I think Virgin Active are onto something interesting with their wellness centres.
In early January I went to the Virgin Active Wimbledon with my partner who was signing up as part of her company scheme. We went on a tour around the gym, and I was impressed. After a £3m refurbishment, the gym was looking in really good condition, comfortable, and inviting. Loads of classes every day, an abundance of space and equipment, a heated swimming pool, sauna, steam room and jacuzzi, pilates rooms. And on top of this a comfortable seating area with the Kauai branded restaurant serving a healthy selection of food and drinks.
The going rate was £149.99 per month for a 12-month contract. In addition, they were offering a New Years promotion with the first two months being free. And they said I would get a partner’s discount, so I would pay £119 per month for March to December, so an effective £99 per month.
Intrigued by the business, I did some digging around.
The CEO of Virgin Active is a South African called Dean Kowarski. An accountant-come-investment banker by background, he saw a gap in the market for a healthy foods concept and started Kauai, which together with Nu has over 233 stores globally.
Eating, Dean says is one part of a puzzle, along with exercising and sleeping well. If you get two correct, but not the third, you are not optimising your health.
He has worked hard to align nutrition along with health and fitness. This led to a merger between Kowarski’s nutrition company, the Real Foods Group, with Virgin Active. The Real Foods Group was valued at £28.6m. It seems that Brait, the investment vehicle owned by South African retail entrepreneur Christo Wiese is the main shareholder, along with Richard Branson’s Virgin Group being minority shareholders.
In 2015, the Virgin Group sold 80% of Virgin Active to Brait, for a £1.3b enterprise valuation, whilst retaining a 20% share which now has reduced to 16.8%.
Kowarski is obsessed with empowering people to change their lives. Under his leadership, he has restructured the business, overhauling complex structures, simplified the head office and changed the organization of territories. As an example, with the centralised structure, they can set up one or two flagship clubs in a European city, without the need to set up a head office in each country, as would have happened before. Qatar is the next territory on the radar after the existing footprint.
The goal is to have a flagship premium club in 28-32 cities throughout Europe.
Virgin Active currently has 225 clubs in eight countries, including Australia, Singapore, Thailand, Italy, South African and the UK, and 233 restaurants.
Engaging with food
Under the previous structure, the food business was operated by a third party, and so club managers took no interest in the performance and integration of the business with the main gym business. Dean says the food business is critical, because once members engage with the food, and they see results, this drives more usage of the gym and hence more reason to come back.
Managing churn
Traditionally one of the biggest problems gyms have with membership is churn, with up to 40-50 percent churn each year. Dean’s goal is to drive engagement and usage and keep members for life. He wants to create a community feel, similar to a country club, where members feel part of a community.
They have a loyalty scheme, where if a customer goes four times a week, they get a voucher for a free smoothie (cash cost is £6). So do the maths. Go four times a month, and you’re getting an additional £24 of value. So the gym cost effectively reduces now from £99 to £75! The customer really feels like they are getting value. Why does the company do this? By getting the customer to return month after month, they are reducing churn, and earning more customer lifetime value.
In some of the bigger clubs, such as Virgin Active Chiswick, they have a board-room and co-working spaces. This complements tennis and padel courts, outdoor swimming pool, and full gym. Although there, the monthly fee is more like £299 per month, double that of Wimbledon. To afford a monthly payment of £300 per month takes an affluent individual. A member can therefore go to the gym for a workout, have a shower after, get breakfast, settle down to some work, and have a meeting if necessary. Then after, have a social catch up with some other members. He wants to start turning the gym from third space to second space, to take up as much time between a customer’s “nine to five”. The gym fees will then be supplemented by revenues from other channels including Kauai.
The group has been on a massive investment drive over the past couple of years to refurbish their clubs. The Wimbledon club alone has seen £3m invested. This work to create a “second space” is the key differentiator between a gym and a wellness club.
How does all this reflect in the financials?
Revenue for 2023 was up 14% to £120m, split £100m membership dues and £20m revenue from personal training and swimming lessons. Operating loss decreased from £36m to £4m, which is an improvement. The main reason for the improvement in the operating loss was a lower impairment charge in 2023 compared to 2022.
Opex was £125m, made up of depreciation (£25m), employee expenses (£54m), and “other” expenses of £37m. The total lease expense was £17m, made up of £9.2m right of use asset depreciation and £8m lease liability interest (IFRS 19 lease accounting). The depreciation portion affects the operating profit line item, included within depreciation, whilst the interest portion affects the Profit Before Tax line item. However, they do quote the total charge which would have been expensed as operating expense before the adoption of IFRS 16, which was £20.6m. This is 17% of revenue.
Loss before tax was £15m, reflecting the interest on lease liability and finance costs on inter-company borrowings.
During 2022 there was a significant impairment charge of PP&E of £32m and intangibles/goodwill of £5m. Impairment charge in 2023 reduced to £2.5m, related to goodwill.
Underlying EBITDA increased from £3m to £8m, which is positive. Although naturally this number excludes the hefty depreciation charge as well as finance and lease interest costs.
Turning to the balance sheet. Due to the nature of its business model, it has a high capital employed, of £339m. Taking the EBITDA of £8m, gives a ROCE of 2.4%. What I would like to understand is where are the projections of the business over the next 5 years, and what are the capex plans. The goodwill figure of £50m relates to acquisitions of health clubs, and could be impaired in the future if conditions adversely change.
The business is funded by inter-company loans of £90m, which increases its interest rates. Debt to equity, including lease liabilities is 71%, but only including the inter-company debt drops to 40%.
The experience is wonderful. As you walk in, there is a pile of freshly washed towels ready to use after your swim or shower. There is a refreshing smell in the gym, similar experience to what you smell when you walk into a Starbucks. The staff are friendly, the equipment is modern, and they have everything. Classes are plentiful. The café is very good. There is a state of the art app where you can book classes and redeem your loyalty points.
Will Virgin work? It is too soon to say. They have come a long way since Covid, when the company went into significant financial distress. Wellness clubs were some of the worst industries affected during the pandemic. Imagine having no customers for months at a time, and at the same time landlords are screaming on the phone for their rent. They have got through it though, membership levels are only 7% below the pre-pandemic numbers, and things are looking up. The balance sheet has a high amount of capital employed, and returns on invested capital are low at the moment. But if member numbers keep growing, they can manage the churn, really make Virgin the place that people want to spend most of their day (the second space), they will be able to charge higher fees, an the group will become more profitable.