Activist hedge fund eyes Life Time Fitness, makes bold founder sweat

For three decades, Bahram Akradi, founder and CEO of Life Time Fitness Inc. (LTM), has avidly promoted the healthy, active lifestyle. Today Akradi’s company is the target of an activist investor — one that presumably wants its balance sheet whipped into shape to produce healthier returns for shareholders.

A native of Tehran, Iran, Akradi came to the United States in 1978 at age 17, taking a health-club job while earning an engineering degree at the University of Colorado. He went on to become a partner in the U.S. Swim & Fitness gym chain, which he sold to Bally in 1986.

He then started Life Time with a single suburban gym in 1992, growing his chain of expansive, amenity-rich, “resort-style” fitness centers to 111 locations in upscale suburban areas across 24 states, with a stock-market value of $2.2 billion. It was one of the great consumer growth stocks of the last bull market, soaring 250% from its July 2004 initial stock offering to its peak above $64 in October 2007.

The company made its 100,000-square-foot showplaces of fitness and vanity a common feature of top-tier retail districts in well-off bedroom communities mostly in the midsection of the country — areas then riding the housing boom and filling up with energetic professionals who treated themselves to clubs with full spas, pools, the trendiest exercise classes and a slate of children’s activities.

Akradi, meantime, remained the vigorous, handsome embodiment of his brand. He competes in a series of triathalons the company helps sponsor. He’s the guiding spirit behind the company's glossy monthly magazine. And he took to having Life Time refer to itself in all corporate press releases as The Healthy Way of Life Company.

The recession hit Life Time hard, as many consumers were too strapped to keep up with the $100-plus monthly dues, and expansion plans were held back. The company has resumed growing again, adding a few new branches a year at a cost of $30 million to $50 million apiece. The shares have worked their way up from a low of $7.50 to the mid-$50s, peaking recently above $56. 

But it’s been tough to enlarge the membership base quickly. And consumer-growth stocks that begin feeling their age while still being run by a charismatic go-go founder or an imperial CEO often find activist professional investors coming by uninvited. This is, for example, the position Abercrombie & Fitch Co. (ANF) and Darden Restaurants Inc. (DRI) have found themselves in.

Marcato Capital Management — a hedge fund firm run by Richard “Mick” McGuire, a former partner in Bill Ackman’s Pershing Square Capital — this week disclosed an effective 7.2% stake in Life Time Fitness through share and stock option holdings. The firm acquired the stock at prices between $46.36 and $49.29, so it's already nicely in the black.

While Marcato did not detail in its SEC filing any particular action it was urging management to take, most signs point to McGuire pushing for some financial engineering moves that could exploit the considerable value of Life Time’s real estate. When Marcato buys a stock, it usually believes the company could be allocating its capital better.

Kenneth Squire, founder of 13D Monitor, tracks the filings investors are required to post if they acquire at least 5% of a company’s shares. Commenting on Marcato’s Life Time filing, he noted that McGuire “has had a great deal of experience with real estate based activism.”

A slew of investments

While he was with Ackman at Pershing Square, that firm went after Target Corp. (TGT) and sought to have it hive off its store real estate. As head of Marcato, McGuire two years ago bought into prison operator Corrections Corp. of America (CXW) and worked with management to convert to a real estate investment trust, which minimizes taxes and tends to result in a much higher stock valuation.

Other current investments by the firm include Applebee’s and IHOP parent DineEquity Inc. (DIN), sleepy family-run department-store chain Dillards Inc. (DDS) and Sotheby’s Holdings (BID), which has a real-estate component thanks to its valuable New York and London headquarters buildings going unreflected in the company’s market value.

Piper Jaffray analyst Sean Naughton notes that Marcato might urge Life Time to consider converting some of its real-estate assets to a REIT to boost the total value for shareholders. While the company has always expressed a willingness to explore such a move, management hasn’t committed to it.

Life Time owns 70% of its 111 centers, and the majority of the owned properties have no mortgage attached. Squire points out that Akradi has said the real estate could have a market value of $2.8 billion, while the company’s net book value is $1.4 billion. That implies a lot of hard-asset support for Life Time’s $2.2 billion stock-market capitalization, especially given that the business itself produced operating cash flow last year of $345 million.

Using market valuations for comparable REITs, Naughton figures Life Time shares would be worth up to $74 each if a conversion occurred, though he assigns only a 40% chance that Life Time will go this route. Marcato could also advocate that Life Time simply take on more debt supported by the owned buildings, to make the balance sheet more leveraged for shareholders’ benefit and fund share buybacks.

Importantly, Marcato’s approach is not necessarily adversarial, as McGuire in the past has shown a willingness to work together with CEOs and boards to agree upon a financial strategy.

Life Time spokesman Jason Thunstrom said the company is “certainly aware” of the filing and “welcomes ideas and suggestions” from all its investors, but would not comment on any particular discussions with individual shareholders.

There are other knocks on Life Time beyond an arguably inefficient balance sheet. The company is on a perpetual capital-investment treadmill, forced to spend heavily on existing and new clubs to keep them fresh and appealing in a world of ubiquitous pop-up gym franchises that can be started for six figures and offer cut-rate memberships. This keeps its return on capital low despite decent long-term growth trends.

And it says something about how tough the fitness-club business is that Life Time has annual member attrition rates above 30% and yet is considered well-managed.

A bullish writeup on Life Time Fitness posted in February at Value Investors Club, a members-only site for sharing investment ideas, presciently raised the prospect of an activist investor taking an interest and options for adding leverage or employing a REIT structure.

The piece also noted that Life Time’s longtime CFO had Michael Robinson retired, and the company is searching for a new permanent CFO, one who might entertain a bolder capital structure.

The situation could develop quickly: Wall Street will be watching closely for any clues about strategic shifts at Life Time’s analyst day on June 4.