Viva Leisure Limited (VVA) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Viva Leisure Limited Acquisition of Australian Fitness Management Conference Call. [Operator Instructions] I would now like to hand the conference over to Mr. Harry Konstantinou, CEO. Please go ahead.

Thank you. Thank you. Good morning, everyone, and thanks for tuning into our conference call this morning to discuss the acquisition, which we announced to the market earlier today, of Australian Fitness Management. This acquisition is a little different to previous acquisitions which we've done but is very exciting for Viva for a few reasons, which we'll go through during the presentation. I'll be referencing the presentation and the page numbers as we go through. Essentially, the acquisition is for Australian Fitness Management, which is the master franchisor of Plus Fitness in Australia but also has issued a license to India and is the master franchisor in New Zealand. Viva has agreed to -- I'm on Slide 6 now or the executive summary. Viva has agreed to acquire all the issued share capital in Australian Fitness Management, which is currently held by the 2 founders, John and -- John Fuller and Nigel Miller. The network currently consists of 197 locations, 190 of which are in Australia, 3 of them are in New Zealand and 4 in India. A further 40 territories have already received deposits to secure their territories in Australia. The Plus Fitness network revenue of franchisees exceeds AUD 100 million, and it's exciting to us for multiple reasons, which we'll get through in the presentation. The acquisition price is an upfront consideration of $18 million with an earnout potential of a further $2 million. The earnout is achievable upon opening 18 locations, which is the forecasted number to arrive at the pro forma EBITDA of $2.5 million. Strategic rationale. So why Viva looked at this acquisition was because it provides a runway and a path for Viva to secure acquisitions well into the future. AFM, Australian Fitness Management, holds the first right of refusal on all franchises wishing to sell, and that's significant for Viva. It also allows Viva to enter into a new low-cost market. So generally, the Viva brands are in the middle tier of pricing and service, and Plus comes in the low-cost market, similar to other corner, express 24-hour gyms. The strategy also fits with our model of expanding into new markets. This is the first time we'll be expanding outside of Australia into New Zealand where we will hold the master franchise from New Zealand. And we see significant growth opportunities in that market, and we've got a bit of a slide on that a bit later on. And we see revenue opportunities for both Viva and franchisees, having regard to a successful franchise business works well when the franchisor and the franchisees are both making money. We see opportunities for Viva to implement its IT systems and other systems to streamline operations for franchisees and to increase their yield like we've done with our own corporate-owned sites. Transaction metrics. As mentioned before, FY 2020 pro forma EBITDA is $2.5 million, and that's pre-synergies. We haven't factored any synergies into the numbers here that we're presenting today. And there, we'll work through those as we take ownership of the business. The acquisition implies a normalized maintainable EBITDA multiple of 8x and an NPAT multiple of 12x assuming the achievement of the earnout. And again, that's slightly higher than we've paid for previous acquisitions. But the runway and the opportunity that this acquisition provides warranted that additional uplift in the multiple. Conditions precedent are very simple. It's the assignment of property leases. There's not many properties that this business uses as their head office, a warehouse. And they're owned by the vendors, so they're related parties. And so the assignments of those won't be an issue. But we've forecasted here that we expect to have -- be completed by 31st of August. Moving along to Slide 8. As mentioned, there's circa 200 franchises open. 44 -- a further 40 franchises have been secured. In addition to that, Viva has identified opportunities for corporate-owned sites in addition to those. And that is also in addition to any potential acquisition of franchises that wish to exit and sell to Viva. First right of refusal is the big thing, $100 million in franchise network revenue. Noting that in previous acquisitions, we've been able to capitalize on our systems in our direct debit savings, costs and things like that, so that's something we'll be looking at immediately. The network has 175,000 members across the 197 clubs, adding to Viva's 95,000 active members now. But that's a network of 270,000 members which we can market to and grow opportunities with. The business is light on staff in terms of there's only 25 staff, and that's all that's required. Generally, you have some franchisee support, some back-office support, and that's all that's required. The majority of the employees are with franchisees, not the franchisor. And as mentioned, the membership rate for these clubs, the retail rate is between $13.95 and $16.95 a week. That's the RAC rate, which we consider to be in the low-cost market. Moving along to Slide 9. What we've done here is show the overlap in geographical territories of the locations, Plus and Viva. What we can see here is that obviously, Viva is dominant in the ACT. Plus is very dominant compared to Viva in New South Wales with 126 sites. And obviously, Plus is in WA, South Australia as well. In Queensland and Victoria, we're essentially same amount of clubs. When you dig down a little bit deeper, we've identified that there's not a significant amount of overlap in these clubs between Viva clubs and Plus franchisees, which is attractive, so we're not upsetting the franchisees. There are 3 locations in New Zealand and 4 in India. And as mentioned earlier, India operates under a master franchise with a third party, paying fees back to AFM. Moving on to Slide 10. Here, we're showing the club openings since inception. You can see that 18 is the average across these 11 or so years, and that's the forecasted number. Remembering I mentioned earlier that the 40 territories have had deposits paid, so we're anticipating 18 of those will go live in FY '21. If less than 18 go live, then obviously, the achievement of that earnout is not reached. Moving on to Slide 12. Here, we've shown what Viva looks like if it owned the AFM network of clubs. You'll see that in FY '20, there was 276 clubs in the network. Viva clubs have grown to 81 since FY '20 completed, and there's 197 clubs in the Plus network. So by the end of FY '22, we're estimating 313 clubs in the network. Viva-owned clubs and Viva brands will be 98. And this doesn't include any acquisitions of potential franchisees where Viva has secured over 100 sites, but these are the ones that are likely to open during FY 2021. Moving to Slide 13, the summary. So here -- and it's a slide we've used previously on previous acquisitions to show the different offerings. You can see here that the markets are slightly different. Viva is in all 4 segments of the market. Plus is in the express market. More territories obviously for Plus Fitness and the membership combined and the direct employees combined. So that provides a summary of where we're up to. Moving on to Slide 15. This is a new one we've provided. And we've provided this -- we haven't provided this before and talked about our competitors. But it's important now that Viva owns a franchise or will own a franchise brand to compare what the other franchises are doing. So in this slide, we've highlighted how many clubs are in Australia and New Zealand and the estimate of member numbers based on management expectations, opinions and also public data that's available on some of these. You'll see from this slide that Viva ranks with these brands as the third largest membership base in Australia according to management and the fourth largest in terms of clubs, with F45 taking that spot above Viva. But in terms of membership, F45 is a much smaller membership than all other health clubs. They average 185 members per club, so their membership is only at 120. But the clubs are up high. So we thought that was an interesting slide to introduce in this presentation. Moving forward, Viva will obviously differentiate in reporting its clubs, its franchise clubs and its franchise corporate-owned clubs. But for now, we've just lumped them into one section. Moving on to Slide 16. Here, we've ranked the brands that we mentioned or the health club brands. We haven't added F45 into this -- and where Viva ranks and where Plus ranks in terms of clubs in different geographies. So we can see the penetration. What you see here is in New South Wales, for example, that Plus is the second most dominant brand after Anytime. So again, what's interesting in this slide and what we've highlighted in our investor presentation is, in New Zealand, you can see that Plus is well behind the other brands. And we see that as a significant opportunity for growth, with all the other brands having circa 50 locations in New Zealand and Plus only having 3. So Viva sees that as an opportunity to grow franchises in New Zealand as well as corporate-owned sites in New Zealand. I'll pass over to Kym now who will talk about the financial metrics. So he'll start on Slide 18.

Thanks, Harry, and good morning, everyone. The financial metrics of Australian Fitness Management appear on this Slide 18. These are derived from management P&Ls and Viva's assessment of the normalized maintainable EBITDA. Now let me just describe what those 2 elements mean. So normalized simply means that obviously being a franchise territory rollout model that they tend to secure territories, accept deposits, go to DA and fit-out and equip the gyms, which might effectively open a couple of months later. So what that means is that from time to time, these -- the rollout process goes across various financial periods given in particular the quantum of clubs that they're opening in each calendar and financial year. So what we've done is effectively normalize that out. So the club openings sit effectively within the financial period that they belong. And so what that's done is it's just simply cut out a little bit of timing across the periods that we assessed. The maintainable aspect of this, we approach this from the fact that, what revenues would exist without any further territories opening? In other words, what is maintainable? And there are elements like -- and we'll go a little bit more on this on the next slide. But there are elements like your franchise fees, your commissions and rebates, your sales of equipment and merchandise to the existing franchisees. So we started with that as a baseline. And then we ran an assessment as to exactly how many sites we think we could open on a pro forma basis across the next 12 months. It seemed logical to use the average across the last decade, being 18 sites, noting, of course, that only 10 have been opened during FY '20, and that's been COVID-impacted. But also, it ties in nicely with the 2 vendors that are coming onboard as managers of the franchises and their earnout KPIs for the 12-month period. So all of our interests are aligned in that. And plus, it is simply the average across the last decade. So it seemed to be a reasonable approach to work out what maintainable revenue and therefore EBITDA would be across those periods. So the FY '19 numbers are as stated there: $1.8 million EBITDA, translating down to $1.2 million in NPAT. FY '20 numbers are based on the February year-to-date numbers and annualized simply because the COVID interruption threw some rather peculiar results in the back quarter. So we figured the last 4 months was February. We simply annualized that and noting, of course, that during FY '20, there have been some structural savings put through the business, such as insourcing some of the previously outsourced services like IP services. And that has actually led to some cost savings across FY '20. And so the FY '20 result is based on 10 franchises being rolled out and creates an EBITDA of $2 million and an NPAT of $1.3 million. The pro forma numbers for FY '20 are simply assuming that there's an extra 8 territories rolled out. So FY '20 numbers show 10, the pro forma numbers show 18, which is obviously the target that we're looking for, and that there's been some slight adjustments to costs and revenues in there. But effectively, the impact of the pro forma number versus the FY '20 number is the inclusion of those 8 additional territories rolled out. The good news about this, and it's rather unusual for Viva to do an acquisition like this, but there's 0 more money to spend as far as CapEx, fit-outs, rebranding. This is effectively a turnkey operation for us. So what that also means is that there's a significant conversion from EBITDA down to NPAT because at the moment, on the books of the company, there's about $400,000 worth of plant and equipment. And accordingly, the depreciation amount is effectively what's between the EBITDA line and the net profit before tax line. There's no synergies assumed in these numbers either. But there's likely to be some immediate back-office synergies, but we just need time to sit down with the 25 staff, understand the operations. But as I said, there's some immediate synergies, like they've got some professional costs for accounting firms and whatnot, but we'll just bring in-house some -- the 25 staff, we need to assess exactly what they do and whether there is some duplication of tasks, which we might also move in-house. And in addition, with the IT background of Viva Leisure, we've got a significant IT costs sitting in the P&L, which we may be able to extract some savings out of that. But these numbers are prepared on the basis that no synergies are extracted on the expense line. Of course, the bulk of the synergies moving forward, in any case, would be on the revenue line because we've got the benefits of applying the expertise of the Plus staff in their franchising model with Viva resources and infrastructure as well as the access to capital to drive this business to the next level. So while we've got a nice pro forma number there, assuming 18 territories, it's certainly not the end game for us to continue to move along at that pace. But without putting any sort of forward-looking numbers in there, we would need to, as I said, understand the business first and then work out what additional plans we might put in place moving forward. What this does is also, we're acquiring this out of cash. Obviously, we did a capital raise a few weeks ago. This cash is going to be applied to this. What it means from a balance sheet perspective from Viva's current position is that we'll have about $8 million cash remaining on the books. We've got a large direct debit coming -- main direct debit coming through tomorrow, which will probably put another $1.5 million in the bank. And then of course, we've got the JobKeeper payment coming at the end of the month, which will contribute another $1.4 million in cash. So yes, the cash position moving forward is looking quite significant despite this transaction. So just moving on to Slide 19. Just a quick discussion on the main revenue and expense items. As I mentioned, we looked at what the maintainable revenue numbers are. So if we start at the franchise fees, the recurring franchise fees, the franchise operators pay $910 a month. So if we assume there's 200 clubs and they paid 12 installments of that, that's $2.2 million in round terms as maintainable revenue. There's then commissions and rebates, which are effectively rebates from the direct debit supply house that's provided to all of the members in the franchise clubs. We receive a rebate for that. As well as we've got Fitness Passport members -- they've got a significant amount of Fitness Passport members roaming through all of their clubs. So we get a rebate from that. That equates to approximately $2 million. And again, we would see that as completely maintainable revenue base. On top of that, a large chunk, which is just over $4 million, is sales of equipment and sales of merchandise. In the pie chart, they're sitting there as Plus sales and Plus shop sales. What that effectively means is that all of the franchisees, as they require additional pieces of equipment and supplies, they'll purchase it through the Plus shop in most instances. And that's the gross sales figure that sits in that income line, and as I said, that comes to about $4.2 million. The final amount, which is, I guess, the variable component is the franchise rollout fee, and this is based on the number of territories. If you go on to the Plus Fitness website, it suggests that you can purchase a franchise starting at $350,000. On tap to the vendors and looking at some of the case studies across 50 or 60 clubs, it seems to be the average is somewhere around $350,000, $380,000, $400,000, kind of in that range as franchisees select slightly better equipment than what the base model might otherwise provide. But again, sitting in the revenue number is that gross franchise fee. So if it is $350,000 that people sign up for, 10 territories in FY '20 create $3.5 million worth of revenue. So that's the revenue side of it. Obviously -- and there's a fairly significant cost of goods sold component to this, and I'll just quickly run through that. Just on the franchise fees and the commissions, obviously, there's no cost of sales on that. It's just a straight cash transaction coming through. On the merchandise and equipment sales, the current operation runs at about a 15% margin. So in other words, there's about an 85% cost of sale against that $4.2 million worth of sales. The territory rollouts and the franchise rollouts, we -- as I said, we did look at some case studies across about 50 clubs. There's a couple of components to that. There's a $50,000 initial territory fee, which is to secure the location and the development application for a brand-new franchisee. That's obviously got no cost of sales to it, but the equipment and the fit-out side of it does. It turns out that the gross profit across 50 or 60 clubs works out at about $100,000 per site. So for each new franchise rollout, we'll get about $50,000 in franchise fees and then about $50,000 in gross profit on the equipment and the fit-out side of the business. So that creates the gross profit. And in the numbers that we've got here, it's around that $5 million, $5.2 million. But below the gross profit line, we've got some expenses, about $3-plus million worth of expenses. The bulk of that sits on the employment line. As Harry mentioned, there's 25 employees. That accounts for about 58% to 60% of the total cost base. So if there are any synergies to extract it, it makes sense that they would be sitting within that. But as I said, we've got none planned. And the other key costs that sit there are communications, so the IT cost for running the entire franchise network and communications with the franchises. We've got some travel costs, rent of the premises. And then there's administration-type costs like your insurance and your motor vehicles, et cetera. So that's the assessment of the business as we see it, which creates, as I said, the pro forma EBITDA for FY '20 of about $2.5 million, which therefore forms the basis of the 8x multiple for the full purchase price. I'll hand that back to Harry now.

Okay. Thanks, everyone. Slide 21 and 22 show what we've identified as our immediate priorities and our ongoing initiatives. I won't go through each of those individually. But in summary, on this transaction, it is slightly different to what Viva has done in the past, but it does provide us with a pipeline of acquisitions for franchisees who wish to exit. We've already identified 15 potential targets and opportunities there. Our internal target will be to secure, either by way of acquisition or open, 20 to 30 franchises of Plus within the first 24 months of ownership. It provides Viva entry into low-cost market and model, which is attractive for us because we can often find locations which aren't suitable for our Club Lime or HIIT Republic brand but are now suitable for our Plus Fitness model. It's going to open up opportunities for us to capitalize on our hub-and-spoke by introducing the HIIT Republic brand as spokes to Plus Fitness and expand into the New Zealand market, which we see is a significant opportunity. It's going to diversify our revenue stream by both direct and indirect membership revenue. It's important to highlight that the vendors are staying on, on a minimum 12-month contract to assist with the business. And in addition to that, the vendors own 14 franchises, which they wanted to hold on to and not sell. So they will also remain on as franchisees. Where we sit in the market today, and these are management estimates and opinions. But Viva is the fastest-growing health club business in Australia today. And we opened more clubs in the last 12 months than anybody else. We're the second largest club owner in Australia by quantum of clubs. We're the third largest now post-acquisition in terms of membership -- health club membership in Australia. And we're the fourth largest network, both owned and franchise, of health clubs in Australia. So they're pretty attractive credentials there. That's all for the presentation, and we'd like to open up for any questions.

[Operator Instructions] First question comes from [ Blake Wilson ].

Harry, it sounds like a good deal. I just wanted to understand, what's the competition with the existing brands that you've got? And do the -- does the acquisition of Plus Fitness impact the rollout of existing brands in other territories?

Yes. So this is why we put one of the slides in the presentation, Slide #9, which shows the overlap. We've looked at all the Plus territories and the Viva territories, and there's hardly any overlap across them at the moment. So we're dominant in some areas, and they're dominant obviously in New South Wales. But you've got a large area like Queensland where there are 12-plus franchises and the 10 Viva businesses. So I mean an area as large as Queensland supports a lot more than that. It doesn't change the rollout. So the way we've structured this fits in with the Viva model in that we have different verticals. So we have a vertical in the business for Club Lime. And that's managed by a general manager of our health clubs, and their KPI is to continue to grow that brand. We have a general manager in a different vertical of HIIT Republic, and their target is to grow that brand. We've got another one for boutiques. And now we will have one for Plus Fitness. We're splitting it into 2. One will be a GM of franchising because we want to look at where we can expand the franchising model and potentially franchise some of our brands, if appropriate, or franchise other options; and also a GM of Plus Fitness to manage the existing franchisees and new franchisees that come onboard. So that's an answer, I guess, in a long way. But essentially, it doesn't change Viva's strategy in terms of its rollout. We're still executing leases where we think appropriate Viva sites should go. This provides a different opportunity to open up locations, which are essentially noncompeting because they're in a different tier of the fitness market to the Viva brands.

And there's no limitation from a contract point to competing with franchisees of Plus Fitness here?

No. Well, there's obviously territories that franchisees have secured. So we don't go into and open up a Plus in that area. And we respect -- and as I highlighted in the early stages of the presentation that our franchise business is only successful when the franchisor and the franchisees are both doing well. So it's not our intention to go and push any franchisees out of business. We're going to put our hand up and say that we will acquire any franchisee that wishes to exit, but we're not going to push them out to exit. We now provide an opportunity for them to exit at what we believe will be an appropriate multiple. But it's a different model, where we put a Club Lime and a HIIT Republic will be generally in different locations to where Plus Fitnesses are. Some will compete. There's a Plus Fitness in Five Dock in New South Wales, and there's a FitnFast, which we own, in Five Dock. But they're different clubs. One's a 300, 400 square meter club. One's a 2,500 square meter club. So they offer different services and have different price points.

The next question comes from Nicholas McGarrigle with Ord Minnett.

Just a question around potential synergies. I think Kym mentioned maybe there's some buying power in the cost of goods sold line through the master franchisor?

Yes. So with a franchise model, the existing franchisors, they help the rollout. So they will provide things like equipment. They'll provide rubber mats. They'll provide the DA assistance and things like that. These are already things that Viva buys at competitive prices. So we see opportunities there to increase the margin for the master franchisor but not obviously increasing any cost for the franchisee, which is, again, important. The direct debit is attractive to Viva, being over $100 million in revenue. And we'll work through to see what we can do to achieve synergies there as we do with the other models. Some of that is contracted to a third party. So we'll have to work with that, but it's not contracted for an extended period of time. But we'll work through that and see whether we can get direct debit synergies benefiting the business sooner rather than later. And any synergies we get on a direct debit line will also benefit franchisees for moving across because we'll be able to do it at a better rate.

Yes, cool. Because I guess I'm just trying to -- I think Kym sort of touched on it that there's not very much cost below the EBITDA line. Just trying to balance the price you paid for this franchise -- master franchisor as opposed to what you'd normally pay for a club in terms of the EBITDA multiples, how did you sort of arrive at the price for this?

Yes. Again -- it's Kym here. Yes, that was -- I mean the first thing was to work out what the maintainable EBITDA was, which we did. The second thing was to work out where we can actually grow this business to in -- probably across the 5-year landscape and, accordingly, what we were prepared to pay for that. I guess we also need to look in context of the amount of opportunities left to acquire in Australia. And they're starting to run out certainly in the large-scale operations. This is the last master franchisor of any size that is currently available for sale, so it made sense to scoop this up if we could get it at a reasonable price and a reasonable multiple based on what we could see moving into the future. And without giving any forward-looking statements, we see enormous opportunity, as I said, on the revenue side by -- I mean, yes, you can take little bits and pieces in cost of goods sold, and that all flows through to the number of franchises that you ultimately open up. So it is kind of a multiplier effect. But now the ultimate benefit is going to come from using the Plus expertise of the team that we're bringing on. As you know, we don't have any expertise in franchises. So we bring them across. We apply our internal and current infrastructure and resources as well as access to capital. And we can really drive this to a different level. The current proprietors have averaged 18 clubs a year across the last decade. And a couple of years there, I think they're up in the 30s. So they're really growing the business quite strongly. As I said, with bolstering Viva's resourcing behind that, I think we can drive it to a much higher level and, along with that, drive the economies and whatnot. So the question is, is the multiple right? It seemed to be right on an assessment of buying a single club in a suburb of Canberra or Sydney at 3x versus buying 200 club-owned master franchise arrangement with almost an annuity income stream moving into the future as well as access to New Zealand and potentially Asia through India. It seemed to be an enormous opportunity and one that we didn't want to miss. So the 8x multiple seemed to be about right.

The -- we're -- Nick, it's Harry here. We're expecting that multiple obviously to average down as we acquire franchisees, which will likely be in the 2.5 to 3x EBITDA range. So what ends up happening there is we convert $12,000 roughly of franchise fees income, not including any commissions, to $150,000, $160,000 of EBITDA once the club is converted. So those numbers -- and our target is to have 20 to 30 of those in the first 2 years. Those numbers are the attractive numbers because the pipeline for any -- or the opportunity for any franchisee to exit now exists and the pipeline for us to buy on a first right basis is the significant part of this transaction.

That's great, yes. So the number over the first 2 or 3 -- 2 years is expected to be sort of 20 to 30 clubs to acquire. Was it part of the due diligence actually going down to the club level and identifying those targets already? Or is it a matter of that's a job to do once you get your -- the keys in your hand?

No, no. We've already identified 15 potential targets. But again, we're not looking to push these franchisees out. We're looking to -- if they want to sell, we're available to buy. So we have already identified them based on a minimum EBITDA of $150,000, and that's the ones that we'll be looking at in the first instance. But yes, they have already been identified.

Cool. And in terms of just ongoing franchise territories sold, I noticed in the presentation, you said that there's 40 territories already signed. What's -- how does that potentially convert over time? Do all those 40s come to fruition? And then what -- do you think that the 20 a year is sustainable? What's sort of cap, do you think, on the number in Australia that you can roll out?

The leading express 24-hour club chain in Australia has over 500 locations and 500 territories. So I think there's no reason that the Plus brand can't grow to that over the next few years. The way it works with those 40 deposits is that people pay a deposit to secure a territory. Once they've secured that territory, they go looking for a location. Once they've secured that location, they submit a DA. And once that DA gets in, that's when it's really granted as a locked-in site. So from the 40, we believe 18 of those are going to lock in this financial year minimum, and the rest are in progress. So like us, when we report our clubs, some of them are sites that you're securing that are not even built yet. And these are the same with these territories. Viva believes we can boost some of the support that AFM gets so that we can accelerate the rollout because it's just people on the ground explaining the concept and selling territories essentially.

And then it's obviously providing you a pretty big opportunity to roll out more greenfields in between now with the Plus -- existing Plus network. Obviously, the HIIT Republic concept is working really well. How do you think that the HIIT Republic studios might work in between 2 different Plus or in -- around a network of Plus sites? How would the economics of that work for the franchisee if you rolled out a HIIT?