Musings from the Janitor’s Closet

In the (in)famous movie, Wall Street (the original from the 1980s, not the sequel), Bud Fox seeks to get insider information to relay to his hero and mentor, Gordon Gekko.  In order to find this information, he persuades a janitorial company to partner with him, thus allowing him to “manage” the business in a way that gives him access to law offices where he can uncover certain inside information that he can profitably trade on.

Having worked in these law offices, I understand the desire to go where the information is.  However, having an equally strong aversion to 4×4 concrete bedroom cells (with lengthy stays), I have always tried to look for relevant information outside of the illegal avenues.  The reality is few people will read the publicly available free filings, but many attempt to go to great lengths to obtain “inside information” at the risk of an extended trip “upstate.”

What follows is a smattering of information “tips” on stocks I have been investigating recently.  None of which I bought, and some I looked at with skepticism in the first place.  I discuss these companies because I think it illustrates how relatively easy it is to garner key information for publicly available documents.


Lifetime Fitness:
I like to stay current on this company mainly because there are two publicly traded fitness gym operators (the other being Town Sports–CLUB) and their business is about as simplistic as it comes.  That means with a lot of personal effort I can understand it.  Sadly, the economics of the business are terrible.  Basically, you invest a ton of money upfront to attract new members and over time all of those members leave.  Before you have an opportunity to make a return on your investment, you need to “spruce” up the place by further investing a ton of money in order to attract newer members.  Rinse and repeat.  How’s that for an elevator pitch.  Fortunately, for gym operators, the public continues to provide ample capital to these companies. (It should also be noted that analysts at all major investment banks assisting in these capital raises are quick to give praise to Lifetime’s amazing growth potential, game changing business model, etc, etc….)

Liftetime Fitness is growing and by that I mean they are building a lot of new gyms each year.  Profitably growing is another question.  A good way to measure that performance is Return on Invested Capital.  I won’t go into detail on this, but it is the way the Board measures the performance of its executives.  In 2012, the ROIC was 7.4%.  The targeted goals for 2015 and 2016 are 8.9% and 9.0%, which in the Board’s words, “we do not believe the targeted ROIC to be probable at this time.”  The company’s current debt allows them to borrow at a fairly accommodating 4-5% interest rate, so earning a roughly 3% spread on new capital isn’t great given the substantial risk.  My problem with this is two-fold.  First, if interest rates rise even slightly (the company has mostly floating-rate debt), the Company will not even be earning a positive spread on its incremental capital.  Second, I question a company that continues to invest when the spread on incremental capital is so low and the longevity of its capital expenditures match up so poorly with the short-term nature of its revenues–almost all contracts are month to month and the churn rate is around 35% annually.

The aspect that is most concerning about this is that Lifetime plans to spend between $320-$355 million in growth capital expenditures this year.  If the Board does not believe that the executives will meet the targeted ROIC and the spread between borrowing costs and ROIC is so low, why continue to invest?  The real reason, I believe, is the nature of companies like Lifetime.  If you are in a heavy capital intensive business with sketchy returns on investment, the best practice is to boast about your growth rate and continue to invest.  By doing this, investors will typically ignore whether or not you are actually making any money on your investments and instead pay attention to those amazing year over year growth numbers.  This point is fairly clear when it comes to fitness centers because their business is so simple, yet the path is well-worn with historical examples of companies that have grown into bankruptcy (think Bally’s Fitness).

Peer Group: The other thing I found interesting in this company’s proxy statement was which companies were chosen as its peer group.  The companies were most certainly chosen by a well-paid third party consulting company to calculate executive compensation.  The list of publicly-traded companies include:

International Speedway: Motorsports arena–think Nascar
Steiner Leisure: Spa and Massage on Cruise Ships and Laser Hair Removal
Ethan Allen: Home Goods
Gaylord Entertainment: Resort/Convention/Hotels
Marriott Vacations Worldwide: Time Shares
Ameristar Casinos Inc.: Casinos
Pinnacle Entertainment Inc.: Casinos
Six Flags Entertainment Corp.: Amusement Parks
Cedar Fair: Amusement Parks
Jos A Bank Clothiers Inc.: Men’s Clothing
Vail Resorts Inc.: Ski Resorts

I struggle to find any coherent strategy for selecting these companies?  Saving the best for last, the other peer company, not mentioned above is The Cheesecake Factory.  The healthy laugh I enjoyed thinking about how this company could be a peer company to Lifetime Fitness was well worth the effort it took to read the proxy statement.  Also, interesting is that the one other publicly-traded fitness operator Town Sports (CLUB) was not included in this list.  Presumably, their executives are paid relatively conservative amounts.

Angie’s List:
Another company I read about recently was Angie’s List.  Angie’s List has tried 3-4 different ways to make money since its inception in 1995.  First, signing up people for memberships to read reviews by real people, i.e. other members.  When that didn’t work, they started selling “advertisements” by the service providers to these members, while heavily discounting said memberships in order to attract a broader advertising base.  However, the churn of these service providers willing to pay for higher positioning on the search results (their form of advertising) has forced the company to pivot again to selling Groupon-type Deals by these same service providers with Angie’s List taking a cut.  This didn’t work out well with Groupon, and I don’t believe it will end well for Angie’s List either.  This company is another great example of how companies can try to get investors to focus on growth without profitability.  But after 18 years of losses, the music may soon come to a stop.

This is a good example of a company that can’t really figure out how it is supposed to make money.  If it can’t do that in an 18-year period, it probably ain’t going to happen.  If I can’t clearly articulate relatively easily how a company makes money in a short statement, I should probably stay away.

However, they have discovered one way to make money.  The CEO has a 10(b)-5 trading plan set up to automatically sell a certain amount of shares every two weeks.  Every other Wednesday, this CEO has less and less motivation to care if this company succeeds.

I am diligently looking for the CEO that  has a 10(b)-5 plan set up to buy shares in his own company every other Wednesday (I am ok with Tuesdays or Thursdays also).  I will report when I discover the company.





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