Paul Cerro's avatar
$37.1m follower assets
No Pain, No Gain. $XPOF Going Higher
If you'd rather listen to the pitch instead of reading all this, I've included the link here that has an audio version.

If you'd like to hear the pitch/debate I had with @ccm_ryan and @ccm_brett on Chit Chat Money, you can find that here.

Summary

  • Company hurt during COVID has executed well on a post-pandemic comeback and has almost returned to full pre-COVID levels

  • Broader tailwinds fueling a return to in-person workouts and the desire to try new fitness concepts

  • Management executing well on diversifying revenue channels, improving margins, and growing internationally

  • The stock is currently trading at 13.9x FY’22 earnings, a discount compared to the broader S&P index, consumer discretionary index, and other high performing fitness names

Business Overview

Xponential Fitness XPOF -1.74%↓ is a boutique fitness studio franchisor that operates in North America and 11 countries globally. Within their portfolio, they have 10 name brand franchises that you may have heard of before: Club Pilates, Pure Barre, Cyclebar, StretchLab, Row House, YogaSix, Rumble, AKT, Stride, and BFT. I’ve included a description of each in the footnotes - just click the number to teleport down there and then you can come right up.1
They’ve grown from 751 studios in Q3’17 to 1,889 as of Q3’21 (September 30th, 2021) and the company believes that they can have a total of 6,900 studios in the U.S. alone. They operate under an omnichannel approach with three main categories,

  1. XPLUS - their video-on-demand platform with over 1,000 workouts
  2. Studios - where individuals can physically go in and exercise at any franchise location
  3. XPASS - a membership option that allows members to gain access across all 10 brands

All these three membership options help the company drive overall system-wide sales and thus, bigger franchise revenue.
Initial franchise investment is around ~$350k, and they have a playbook designed to generate an AUV of $500k in year two of operations and studio-level operating margins ranging between 25% and 30%.

Thesis - LONG

As the stock market continues to be very volatile and tech stocks continue to be selling off with no remorse, I’m looking into various subsectors within the consumer and retail space that can hold up better in a slower economy while still having significant upside potential. This has led me to the fitness subsector and I recently wrote an article on how the fitness industry has evolved from pre-COVID to post-COVID and how we as investors could capitalize, see the article Fitness in a Post COVID World.”

This article will give you some context for this article but I think that Xponential Fitness has a lot going for it that will drive upsized returns in the long run.
Here’s why.

1) Asset light model
Like I mentioned previously, Xponential Fitness is a franchisor of boutique fitness brands. So what does this mean? Well, it’s probably best to quickly explain how franchising works.

Franchising means that the franchisor (Xponential Fitness), offers a branded package deal to qualified individuals (the franchisee) that includes the goods and services and the name of the business to be used for a fee. I (the franchisee) would pay Xponential Fitness upfront fees to “buy” a franchise and then pay an ongoing fee to continue utilizing said name, pay for marketing-related costs while also receiving the necessary training and support needed to make this a success.

So in this case, Xponential Fitness owns all the IP and gets paid for others to use it. Because the company does not want to have company-owned studios long-term, that means that they will only be collecting fees from their franchisees as more studios open.
Simple enough, right?

Yes, however, there is a caveat to this. If the franchisees don’t make money, then Xponential doesn’t make money since the real source of the company’s revenue comes from taking a cut of gross sales from the franchisee.

This, in turn, keeps interests aligned and the need for the franchisee to become successful so that the company (Xponential Fitness) can also become successful.

While the company technically owns 43 studios (out of 1,889 and were acquired during COVID) as of September 30, 2021, they plan to re-franchise or discontinue all of them by the end of the year if they aren’t profitable. This will allow them time to hopefully get things back to running order and then they can hand the ropes to someone else and strictly focus on the growth of their franchisees.

Little to no physical assets = little to no costs in owning those physical assets.

2) Return to in-person
Like I mentioned in my fitness deep dive, people who were forced to do at-home digital workouts during the pandemic are over having to be confined in their tiny apartments or homes and not have any social interaction whatsoever.

Consumers are longing to get out of the house, try something new (or old), and be a part of a community where you’re being pushed by those around you and held accountable.

According to Mindbody, a third of consumers surveyed stated that they plan to visit more studios after trying new workouts virtually (remember this for later) and that 40% of consumers are booking workouts with studios they have never physically visited before, allowing businesses to reach “digital-first” clients.

Adding fuel to fire, from a McKinsey report, 70% of fitness consumers reported missing their gym as much as they miss family and friends. Extreme but hey it proves a point.

Even The CEO of Xponential highlights on a Q2’21 earnings call just how well the business has bounced back.

> When comparing the end of the second quarter of 2021 to January 31, 2020, without even taking into account our newest brand, Rumble, our business has recovered to 103% of actively paying members, 98% of total visits and nearly 90% run rate AUVs.

So while digital fitness will always be a thing, consumers’ shift back to in-person will benefit Xponential Fitness as more and more consumers feel comfortable with attending group-oriented classes.

3) COVID contracts available supply
While returning to in-person is a good thing for the company, it didn’t come without any bloodshed. COVID really put some tough times on fitness centers when we all went to lockdown and with various state orders, many did not survive.

In fact, eight major chains filed for bankruptcy and 17% of fitness centers closed permanently, according to industry trade group IHRSA.

With a significantly reduced supply of gyms and studios across America, there is naturally more demand with limited supply as consumers continue to work out in person.

This will allow those companies that have survived to fill classes faster, boost AUVs (average unit volumes), and in time, even raise prices.

So while tragic that there were bankruptcies and closures, Xponential can help fill the void.

4) Omnichannel approach
As I mentioned in the business overview portion of this post, Xponential Fitness operates through three different channels: XPLUS (video-on-demand), studios (in-person), and XPASS (membership offering across all brands).

I’ll go over each one and speak to why they are key for future success.

In-person
This one is a no-brainer and better yet, it’s actually their bread and butter. Without having physical studios this company would just be a fitness app that offers digital workout classes. A Peloton membership without a bike. But while this seems rudimentary, it’s necessary because of those who either started their fitness journey digitally during COVID or for those that had to compromise with digital because they used to be an in-person type of exerciser.

Xponential fitness did a survey on their members and about 43% or more are excited to jump back in (in-person classes) and cancel their digital subscriptions. Plus, 83% of members who had previously had a big box gym membership canceled those after they joined an Xpo studio.

So as we continue to return to normal, XPOF is seeing once digital users and those that were already physically going to a fitness center, want to get back into the studio. Having these new types of classes built around a community is what is helping the company get back to full occupancy and work towards achieving pre-pandemic AUVs.

XPLUS
XPLUS is Xponential fitness’ answer to video-on-demand. Users can access a library of over 1,000 workouts from their devices.

Source: Website.

You can choose workouts from any 9 brands that the company offers and then select targeted classes within that area of fitness focus. The monthly price for this offering is $30 a month and content is never stale with new classes and programs being released weekly.

With the overall shift in how work is conducted (WFH vs. on-site), people are integrating their lives with more technology. In fact, 46% of Mindbody survey participants stated that they intend to make virtual classes a regular part of their routine, even after studios reopen.

XPLUS allows for the company to branch out and target those fitness users who might not want to physically go into a studio but still want access to all the great workouts that the company has to offer within the safety and comfortability of their own home.

In essence, the best of both worlds. Plus, being an owner of a physical brick and mortar studio, having a digital option is just table-stakes in this new world we live in.

XPASS
With in-person and digital covered, what more could the company do? Well, they decided to launch an internal ClassPass membership option. ClassPass is a membership that you can buy that allows you to use “credits” in order to sign up for different workout classes from different fitness companies in your area within one membership. This allows you to have access to different fitness concepts without needing to have multiple memberships.

So, Xponential Fitness thought, why not make an option so that members could access all of its brands instead of just one? Thus, XPASS was born.

Source: Website.

XPASS utilizes the same concept of “credits” to be utilized across its brands and costs anywhere from $49/month to $139/month depending on how active you want to be.

Two helpful stats that also came out in the company’s Q3’21 transcript that reinforces the effectiveness of the XPASS offering are below.

  • 15% of XPASS users never interacted with the company prior to joining XPASS
  • 23% were previously deemed “inactive” by studio sales staff

So not only have they done well to recruit net new users, but they also have been able to get churned members to get on this service.

When reading the company’s Q2’21 earnings transcript, the CFO brought up a really good point on how this offering can help boost retention, which is a core metric that membership-oriented companies need to keep as high as possible.

> Further building out things like our XPASS, using some of our auxiliary revenue streams to drive members back into studios and allow them to try different verticals and kind of taste the various brands we have, I think will also improve retention across the system as people who may be have been doing rowing for a long time or bar for a long time, it gives me the opportunity to try Club Pilates, keep them in our ecosystem by using XPASS as a tool for member retention.

Instead of churning because “I’m over one thing,” I can just try something else out and hopefully stay on the platform. Makes sense.

With brick-and-mortar, digital, and cross-channel offerings currently being offered, I think the company has a good grasp on acquiring and keeping as many customers under their umbrellas as much as possible.

5) International expansion
While the company has a lot of its footprint already in North America, it does have its eyes set on international expansion. Currently, the company operates within 11 countries like Australia, Saudi Arabia, Japan, DR, South Korea, etc. and with the addition of BFT, it now has over 1,000 studios open or obligated to open internationally.

What’s interesting to note is also how revenue gets recognized internationally. When a franchisor in North America sells a license, they amortize that over 10 years or the length of the license, but that’s not the same when you go abroad.

Internationally, the “master franchisor” is actually servicing the franchisee, the payment, or the proceeds that the company gets from each license sale or each equipment package, gets recognized as revenue immediately. So as they start to see an accelerated ramp on the international front, the impact from a revenue and margin standpoint hits the P&L immediately.

So that will be probably the largest component of revenue and margin growth in the coming quarters as XPOF grows internationally.

6) Economies of scale
Just like any company that makes or sells goods and services, your costs will still grow as a % of growth but perhaps not as quickly, which allows you to grow your margin and thus increase profits. How XPOF can accomplish this with their current business is two things.
  1. Offloading their corporate stores which they’re incurring all the costs for at the moment and,
  2. Continue to sell and open more studios while keeping the growth in their SG&A expense down as much as possible

To my first point about getting rid of corporate-owned studios, the CFO said in their Q3’21 earnings call,

> We discussed that we would be refranchising those out, and we've made really good progress and continue to make good progress on delivering on that commitment by the end of the year. So you'll see SG&A ramp down associated with the company-owned studios throughout the end of this year.

Though this is more of a one-time thing, it will have an impact on the fiscal year 2022 margins.
However, the real margin improvement comes from just doing business as usual. XPOF hires staff to sell licenses and support their franchisees as they continue to grow. As they grow, their staff can support more franchises which means that top-line growth should outpace the growth in SG&A expense.

To give you an example, SG&A expense as a percent of net revenue has gone down from 75.2% in 2018 to 57.1% in 2020. Granted 2020 was a unique situation but even in 2019, SG&A was only 62.3% of net revenue. A difference of ~13 percentage points.

With top-line growing fast and SG&A growing moderately, among other factors, the company believes it can achieve EBITDA margins in the 35%-40% range long-term. This compares to adj. EBITDA margins of 9% in 2020 and 13% in 2019.

7) Psuedo fitness ETF
As I dove deeper into my research on the company I came across a realization that I haven’t experienced in any other business, aside from restaurants, and that is diversification. Some restaurant companies have brands under their portfolio across different cuisines that they franchise out (example, Yum! Brands which owns KFC, Pizza Hut, Taco Bell, and The Habit Burger Grill). This same principle applies to Xponential Fitness.

The company has 10 brands that each offer different types of workout classes that revolve around two things: functionality or high-intensity interval training (HIIT).

So instead of buying into a one-concept type of business (think, Peloton), you can buy into a single stock that has exposure to many different types of fitness offerings.

This in and of itself gives you pseudo diversification amongst the boutique fitness industry so that if you were worried that a fitness trend might fade, you have 9 others that are different that might grow even faster.

This is why the concept of a pseudo ETF came into my mind because you’re holding a basket of different fitness concepts by just investing in one name. Pretty interesting if you ask me.

8) M&A and partnership opportunities
When you already have 10 great brands under your belt, how do you make sure that you can continue giving members optionality while bringing in fresh new concepts into the fold? You either build (create your own), buy (acquisitions), or partner.

Xponential Fitness has done just that across its lifetime and I don’t believe they’ll be stopping anytime soon. Let me explain what they’ve done in the last two years.

Acquisitions
XPOF has made two acquisitions as of recent, Rumble, and BFT. For those of you that are not in the NYC area, Rumble was all the craze pre-COVID and it seemed like so many millennials would talk about it as a status symbol within their conversations.

Rumble operated under two different concepts; boxing or running. This appealed to many fitness enthusiasts that wanted that special HIIT class but with a strength component to each. XPOF acquired Rumble in March of 2021 and will be spending time building out that brand as it is still in just the single digits for the number of studios.

The most recent acquisition that the company has made was for BFT. What’s unique about this acquisition is that the company paid $44 million and immediately expects the deal to be accretive on an EBITDA margin basis, but also opens more doors internationally. Because of this one deal, BFT alone led to a 15x increase in international studios to bring the total to 130. What’s also great is that there are over 150 BFT studios that were previously sold prior to this deal that is contractually obligated to open across the Asia Pacific region within the next 9 months. So not only immediate growth but a pipeline for future growth as well.

Source: Company S-1.

Aside from these two deals that the company has made, XPOF has a track record of rolling up strong, name-brand fitness concepts into the fold such as Stretch Lab in November 2017, Row House in December 2017, AKT in March 2018, Yoga Six in July 2018, and Stride in December 2018.

I think we will continue to see the company paying close attention to new and cool fitness trends and concepts to acquire in an effort to improve optionality and stay with the times.

Partnerships
A recent, exclusive, partnership that XPOF has signed actually has to do with LA Fitness. This deal allows Xponential fitness franchisees that already have a studio open in their protected territory, to open another studio within an LA Fitness or City Sports Club gym. Pulling a quote from the press release,

> Studio development time and buildout costs of these locations will be less than those of a traditional standalone studio, and existing franchise partners will have an opportunity to drive additional revenues while operating these locations free of initial franchise fees and lower marketing fund fees. AUVs at these locations are expected to be lower than those of traditional studio locations; however, this opportunity provides for reduced operating costs than standalone studios.

The agreement lays out a minimum development of over 350 franchised locations over five years to add Xponential brands in more than 500 Fitness International locations.

The reason I point out this partnership is because of how creative management is getting to fuel studio growth and even on the most recent transcript they mentioned that they could see themselves continuing to do agreements like this in the future with other gyms.

Risks
Like all companies, there are some risks that cannot be ignored when trying to operate the business as efficiently as possible. For XPOF, I’ve listed out four risks that I feel could be the most damaging to the business and the likelihood of them happening.

1) More COVID restrictions
Just like how it affected the business the first time around, the company is not immune to it happening again. With new variants arising as the norm, the potential for another lockdown might be slim but that doesn’t mean that state or city measures aren’t a real risk. There could be another situation that calls for strict social distancing measures, vaccine mandates, and even occupancy caps.

If this were to happen again in the future, the franchises will see a big hit to AUVs and potentially lost momentum of opening new studios which will directly affect XPOF’s ability to become profitable.

2) Lack of market liquidity
Another point that is definitely applicable to XPOF, at least the stock price, is the lack of market liquidity. What do I mean by this? I mean how little money is flowing in and out of the company on a daily basis which stems directly from the number of shares being traded on a daily basis.
On average the company trades about 208k shares a day. At an average price of $17 let’s say, that’s only ~$3.6 million in dollar terms. This is incredibly low for a company and could pose a risk for investors looking to exit a position since there aren’t enough transactions happening on a daily basis. Volatility in this name will remain high until it becomes more recognized and gains more awareness. Just something to be cognizant of but that shouldn’t deter you from potentially entering a position.

3) Cannibalization
With the incredible growth of new studios opening and licenses being sold, it begs to ask if all these openings could in fact eat into each other’s ability to earn revenue. Because the company has XPASS which can be beneficial for the company and the studio franchisee, it could eat into the revenues of the studios and then make a dent into the company’s revenue. The ability to strategically draw lines and not flood the market with studios too close to each other will be paramount as the company expands to its potentially ~6,900 count in the U.S.

4) Labor costs
Along with the growing great resignation over the last year, workers are hesitant to return to a job that they don’t feel pays them enough or requires more in order to stay. In an industry that relies on good fitness instructors to teach these classes and record workout videos, they are in high demand and they know it.

Interviews have shown that Peloton instructors make anywhere from a six-figure salary all the way up to over $500,000 in total compensation. Now I’m not saying that XPOF pays their instructors that much but a quick glassdoor search for Rumble salaries in NYC says about $3,200 a month. So in theory, ~$38,000.

However, this doesn’t mean that the company hasn’t paid up already or won’t have to in the future.

Valuation
To be honest with you, valuation is probably the easiest part of this entire research. The business in and of itself is not rocket science either.

The company sells franchises → franchises make money → company makes money → company sells more franchises to make more money while keeping costs down → company is profitable. Simple.

So while the company is not yet net income positive for FY’21, it is planning on being profitable in FY’22.

The company is estimated to earn $0.70 a share in FY’22 and with a current share price of $13.46, that gives us a forward P/E multiple of 13.9x. Not crazy considering that the S&P 500 index is trading at a 17x forward multiple, the consumer discretionary index at 22x, and even other fitness names like Planet Fitness PLNT 0.85%↑ and F45 Fitness FXLV 3.11%↑ are trading at 45x and 4.6x, respectively. Though F45 has had terrible management which is thus shown in the stock price.

Factoring in a modest 25x forward P/E, to account for faster growth names, to the company’s $0.70 in estimated earnings and we get a share price of $17.5, or a 30% upside from yesterday’s close. However, I believe with more growth internationally, and with economies of scale, the company can be worth north of $30 a share in as little as two years ($1.5 in earnings - estimates are $1.77 - and a 20x P/E).

Closing Argument
Everyone is so absorbed in the “next big thing” which usually involves technology-related companies while failing to realize that there are many consumer and retail names out there that can return a pretty penny.

I believe that XPOF is one of those names and in a world where mental health and general wellness are huge factors for many, fitness is one of the best ways to accomplish that. For all the above reasons, that is why I am bullish on the future of this fitness name.

To help with operating leverage as well, I've included a follow-up article that explains (visually) just how this is achieved.

Nathan Worden's avatar
Enjoyed this pitching and looking forward to listening to your conversation with @ccm_ryan and @ccm_brett

This seems like a good time to repost the video of you pitching XPOF as well:


Paul Cerro's avatar
@nathanworden I thought you were about to do me dirty again with that hard brain thought pic lol
Nathan Worden's avatar
@paulcerro Not today 😄

(but the fact that the image exists out there means there is a non-zero chance that it could "surface" again in the future 😄)
Nathan Worden's avatar
@nathanworden But to be fair, I won't post it again if you don't want me to 🙂
Paul Cerro's avatar
@nathanworden no no idc it was funny
Chaewon Lee's avatar
Hmmm..they do have debt though. Are you not worried that buying more brands might put it into financial distress?
Paul Cerro's avatar
@leec they do have debt but they also generate positive FCFE so it's serviceable. The rates on them too aren't nuts so I'm not concerned, plus the added debt helps with COE in the cap structure
Chaewon Lee's avatar
Putting aside the mutli channel model, still not convinced in-person fitness is a winning investment...all those chains that shut down, yes they couldn't have predicted COVID, but the fact is everyone is already working out at home now and have all the resources to do so, why would we expect that "progress" to unwind?
Paul Cerro's avatar
@leec fair. Simple answer is they don't want to. Participation rates of $XPOF franchises are almost back up to pre-pandemic levels, looking at planet fitness for example $PLNT, their memberships have been on the rise as well (hence the stock rebound) and if you look at the pride and joy of at-home fitness, $PTON, their stock is down over 95% from the highs. The shift is there. Also Tonal, another at-home player just laid off 20% off it's staff to prep itself for an IPO.

Additionally, an increasing overall percentage of Americans used at least one health club or studio, reaching 27 percent of the population—the highest total on record, according to recent data from IHRSA
Brett Schafer's avatar
This is awesome. You're welcome back on the pod anytime
Chaewon Lee's avatar
The studio growth chart looks impressive, but noticing the chart ends before covering 2H21 and 22 where I imagine a lot of holdout studios would've had to close...and I also imagine the growth shown in the chart is mostly attributable to M&A, which you can only do so much of at such a rapid pace. What does the organic growth level actually look like going forward?
Paul Cerro's avatar
@leec great question, so the rollups help but it's not like a traditional PE style roll-up where the units basically already exist. Their net new growth far exceeds their acquisitions. For instance, Rumble acquisition was just a handful of studios and the BFT acquisition immediately 15x their international stores for ~$44M. Not a bad return if you ask me for the immediate gas thrown on the fire
This is great! Seems like an interesting company. Why do you think barely anyone has heard of it?
Paul Cerro's avatar
@nb96 yea that's a good question. It's technically a small cap stock (towards the bottom of the band of small cap size range) so not much coverage in general. You'll have small investment banks that cover it (I think 2/3?) But bigger guys haven't yet. Because of this though, I think that's why retail investors have an opportunity because it's a really low under the radar stock and can get in at relatively the ground floor. Potential multi-bagger
@paulcerro so you’re basically saying you can get in before it’s too widely known and then the price attractiveness won’t be as good?
Paul Cerro's avatar
@nb96 yea pretty much. That's the benefit in investing in micro cap or small cap stocks because you're one of the people that got in really early instead of too late
@paulcerro so why now? Why not wait and see if it goes down more since many consumer names have been getting killed?
Paul Cerro's avatar
@nb96 timing the market is very difficult. I wouldn't recommend doing that. However, the risk/reward at these levels is good. Can it go lower? Sure. Can it also be the bottom? Sure. But the thing is we don't know. So it's about thinking of the upside is there, and then being okay with taking a position at a price that you're comfortable with given this years crazy volatility.
@paulcerro that makes sense. Looks like the volume isn’t bad either. Little options activity. I go to pure barre myself so I’m a fan of the brand. Had no idea it was a stock
Paul Cerro's avatar
@nb96 well to be fair, it's technically not a stock. The brand just falls under the parent company but yes, indirectly it's part of the company that is publicly traded.
@paulcerro yes I know what you meant. Thanks for explaining it to me!
Thanks for the write-up. Any thoughts/details on management? And also curios how their member growth looks like.
Paul Cerro's avatar
@bmetin Management seems to be on point with capital allocation. Most of them at the C level used to be operators of their own fitness businesses so they know a thing or two about making the business successful.

While they don't report specific numbers on memberships, management does comment on attendance rates which are right up there with pre-pandemic levels. Literally a stones throw away. This is reflected in the increasing AUV numbers that have been coming out quarterly.
Michael Carnevale's avatar
It's down a lot from the highs, do you think it'll go back up any time soon?
Paul Cerro's avatar
@m_carney it's been frustrating to say the least but yes, even in February I thought this stock was worth $30. It almost hit it and then the market blew up but what's interesting is that after it's most recent earnings, growth is still there and consumers are still actively going and working out. AUVs about a hairs length away from surpassing pre-pandemic levels
Michael Carnevale's avatar
@paulcerro You said they're targeting $500k in per store sales, but how close are they to that and what's the probability it'll go higher (past 500)?
Paul Cerro's avatar
@m_carney yes management wants to target $500k for franchisees but right now, global run-rate is $450k but North American store run-rate is a little over $470k. So it can get there for sure and if you zoom out, it can keep going higher with more XPass memberships and just price increases. In the link at the bottom of my main post, it factors in a 2% annual increase to AUVs which I think is modest
Eric Messenger's avatar
As someone who is a lifetime fitness learner and went from 325 pounds to 185, and still does Yoga, MMA, strength training, animal flow, whatever unique training I can fond; I like this idea 1,000x better Peloton in terms of fitness focused investments. The diversity is smart. All the fad stuff with ONE trick fitness ponies, will never work long-term IMO.
Paul Cerro's avatar
@wall_street_deebo same man. I workout everyday so I'm big into fitness myself. It's great because $XPOF has 10 brands that it can leverage to a wide array of potential fitness enthusiasts (my point on being a fitness ETF) and encourages social aspects through classes. There are just so many tailwinds supporting it that it almost seems like a no brainer, especially between $PTON and itself
Chris's avatar
Triggered a daily chart up trend recently, the weekly chart downtrend resistance level is 19.08, according to the way I use technical analysis, it is also holding its monthly up trend too.
Paul Cerro's avatar
@etfs I'm no technical expert but yea the stock has had some really weird movements. Fundamentally though it's a great biz and when it comes to the options market, it's been pretty quiet
Chris's avatar
@paulcerro Of the 2 major market indices I follow via their etfs $SPY (sp500) and $QQQ (nasdaq 100), I only have the $QQQ in a daily chart up trend, so $XPOF looks better to me than $SPY, which is still in a daily chart downtrend, and is one indication that $XPOF is recently outperforming the market as defined by the sp500.
Paul Cerro's avatar
@etfs it's funny because while there technically is no fitness etf, part of my thesis was that this company almost acts like one given it has 10 brands under it's belt
Stock Metal Investment's avatar
Very deep dive, loved it. I might look into the company now.
Paul Cerro's avatar
@stonkmetal it's my second biggest position at 16% of the portfolio. Very high conviction in the name for all the reasons above and on the follow up post that explains how they can achieve 40% operating margins down the road
Stock Metal Investment's avatar
@paulcerro Seems to be a new IPO, interesting indeed, I'll start digging :)
Paul Cerro's avatar
@stonkmetal please do! And always happy to answer any questions if you got them
Stock Metal Investment's avatar
@paulcerro will keep that in mind!
Jensen Butler's avatar
Great piece. Would've liked a little $PTON push but maybe I'm just biased (and battered)
Paul Cerro's avatar
@jensen this is the long leg of a L/S pair trade with $PTON
Sika's avatar
Very well thought out post. inflation keeps picking up though, do you think people would cancel their memberships since prices aren't going down?
Paul Cerro's avatar
@sikaboat that's something that I've been grappling with all of 2022. Been completely destroyed by a weakening consumer even though they've held up well this entire time. I want to say some discretionary will be affected but since the average XPOF membership is $90 and the average gym membership is $50, I feel like the extra $40 is well worth the value you're getting considering you're getting an instructed class out of it. It's recent Q suggests the consumer is holding up well with them
Ben's avatar
But do you think there will be slower growth from rising rates and the harder ability to get financing to open studios?
Paul Cerro's avatar
@bwinvests I've been asked that a few times and my answer is that the company works closely with being able to get their franchisees the financing they need in order to open up their studios. Additionally, when you think about the capital requirements to open one, it's not that much. On average, it's about $350k to open one compared to a traditional gym like Planet Fitness $PLNT that can cost well over $1M because of the equipment needed. Plus, liquid assets need to be $100k, minimum net worth needs to be $500k so it's not like many potential franchisees are priced out from opening one. In my opinion, it's on the better end of the spectrum for those that want to open a franchise because it's not the most demanding but neither the most loose. I'll call this, the sweet spot for franchisees and a 40% CoC (cash on cash) return at 2 years (how much money you can make back at the end of 2 years) is pretty up there for franchise business opportunities.
Owen Martinetti's avatar
Do you think the Omni channel approach will actually work or is it more of needing to do it to stay competitive?
Paul Cerro's avatar
@peppermint I think it's necessary. Pre-covid, digital was there but it didn't really gain steam. Pandemic changed all that but as fast as the pendulum swing one way, it swung back after things reopened. I do believe that there are still many that will like the option of digital at the very least

Can find more about it here
Paul Cerro's avatar
@peppermint also, XPass helps because as a consumer, I can get access to different types of classes while only having one membership instead of multiple. Think there's a real value add there and the take rate is only 30%
Owen Martinetti's avatar
@paulcerro So what's the incentive of offering that then if the store owner has to give up 30% of that membership offering?
Paul Cerro's avatar
@peppermint being a part of the XPass membership means that they can possibly get customers in that they might not have gotten otherwise. It's more of a right to play in a space that offers optionality for the consumer. It doesn't actually hurt you and in response, the 70% is split amongst the franchisees that participate
Conor Mac's avatar
My man came prepared, damn!
Paul Cerro's avatar
@investmenttalk You said high-quality! Needed to do whatever was necessary for convincing!
You mention multiples but since then, they've come down a lot since the start of the year. You still think it's worth $30?
Paul Cerro's avatar
@dp23 100%. Many consumer and Retail stocks have taken a hit because of inflation and recession worries but $XPOF has proven most recently that people are still going to the studios, AUVs are growing, international is still growing and people are still purchasing licenses. I had $30 which the price got pretty close to, but I still think that in 2/3 years, this can easily be a $40/$50 stock
Eitan Rothman's avatar
With Tonal laying off 35% of their workforce at the end of last week, how does that improve your outlook on XPOF?
Paul Cerro's avatar
@eitanr you've been keeping up with the news! Yea not a great look but I'm guessing that in order to make themselves more marketable for an IPO, they're trying to cut expenses where they can and open is the easiest way to do that. If you want a similar case study to Peloton $PTON, Tonal is it. $3500 wall mounted gyms don't seem sustainable when people keep wanting experiential type experiences. In-person being that which is reflected in not only $XPOF management commentary but also Planet Fitness $PLNT
I'm more of a macro investor and began looking at single names and think your content is great!

Quick question - Consumers have seen their real wages decline with strong inflation. How do you view XPOF and their business strategy in an unfriendly economic cycle?
Paul Cerro's avatar
@quant_investor Yes, the consumer has been hit hard but there are a few aspects of the business that I believe will help the business mitigate consumer risks.

1) the average gym membership is $50 compared to Xponential Ftiness's $90/mo. Additionally, that $40/mo delta gets you classes, active instruction, and social aspects that regular gym going does not.

2) Since there's such an emphasis on mental and physical health over the last few years, exercise plays a critical role in achieving that whether it be simple yoga or something more intense like HIIT training. Both of which XPOF has.

Could there be churn? Yes, but management commentary suggests otherwise and rising AUVs point to the contrary of a slowing consumer in the fitness category
Mia's avatar
What’s the biggest brand they have?
Paul Cerro's avatar
@mimimonk they started with Club Pilates but Pure Barre and Club Pilates are their biggest holdings right now
Chris Abbenda's avatar
But why this over $PTON? I feel like there's more upside with a turnaround
Paul Cerro's avatar
@chrisabbenda that's a very big "if" considering that $PTON is lighting cash on fire and it's doing everything to slow it down. While yes, a turnaround could make for an attractive return, you're getting less of a headache and for lack of better words, gambling stake when you go with $XPOF instead. Depends on what your risk tolerance is
Michael Gu's avatar
Great read. What do you think is the biggest risk to the business? What do you think the company needs to nail down for your thesis to hold true? Who do you see as the biggest competitor to XPOF?
Paul Cerro's avatar
@hungrytakoyaki All good questions. To your first one, the biggest risk to the business I feel is that if inflation keeps going higher, people will eventually have to cut in areas where they might not have thought about cutting before - aka fitness. Though we've had months of near 10% inflation and participation rates have not slowed at the studios.

I think the biggest thing that XPOF has to nail down (which it's doing currently) is boosting AUVs for its franchisees. This factor is 1 of 2 key inputs that flows through the rest of the business. If the franchisees get higher sales volume than that means more sales to XPOF. Higher AUVs means faster cash on cash returns which entices more people to open studios since it would be classified as a good business.

Biggest competitor is honestly F45 Fitness $FXLV and from what I've been told, corporate has mismanaged things and franchisees are left to fend for themselves which you might be able to tell from the stock price collapse.
From a comps perspective - it seems theyre doing what peloton, tonal - like companies are doing. What differentiates them/sets them up for success in this competitive market with lots of other existing players / new players joining in? (Also with youtube having countless free workout classes without physical hardware)
Paul Cerro's avatar
@pc123 Okay this will be a long-winded response but I guarantee it'll be worth your while.

As far as public comps, there aren't really many. If you want to talk about the purest play company out there, it's F45 Fitness $FXLV and they have been doing poorly this year though it's warranted. Other fitness names like $PTON $PLNT $LTH $BODY exist but they aren't the best one's to represent.

So let me quickly address the digital question you have. Yes, there is plenty of content out there (digitally) that consumers can take advantage of. However, this is not the core competency of $XPOF. While XPOF made a digital presence mainly due to COVID, its bread and butter is in-person studios. It's getting people together, led by instruction, and can accommodate a variety of different types of workouts. So while they do have a digital arm, they are not competing with digital players. Tier 1 is in-person studios, tier 2 is digital for those that like the brands of XPOF (can't get them elsewhere) but want to workout on their own.

Lastly, there are other fitness franchises out there but none are close to the scale and attractiveness that XPOF has. Their low investment cost, minimum liquidity needed ($100k) and $500k net worth actually allows not only more people to qualify to open a studio but also boasts excellent Cash on Cash returns for the franchisee. I've commented a bit about this above in other comments but when it comes to making your money back quickly with not as much upfront equity needed, XPOF really reins supreme in that front. Short answer - they just do it better.
Super interesting and very detailed analysis! This is great
Paul Cerro's avatar
@mrep thank you so much!
Love the idea of the XPass, I wonder how much that will help with net new memberships and retention. That feeds into AUVs right?
Paul Cerro's avatar
@gregb60 Me too! I think it can't hurt and I would label it a "call option" and as an investor, I'd rather have as many of those as possible. And yes, that will help feed into AUVs since the 70% left to studios will funnel in there.
Tom's avatar
This is a very interesting pitch. Who are it’s main comps?
Paul Cerro's avatar
@tomate thank you! The best one is F45 Fitness $FXLV and then you have $PLNT as the next best and $PTON as the last.

It's hard to base it off of other franchise models because most public ones are restaurants with obviously different business models.
Yaaaaaaas
The Science of Hitting's avatar
Interesting write-up @paulcerro, a new name to me.

Thanks for posting!
Paul Cerro's avatar
@tsoh_investing thanks, Alex! Been getting really into franchise concepts recently and I think they have great potential especially with their full franchise model and ability to expand operating margins well past 30% in the next year or so (last link in the post).

In the early innings!
Great read and very thoughtful argument. All of the reasons against owning $PTON should support your thesis. Although the impact of inflation is probably less severe in major cities (where studios tend to have a much larger footprint), I am very curious how it will impact discretionary spending in more general terms. Will people continue to prioritize health and fitness if we are headed into a recessionary environment (regardless of the severity)? Also, how will rising rates impact the franchise model and rising borrowing costs of those who are trying to open up studios? Although the growing prevalence of workout studios across the country is undeniable, it is still a fairly new concept and I wonder how it plays out over the next decade if the next generation does not have the same preferences as it relates to working out…
Elijah's avatar
Do you think them continuing to buy brands makes sense? Sounds like they're doing it because some brands can't scale
Paul Cerro's avatar
@elijxh I can see why one might think that but it's actually a really smart idea. By buying new and upcoming brands, they can take their expertise of scaling the franchise model and get it out there quickly and effectively. This leverages the "know how" of running a business.

Secondly, buying brands does two things, 1) it helps them stay fresh because they can get new boutique offerings that can attract new customers that may want the "new" thing or just making sure that they don't get left behind (think a gym that is just a gym and will only ever be just a gym - boring!)

2) with new brands, this can feed into the XPass offering that allows customers to try different classes under the $XPOF umbrella without needing multiple memberships. This is where the idea of an internal Class Pass comes in handy.

So it's not a matter of lack of scale, it's a matter staying fresh, leveraging their expertise, and then making their XPass more value additive
Elijah's avatar
@paulcerro How many brands do you think they could end up acquiring then before it doesn't make sense?
Paul Cerro's avatar
@elijxh They're at 10 now, but I don't think there's a "number" before it gets crazy. They could very well double the number of brands under their belt if it makes sense. The acquisitions have to be attractive, which they've done so far, and roll up well into the asset-light franchise brands they currently have. Could see them being a fitness brand conglomerate like a consumer/retail $IAC

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