 members which demonstrates the strength of this model. This means there is no incentive for competition to enter as they will often need to steal 5000+ members to break even. There is also no incentive for customers to switch to another gym as they have to be more expensive to cover their increased costs. BasicFit enjoy a disclosed 30%+ ROIC on mature gyms (older than 2 years) and in fact this year posted around 35% ROIC. The company have been highly successful and have rolled this model out to a number of countries outside of their native Netherlands including France, Spain and Belgium. The downside is that BasicFit are owner operated and not a franchise model meaning they use their own capital unlike a company such as Planet Fitness which means they cannot grow as quickly. Despite this, they are still the fastest growing gym company in Europe.

The general thesis for BasicFit is 3 fold. 1, that BasicFit will continue to grow and reach its target of 3000 gyms by 2030. 2, that the gym penetration in European countries will increase from around 10% in some areas like France, to levels similar to that of the US of around 22% meaning their members per gym increase. And 3, that BasicFit will be able to maintain and protect its guided ROIC of 30% despite the entrance of new players such as Planet Fitness which recently announced entry into Spain through acquisition. Most write ups you will see, focus on combining these 3 factors to estimate what BasicFit will be generating in FCF by its 2030 target of 3000 gyms is reached. This is certainly important but in my view means a lot of investors miss key factors that give this company the potential to be special. What I want to focus on is the protection that is built into this business model and the low risk profile of this company’s cashflows in the context of the development of the industry over the coming years. I will also be making an unlikely comparison which may give some insight into why I feel so strongly that BasicFit can be a long term winner.

Low Risk, High Reward

A key part of any investment I make based on future earnings growth, is built on a low risk profile. A company must show to me that its returns going forward are either highly predictable or that they are following a trend which will continue to grow its addressable market and in turn their earnings. In the case of BasicFit both are met. We have already experienced the worst of unpredictability in the gym industry through Covid. It is safe to assume that under normal (or even bad economic climates) the amount of gym members will remain stable for its mature clubs - those paying for more premium memberships may cancel and sign up to cheaper offerings such as BasicFit and offset some losses they suffer from cancellations from their own members. CEO Rene Moos has explained in the past that a big part of maintaining their core users number is having an easy come easy go policy. Unlike some gym chains you may know if where you have to sign a form at the front desk or write a letter to cancel, BasicFit do not make it hard to cancel it’s memberships and this can be done through the app (4 week notice period). Research has shown that this makes customers far more likely to rejoin in the future as they do not feel tied in. It is understandable that people experience peaks and troughs in their gym motivation and this policy allows BasicFit to ensure they do not sour their customer relationships, keeping a steady flow of their more inconsistent users happy enough to want to sign up again in the future.

The fitness industry in Europe is also in a consolidation phase with research showing that from 2022 to 2026 the market is predicted to grow at a rate of over 7%. In addition to this, BasicFit are able to capture business from legacy gym players and mid market offerings. What this means is BasicFit are predicted to be seeing an increase in members at their existing locations over the next few years and also have opportunities to invest in underserved areas in their existing markets as well as new ones, where there is not a big gym chain presence. This runway is the reason why this company are so attractive. Unlike the UK gym players such as the Gym Group, they have an incredible runway of growth ahead of them and will be able to fiercely protect this new business in new markets and cities thanks to their strategy of opening multiple gyms at a time to prevent competitors to be able to viably enter that market.

In my view this makes BasicFit a very low risk bet on the company’s ability to continue operating efficiently in its existing locations, meet demand for its services in new regions and convince large numbers of people in European market to pay less for more. To invest, you need to establish if you think BasicFit’s existing gyms are disruptable and if they are able to continue to maintain their superior operational performance in the face of increased competition. I think BasicFit have enough competitive advantages to resist mean reversion on their impressive returns on capital over the long term and to continue their growth. Lets explore why.

Gym Industry Dynamics

The Gym industry is very unique from any other kind of retail industry in the sense that geography is basically the sole factor in driving traffic. In the low cost sector especially, the only differentiator between these gyms is the location. If a gym is the most local to you, that is where you will likely go. Studies show that people do not want to travel more than 7-10 minutes to get to a gym meaning that careful planning for locations is crucial for any company. If you had the option of going to a gym that was 5 minutes away in the car with adequate facilities or travelling 20 minutes to the other side of town for a more up market experience, studies show most people will pick what is local to them.

This feeds into the cannibalisations of gyms. Lets say for example that not only is there a gym 5 minutes from your house but there is also one across the road from your office and another location 3 minutes drive from your mother’s house. If you were one of the few people who was considering travelling to a gym further away, you would likely be swayed by the ease of use of multiple locations, which even with BasicFit’s premium membership for access to multiple gyms, would be cheaper than your existing gym subscription. To some this may seem counter productive as you are giving away 2/3 of membership revenue for one customer however this gym network has the effect of locking down your members in a non destructive way. The convenience offered far outweighs what you can get anywhere else so you are far more likely to stay. And as already explained this cluster strategy also protects BasicFit’s customers from being snatched away by new players.

An Unlikely Twin

The best comparison I can think of is actually one outside of the fitness industry. If anything it is the complete opposite of it. A lot of the dynamics at play here are similar to that of Dominos Pizza. If you look at a map of Dominos Pizza locations in the UK, you will often see a surprising amount of stores in a small area. My hometown for example has 7 Dominos stores in a roughly 5 mile radius. Domino’s strategy in the UK was very simple, to scale to serve as much of the UK population as possible while maintaining an efficient operation and a high quality product. In particularly densely populated areas, this requires more stores and a similar fortressing strategy is at play to ensure customers are never waiting too long for their Pizza and satisfaction rates remain high. The company have also embraced technology and app orders make up over 50% of their online sales, which feed into their data and ability to spot consumer trends and advertise DTC. In a similar manner to BasicFit, location is key. Consumers want their food quickly and the distance from their home to the store is the key factor. If all other factors are the equal, you will likely order from the store which is closest to you. The company however had a bad reputation in the early 2000s for a cheap product compared to its competitors such as Papa John’s and Pizza Hut and had to make a massive push to change their pizzas to satisfy consumer demands. The modern era of the company started around 2010 when they began to update their menu to fit consumer needs and this snowballed into the franchise monster we see today.

Much of these factors mirror the gym industry. As already discussed, success in this business it is all about your locations and being able to prevent competitors from taking away customers from your gyms. BasicFit mirrors Dominos is its fortressing strategy but differs in the sense these extra gym locations provide additional value to individual customers in that area. There is no benefit to you as a consumer of Dominos if there are 2 stores 10 minutes away in either direction but multiple gym sites can be of a great benefit to gym goers as already mentioned. This illustrates how BasicFit’s cluster strategy is in some ways more powerful than that of Dominos as it adds value to both the customer experience and to the company. This prevents competition by offering a product that meets consumer demands as there is no longer enough demand to support a new gym. Nobody is going to describe a Dominos pizza as the best pizza they have ever had and nobody is going to claim the best gym they have ever set foot in was a BasicFit. However both companies fill a need and do just enough to justify their prices to the average consumer. If you look up reviews for most Domino’s stores and BasicFit gyms you will see an average rating of around 3.5 stars. This illustrates that the companies respective businesses are not built on an incredible product that cannot be replicated, but more on convenience and a low price.

Also like Dominos, BasicFit have embraced technology to an extreme degree, in many ways revolutionising the gym industry from an operational cost perspective. Unlike a traditional gym which needs 5 or 6 staff members to run it, most BasicFit locations have 2 members of staff and can even stay open with nobody at the physical location thanks to investments in smart surveillance technology which allows dozens of locations to be monitored offsite and any issues to be called in by either a security employee monitoring the gyms or be flagged up by motion detection cameras which can detect if someone faints or has an accident while inside the gym. This gives them a tremendous cost advantage over their competitors and further compounds the effects of their cluster gym strategy as they can operate multiple gyms in a small area for a fraction of the cost of the existing/potential players.

If you go back and read the VIC write ups on Dominos ($DPZ) in the late 00s early 10s you will see a very similar narrative to what is currently being said about BasicFit. To quote a write up from 2007 - ‘I would also argue that the time to build a position in Domino’s is when the company is facing significant headwinds due to cyclicality and not due to problems with the business model.’ At the time the company were dealing with a significant amount of issues including very high ingredient costs, concerns over its balance sheet in a high rate environment with a market cap of under $1 Billion and net debt of over $1.6 Billion as well as the aforementioned bad consumer perception of the quality of their pizzas. Despite this negative sentiment, they were still the clear market leader in 2007.

If you compare this with the current concerns regarding BasicFit, there are obvious parallels. The company have had to deal with elevated costs due to both increased rents and energy costs. These, just as ingredient costs were for Dominos, are temporary headwinds. As well as this, people have raised similar concerns regarding BFIT’s balance sheet and especially so given the high interest payments that were made this year due to the higher interest rates which impacted profitability. Many are concerned that the company will be unable to continue to grow at the pace they have been due to their high level of debt and higher relative costs to a franchise model to set up new gyms.

Although this is a valid concern, it is important to contextualise BasicFit vs their competition. Just like Dominos was in 2007, they are the clear market leader in Europe. Despite not being a franchise model and capital light like Dominos, they enjoy the title of the market leader which as we have explained means their continuing business is well protected going forward. The benefit BasicFit have over their competition is they are able to slow down their expansion if necessary to prioritise cash generation because they are the market leader. BasicFit’s strategy means that legacy operations are not a threat to them as they can be disrupted at any point. The real concern is if aggregators such as PlanetFitness begin to disrupt legacy regions before they do. Despite the aggregator competition being less profitable and having a higher member rate required to break even, I feel it prudent to assume a worst case scenario that if they have the first mover advantage, BasicFit will struggle to outcompete them for members due to the best gym locations already being set up.

However, this is why you must take into account Europe’s low gym penetration. The low amount of gym penetration compared with the US or Scandinavia offsets the possible risks here as the market is growing rapidly. When asked about Planet Fitness entering Spain on yesterday’s earnings call, Rene said that it is his view that there is more than enough space for 2 large gym chains in Spain, but did once again stress their ability to break even at a far lower member amount than PLNT. In a country like France where gym penetration is around half that of the US, BasicFit have done very well due to this combination of a growing its addressable market through advertising and brand recognition and taking market share from legacy and mid market gyms. BasicFit now have over 600 gyms in France when as recently as 2018, they were just over half as large as budget provider, L’Orange Bleue. The fact they were able to outgrow a budget franchise with their model shows the power of this business.

Last year the company announced for the first time that they plan to pursue a franchise offering alongside their owner operated clubs. With their technological advantages and established brand name, the company would be able to enter undisrupted markets in a much faster way, effectively land grabbing prime locations to beat out the local mid market cohort of gyms before another large player does. It is possible that in the future the company will seek to buy back these gyms to bring them in-house at agreed prices but this may not be a priority. What is crucial to understand is the fact the company are even able to consider doing this is amazing. Everyone else in the gym industry is locked into either opening their own gyms (which make less money and are harder to run that BFIT) or opening franchises where their brand name is not as recognised and they cannot be run as cheaply as they do not have the technology to reduce the amount of staff needed. BasicFit have the ability to roll out a capital light expansion programme to take the burden off their balance sheet and in turn focus their own capital on locations they know will have a high success rate. That is not to say that another company cannot replicate the autonomous model BasicFit have, but it is important to remember that getting to this stage has taken years of investment and by the time another company catches up with BasicFit’s low operational costs, locations will already be up and running and they will not be able to enter that city. By investing in technology early, the company will continue to reap the rewards which will even extend to franchise locations who the company can pitch as needing less staff to run and be cheaper to maintain.

Final Thoughts

Although very different businesses, I see the potential for BasicFit to replicate what Dominos did in the 2010s by consolidating their position as the market leader in Europe. They are in the most important period of their history and if they execute correctly, the rewards for them are an impenetrable moat which is a free cash flow machine. I will leave you with one final bit of information before I bring this write up to a close. At the 2023 Annual Results Presentation yesterday, CEO Rene Moos highlighted that if the company stopped all expansion efforts they would have spat out over €700 Million in EBITDA last year and that is in a year with higher than normal costs across the board. The company at it’s current valuation of €1.5 Billion trades for just over x2 this number. Their long term targets completely obscure their current profitability, again something which those familiar with the company have heard many times before. But what every write up you have ever read on BFIT fails to emphasise is how good the business is right now, not just how good it can develop to become. Hopefully this write up has added some colour to the company’s market position and the advantages it enjoys over its competition both new and old.