We excerpt from stories about an investment opportunity to support judgments about the key drivers of the odds of upsides & downsides to that investment's future returns. We discipline ourselves to express explicit odds for key drivers that are usually discussed only qualitatively, such as the odds that Planet Fitness becomes the One & Only alternative for its current members, achieving leading churn & profitability.
With our judgments for key drivers, together we produce many scenarios for long-term cash flows. For example, we see a 50% chance this company will produce more than $22 billion of cash over the long-term, which it could do if it’s the One & Only alternative for its current members, One of a Few alternatives for members at 1,000 new gyms under contract with franchisees, and One of Many alternatives for other prospective members in its long-term plan. We see a 20% chance it makes more than 30 billion, which it could do by dominating its first 2 markets and being One of only a Few alternatives in the 3rd market. In the interactive chart below, drag the dot to 80% to see that case, or to anywhere else to see any of the other 99 cases whose odds are driven by our odds for their drivers informed by our research attached to those drivers. If reading a smartphone, flipping to landscape orientation will help.
We can even produce scenarios for expectations for those long-term cash flows by other investors in the future, such as in 2 years, for example. Here we see 100 scenarios for those expectations for cash balance. Those expectations in 2 years influence multiple in 2 years, and our odds for those expectations enable us to handicap odds for multiples. We see a 90% chance EBITDA multiple is above Gym Group’s and a 50% chance it is above Basic Fit’s. We see a 10% chance it’s still above 25, and we can see investor expectations for Growth, Scale & Profitability that could motivate that. On the other hand, we can see investor expectations that would motivate a multiple below Gym Groups. In the bottom panel below, hover over some multiples dots to see those expectations. By estimating odds of those stories, we can estimate odds of exit multiples, which is much more useful than just looking at a wide range in a data table with no explicit odds for either end of the range.
Our story-driven odds for investors’ outlook for Planet Fitness at various future horizons help us produce odds for its valuation at various future horizons. We see a 10% chance it is more than 2.5x today’s value in 5 years, which is an IRR of 20%. On the other hand, we see a 10% chance it is more than 40% below today’s value. If we had diversified investments like this in a portfolio, we would expect it to return the mean of about 1.5x over 5 years. These odds can help us weigh better whether and how much to invest in this company, and with what deal structure.
Having Quantified Stories about Planet Fitness in these Scenarios for future return on it, we can get a quantified perspective on how much that return depends on investors’ outlook for specific drivers. For example, at year-end 2021, investors are likely to remain confident that Planet Fitness will be the dominant alternative for members at its new 1,000 locations under contract with franchisees, but if ongoing research suggests instead that they are likely to lose that confidence, then we might see much higher odds of serious downside to valuation. Below, drag the blue bars in the left chart to change the odds, and note the influence on the odds in the right chart, or vice versa. This quantitative confirmation of the importance of this expectation will motivate us to prioritize more research on it, which we will attach directly to our judgment for these odds in order to improve that judgment.
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Odds Expected by Investors at Year-End 2021 that Planet Fitness is the One & Only Fitness Center for Members at 1K New Locations
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Planet Fitness Equity Value at Year-End 2021
Private-equity firm TPG is acquiring Crunch Fitness through its growth-equity unit. Started in New York’s East Village in 1989, Crunch owns and operates more than 300 fitness centers across the U.S., Canada, Australia and Spain. Crunch began franchising in 2010—a move that Mr. Rowley said was “monumental” to the company’s growth. The franchise model has propelled the chain’s growth domestically and internationally. Today, about 50 locations are corporate-owned and nearly 300 are franchised under 88 franchise owners.With TPG Growth, Crunch will continue to expand its footprint and offerings. Mr. Rowley said the gym operator has focused on upgrading the interior of its locations and providing exercise classes, carving out a niche in the premium segment of high-value, low-price health clubs. The HV/LP model refers to facilities that offer a variety of amenities at affordable prices. Crunch is among the latest health club chains to trade hands in a sector that has become a robust landscape of private-equity activity.
Planet Fitness, Inc. (NYSE: PLNT) today announced that it has opened its 2,000th location in Colorado Springs, Colorado on E. Woodmen Rd. on December 31st, 2019. The Company also opened its 2,001st store on December 31, 2019, bringing its 2019 total store openings to a record 261.
Scenario #1 – Containment by March: The virus outbreak is contained by end-March and production disruption is limited to the first quarter. Policymakers in China and Asia move to provide meaningful fiscal and monetary support, with China expanding its fiscal deficit by 1.2 percentage points, keeping it high for the second year running. Global growth dips to an annualized rate of 2.5% in the first quarter, down from 2.9% in the fourth quarter, 2019, but recovers meaningfully from the second quarter onward.
Scenario #2 – Escalation in new geographies, disruption extends into the second quarter: In this scenario, new cases continue to rise in other parts of the world, before peaking by the end of May. The disruption extends into the second quarter, affecting corporate profitability in select sectors, risking the emergence of corporate credit risks. If the dislocations in asset markets also persist into the second quarter, a sharp tightening in financial conditions may mark a tipping point, exacerbating the impact on growth via weaker corporate confidence, falling capital expenditures and cutbacks in hiring. In response, policymakers around the world would step up easing measures, with fiscal policy in Asia and Europe and monetary policy in the U.S. doing the heavy lifting. Today, the Fed announced an unexpected half-point rate cut and our Chief U.S. Economist, Ellen Zentner, expects the Fed to cut rates again by a quarter-point at its April meeting, with the risk of an earlier action given the “fluidity” of the situation. In this scenario, global growth averages just 2.4% in the first half of 2020, but starts to pick up in the third quarter.
Scenario #3 – Persisting into third quarter, escalating recession risks: The outbreak’s global disruption continues to spread into the third quarter, encompassing all the large economies. China faces a renewed rise in new cases as it restarts production. The extended disruption to economic activity damages corporate profitability and brings about a rise in corporate credit risks and significant tightening in financial conditions, which exacerbate the slowdown in global growth. Central banks will embark on a renewed easing cycle, with the potential for a coordinated response. In this scenario, we expect the global weighted average monetary policy rate to dip to its lowest level since 2012. The Fed would extend its cuts from March-June and could become more aggressive and take rates to close to the lower bound by the third quarter. The fiscal response across key developed and emerging economies also becomes more aggressive, with China taking up two percentage points of fiscal expansion. The cyclically adjusted primary fiscal deficit for China and the G4 nations (Brazil, Germany, India and Japan) widens to 5.1% of GDP in 2020, from 4.1% in 2019. Global growth stays weak (i.e., below 2.5%) between the first and third quarters.
Just how bad will the new coronavirus be? I can’t answer that question, but I have observed the debate splitting into two broad camps: Call them the “growthers” and the “base-raters.” The term growthers refers to the notion of exponential growth, and indeed the number of Covid-19 cases appears (by some accounts) to be following an exponential pattern. Some scientists have estimated that the number of cases doubles about every seven days. If you play that logic out, it is easy enough to see how people might be complacent at first, then in a few months there is a public health crisis . . . the growthers find it easy to imagine that the number of cases might overwhelm the capacity of the U.S. health care system. Even if you think a speedy American (or more likely Singaporean) response argues against this scenario, it is harder to be equally sanguine about all the world’s nations, most of which are much poorer and have lower-quality public health systems than the U.S.
Of course, that process of doubling won’t go on forever. At some point, the number of people who have already been exposed to Covid-19 would become so large that their immunity could lower the subsequent rate of spread. Furthermore, society would adjust by having fewer large gatherings — many conferences already are being canceled — and by taking other precautions . . . The base-raters, when assessing the likelihood of a particular scenario, start by asking how often it has happened before. That is, they estimate its base-rate likelihood. And history shows that major pandemics have lately been rare. The SARS and Ebola outbreaks largely petered out, HIV-AIDS was of a very different nature, and the 1957 and 1968 flu epidemics are now distant memories. Base-raters acknowledge the exponential growth curves for the number of Covid-19 cases, but still think that the very bad scenarios are not so likely — even if they cannot exactly say why. They view the world as hard to model, and think that parameters do not remain stable for very long.
To understand how the spread of such a disease can be contained, it helps to break R0 down to its constituent parts. A simple formula that I got from Buckee is: the probability of infection given contact with an infectious person (b), multiplied by the contact rate (k), multiplied by the infectious duration (d) In some cases you can shorten the infectious duration with treatment. Quarantining people once you know they’re infected effectively shortens it, too. Variables b and k, meanwhile, are clearly dependent on behavior. The probability of infection is reduced by things like frequent hand-washing, replacing handshakes with fist bumps and such. The contact rate is reduced by staying home. By putting much of the country on lockdown, Chinese authorities reduced the contact rate enough that Covid-19’s R0 in the country fell below one. They also incurred huge economic and social costs. Now, as China begins to go back to work, the big question is whether a less-draconian approach can keep the disease in check or whether it will just start spreading again. That’s the big question in the U.S., Europe and pretty much everywhere else on earth too. It can’t be answered entirely by professional epidemiologists, either.
Morgan Stanley defined 3 scenarios for COVID-19 impact. We may have different odds of their 3 scenarios, and we may even define scenarios differently. However we define scenarios and call their odds, we also need to handicap their impact on what we can invest in. We did that for Planet Fitness. Its stock has dropped > 30% in the last month. Some of that may be risk aversion and increased cost of capital. Some of it may be reduced outlook for future cashflow from risk of slowing new member signups, risk of lower peak penetration, and even risk of increased existing member cancellations. We took a quick look at pricing and membership terms and alternatives like Peloton and ended up with odds for 2-year valuation and how those odds may change in the 3 different COVID-19 scenarios. The impact looks quite asymmetric to us. Drag the blue bars to explore how changes in COVID-19 scenarios odds may change the odds of different valuations in 2 years. Click "Post" to share your odds and reasons.
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Planet Fitness Equity Value at Year-End 2021
While we saw only 50% expected return for Planet Fitness over 5 years when we looked a month or more ago, some things have changed. Over the past month, expectations have increased for disruption by COVID-19 in the US, where Planet Fitness' members live, equity indices have dropped sharply, and Planet Fitness' market cap has dropped over 30%. As the previous post shows, we have sketched out ways that different scenarios for COVID-19 might impact Planet Fitness' actual cash flows and expectations for them. While we sought downside drivers like delayed sign ups, existing member cancellations, and lower peak gym memberships in decades to come, now the odds appear to favor owning Planet Fitness more than before. We see lower odds of losing money, and a better expected return of > 40% over 2 years and > 100% over 5 years.