Discover more from Yet Another Value Blog
Buckley Capital Partners' Zack Buckley provides update on $XPOF thesis following short report (podcast #184)
Zack Buckley, Managing Partner at Buckley Capital Partners, joins Yet Another Value Podcast for the second time to provide an update on his Xponential Fitness, Inc. (NYSE: XPOF) thesis since he was last on the podcast and following the Fuzzy Panda short report on the company.
***This podcast is brought to you by Stream by AlphaSense.***
How can you increase ROI on your investment research spend?
Stream provides a 26,000+ expert transcript library, powered by AI search technology, and highly competitive rates on one-on-one expert call services. We can even arrange for an experienced buy-side analyst to conduct calls on your behalf. Traditional expert networks are dead, they just don't know it yet. Get the ROI Guide
Please follow the podcast on Spotify, iTunes, or most other podcast players, as well as on YouTube if you prefer video! And please be sure to rate / review the podcast if you enjoy it, or share it with someone else who would enjoy it (more listeners is a critical part of the flywheel that keeps this Substack and podcast going!).
Disclaimer: Nothing on this podcast or on this blog is investing or financial advice; please see our full disclaimer here. The transcript below is from a third party transcription service; it’s entirely possible there are some errors in the transcript.
Transcript begins below
Andrew: All right. Hello and welcome to Yet Another Value Podcast. I'm your host, Andrew Walker. If you like this podcast, it'll mean a lot if you could rate subscribe, review, and follow wherever you're watching or listening to it. With me today, I'm happy to have for the second time, my friend Zachary Buckley. Zach, how's it going?
Zachary: Good. Thanks for having me on.
Andrew: Hey, I'm really glad to have you on for the second time. We're going to talk about why we're doing this in a second. Before we get there, let's just start with the disclaimer I always start with. Nothing on this podcast is financial advice. That's always true, but probably a little bit particularly true today because we're going to be doing an update on a SOC that had a widely published short thesis on it. So people should just keep in mind not financial advice. Please do your own research, and consult a financial advisor. So Zach kind of the impetus for you coming back on was you came on in October, and we talked about Xponential fitness, the ticker there is XPOF. After that, the stock did absolutely fantastically and it all was going kind of swimmingly until late June. A short report came out.
A very detailed short report, a very interesting short report. I'll include a link to it in the show notes, but the market shot first and asked questions later. I think the stock dropped about 50% in a day. It's recovered a little bit since then, but it's still well down. And I know you have just been doing a ton of research on the company, kind of just like following up all the leads. So I'll pause there. I've got the short report. I can go through all the things, but it just paused there and turn it over to you.
Zachary: Yeah. Thanks so much. Yeah, I think when the short report first came out, obviously we were concerned and there was a tone of information to digest. And so I would say we spent the entire morning just trying to go through all the information, and by about 3:00 PM I felt like we had gotten to a point where we were very comfortable. The vast majority of the report was misleading or inaccurate in some cases. And so we basically doubled our position size that day. And basically, the stock prior to the short report peaked at about 33, and was trading at about 29 or so the week or two weeks before the day of the report opened around 25, or sorry, the night it closed at 25 the night before.
And then that day intraday, it traded as much as like below 15 a share, and it closed around 16, so it was down about 37%. And then the next day I was up about 10% as management started to defend themselves. But yeah, there's a tone to go through. It was a very detailed report. Certainly, parts of the report were true, but I think the vast majority of the important facts about the company were misleading. And so we feel very good about the investment. If anything, I think we have higher conviction and Xponential today, having spent so much time going through every single facet of the short report.
Andrew: So the short reports released late June, the company comes out with a quick PR saying kind of typical of what you think, Hey, our business remains strong, but they go into blackout pretty quickly. So we're recording August 1st, we're going to get this out before them, but the company's going to report after market on August 3rd. So I think they've been a little bit blacked out in terms of what they can say. But I guess just to go into the short report, it's kind of a two-angle short report, right? The first is talking about management and particularly the CEO's background in some allegations there. And then the second is kind of economic questions around the business. And either one, when you've got a credible short seller coming out against you is scary. But the combination I think has led a lot of people say, hey, I just can't touch this lives clarity. Obviously, you've done a lot of work on both sides. What side do you think we should kind of start by addressing?
Zachary: We could just kind of go chronologically. We'll start with the short report, like the personal attacks.
Andrew: Okay. So the short report starts off with a bunch of, I don't want to say attacks, but allegations, whatever you want to call it against mainly the CEO of Xponential Fitness Tony Geisler. The first thing it comes right out. And the first image there is Tony, it's Tony, right?
Zachary: Correct. Yeah.
Andrew: Okay. Just making sure. I was saying that and I only have his,[crosstalk].
Zachary: Anthony or Tony Anthony, either one.
Andrew: He's mid-twenties. He's the CEO of a startup gaming business. And the first image in the report is him on a TV show holding up a box and it says, this box is empty. And then it goes on to say how the company, he was the CEO of, they say it was a pump and dump. So do you want to talk about kind of the background there and what you kind of uncovered?
Zachary: Yeah, definitely. So Anthony was CEO of Interactive Solutions, which basically went public through a reverse merger in February of 2000. Essentially what happened was is there was a rogue shareholder group that owned Interactive Solutions and then was selling those shares illicitly or improperly through basically a firm in Thailand called the Britain Group. And so the purported stock sales all came from the Britain group, which had essentially no affiliation with interactive solutions. So you should imagine just, it was a shareholder group that had nothing to do with the management team, nothing to do with the board. And that shareholder group essentially was selling share certificates that they shouldn't have been selling. And the FBI was aware of it, and the Australian police, the FBI, and the type police collaborated and rated the Britain group. And obviously, 84 of the 85 employees of Britain Group were arrested. And like, as we know, no one from basically all of the interactive solutions was indicted or implicated. So the FBI was aware of it. And there was no one from Interactive Solutions that had any sort of indictment or charges pressed against them.
Andrew: I'm just left 84 of the 85 employees arrested. How would you like to be that 85th employee? Was it the janitor and they just didn't know or was there like one person who was doing actual work and then everyone else went to jail and they're like, wait, what? What just happened to everyone? So I guess the question there is, as you said the FBI was aware, they never charged anyone at Interactive, so maybe the pump and dump elements kind of don't apply. But then the other allegation is that interactive, even if he wasn't involved in the pump and dump, was selling vaporware, right? Because the first image says this box is empty. So what did your research kind of turn up on that side?
Zachary: Yeah, so Interactive Solutions was building a game that allowed users to play casino games on their computer at home. And Geisler is holding a box that's representing the graphics of the game at its expected completion later that year. And so there was every intention of publishing that game. They had deals with the Venetian as an example, in order to sell that. So it was a legitimate game that they were selling. So it wasn't vaporware at all.
Zachary: The game was commercialized and had real partners. Like it wasn't vaporware.
Andrew: Yeah, I think it was commercialized in February 2000. I mean, I'm in grammar school at the time, but it was the.com bubble. So you think like, hey, you're the CEO of a publicly traded gaming tech company, right? Like, you've got a partnership with the Venetian. Like a lot of it is the promise of releasing a game, and they do ultimately release a game. Yeah, it's not successful. But they released something in tones of the companies from back then weren't successful. It kind of just strikes me as an entrepreneur doing what they did and maybe executing versus everything else then. Am I thinking about that incorrectly?
Zachary: No, I think I agree. I mean, I would also say like, Anthony was 23 years old at the time he's a really young kid, right? And this was like probably one of his first business ventures. So the fact that he was CEO of a public company when he was 23 years old, I mean, I think it's somewhat impressive. He didn't do anything wrong. The public company didn't do anything wrong. Ultimately, the company wasn't successful. But I think a lot of successful entrepreneurs have business flops early on in their careers.
Zachary: And so I don't view that negatively if anything the fact that he was 23 and already doing that kind of thing at that age, I think speaks to how entrepreneurial he is.
Andrew: To me at the start when I saw, like, obviously they led with that for a reason that was the most concerning. Some of the other stuff's concerning, but that was the one that got me, because I was like, oh, if you're involved in a pump and dump, like I just can kind of never trust you going forward. It's old, like, there are some people who are like, oh, this company is great. I'll be like, yeah, but the last company they ran was a fraud and everyone ended up in jail and they did serve three years. But once you kind of dig into it, and yes, the stock got manipulated, but it doesn't appear anyone at the company was involved. Like, I do think it's the scariest allegation, but I think it's also probably the one easiest to dismiss. Do you disagree with any of that?
Zachary: No, I agree with you. And I think the other thing is like, the video also looks very damning, right? Like he's declining to comment over and over again. And so if you watch that video on YouTube, you're like, wow, this looks really sketchy. But when you understand like, his lawyers have probably just told him to not comment on anything, and he was somewhat blindsided by the reporter. I don't think he would've ever gone on had he known that the line of questioning would've gone to a place where he just had to continually say no comment.
Andrew: For those who haven't seen yet, the video Zach's referring to is, I think it's a local ABC affiliate, that does an interview with him after the pump and dump scheme has kind of started to unravel. And I think it's pretty clear that he was on there to talk about the product and how excited he was for the commercialization efforts. And all they ask about is the pump and dump, and he's like in a no-comment state and pretty flustered by the almost bait and switch, if that makes sense.
Zachary: Yeah. And I would've been flustered by that as well.
Andrew: Well, so let's turn to the second allegation. And this is allegations that before Xponential, he was the CEO LA boxing, which you can correct me if I'm wrong, ends up selling to UFC for hundreds of millions, or I think it was even $2 billion in 2013. And he's the CEO there. And the second allegations are he's kind of screwing his partners over. And a lot of the LA boxing franchisees don't like him in his time there. So he screws people over. And it's kind of just overall, hey, this is an unscrupulous guy, right? He screws over his partners, the franchisees don't like him. Yes, it's a successful business outcome, but if you're partnered with him, this is a sign that things aren't going to end up well for you.
Zachary: Yeah. I mean, again, anyone who's been in business for a long time at some point in time may not make some of their partners happy. What happened at LA Boxing did not concern me at all. There were two lawsuits essentially that came about in that were presented, I would say, through the short seller's work. And neither one of those lawsuits really had any concern for me. I mean, I think in one of them it was basically like a disagreement around termination.
Zachary: And then the other one, it was someone who founded one LA boxing studio trying to get paid for the selling of the LA boxing franchise. Now anyone who knows franchise or economics if you found one studio that doesn't give you any right to the value of the franchise order. So that would be like, if I founded a Club Pilates and then I wanted to get paid equity in Xponential fitness, I mean, it just doesn't make any sense. And so neither one of those were concerning from my standpoint, but happy to go.
Andrew: Yeah. I agree with you. Some of the stuff in there did add to the overall feel. Like when you go from pumping up to the stuff we're going to talk, it's like, oh, it's just adding to that. But that was the least concerning. Let me go to the weirdest one. So they uncover, I think it's from 2015, it's a case where a court-appointed processor goes to Tony's house to serve him documents and he gets charged with, I guess he has a gun. He goes up there and criminal charges are filed against him for assault without a firearm. So even though he has a gun, it's assault without a firearm. And then he also gets charged with a kind of like threatening or intimidating behavior because he is got the gun. And it's a big red flag. It's like assaulting or threatening a process server. So it's a strange story. I'll pause there and just like turn it over to you. Did I say all of that right and how do you think about that?
Zachary: Yeah, so I guess the first thing I would say is that when Tony talked about it after the short report came out, he said that he didn't have a gun. So I think whether he had a gun or not, at least according to him, he didn't. I think that's up for debate. Let's assume that he did have a gun in that case, why would he have a gun in this circumstance? There's like a strange man who he doesn't know who's inside of his garage on the day that he's moving. And he has to go confront that person who he has no idea who is with his wife and kids inside of his house. I don't own a gun, but if I had someone that's standing in my garage who I didn't know who it was at three hours after sunset, I would be very concerned by that person being there.
And again I don't own a gun, I don't carry guns. But I can understand why that's the reason people have guns, right? If there's a strange person in your house, that's why lots of people own guns. This is to make sure they feel safe and protected against that person. So I don't know if he had a gun or not, but to the extent that he did, I think you could understand why you might want to do that in a circumstance where there's a strange man in your house essentially.
Andrew: I definitely hear that it was just the weirdest one. Because it was moving day. So I think there were movers there and stuff. It was just very strange. And again, it lent to the reports, Hey, is this guy like kind of a loose cannon or is this all just one-offs?
Zachary: No, I agree. I mean, when you put all of those things together I think it certainly hit its mark or created the intention that the short seller was looking for, which was to really disparage and call into question Anthony's character. And so I think that's why it was important to spend a lot of time dissecting each piece one by one and like going through the case summary and reading exactly what was said publicly and just understanding that there were I think reasonable reasons why, and also all of the charges were dismissed ultimately. So there was also the second charge was assault with a deadly weapon or instrument other than a firearm.
Zachary: And so we're unclear what occurred there. It doesn't require any actual physical assault for this to happen, but it does require the use of an inanimate object to attempt an assault. So we don't know what that was but it was ultimately dismissed. So both charges were dismissed. Anthony said he just walked into the garage and basically started yelling and said, get out of my house. So without any objects, gun or otherwise, I tend to believe that what he said is true both charges were dismissed. And so I feel pretty comfortable about that.
Andrew: So the last thing on kind of the personal stuff is he condones XPOF has a culture of sexual harassment and he condones the culture of sexual harassment and discrimination. I'll just turn it over to you.
Zachary: I mean, I guess as a first statement, obviously this was deeply concerning to us hearing this as shareholders, of course, we would never want this to happen with any company that we own Stock Ham. I think it's also a really tough allegation because unfortunately in the past 10 years, we've seen so many of these allegations ultimately turn out to be true. And so I think oftentimes when people are accused of this, it's a shoot first and ask questions later because so frequently people have been guilty of these kinds of allegations. Now we have done a bunch of work prior to the short report coming out, and we had talked to a lot of female employees. 70% of Xponential employees are female. The tone of the franchisee owners, like most of the pure bar owners as an example, are female.
So there is a very female-centric culture at Xponential Fitness, and we had never heard any allegations of any sort of sexual harassment or anything as being an issue or part of the culture. The second thing that I would say is that there's never been a lawsuit or a complaint filed against Tony or Anthony over the last 20 years. So you would think if he was at a company with 70% females, there would be something at some point in time if there really was a culture of sexual harassment. We did a tone of calls afterward and asked people about this, and we never heard anything that gave us any implication or any idea that this would be a problem or that there was any culture of condoned sexual harassment as the short report talks about. And so I would say the probability of that being true, just given the fact that there were so many other, I would say factual inaccuracies in the report, I think is extremely low. And certainly, it's not pervasive culture-wide because we weren't able to find anyone that had this complaint.
Andrew: Man, I don't know how journalists do, that was a lot less fun than going through all those lists and allegations, like obviously they're all serious allegations, talking about them was a lot less fun. So let's turn to the stuff I think you and I are more interested in, and that is actually more fun to talk about and think about and debate. And there are lots of questions it leads off with the personal queue tax, but then it goes into lots of questions on the economics and the stuff that I think you and I actually prefer to think about, right? So it starts talking about, hey, you've got a lot of franchisees losing money. It goes into hiding permanent closures, kickback charges, billing and practices, all sorts of things that I think are really interesting, right?
And if you've ever looked at franchisees or any type of retail business, this is the stuff that scares you, right? Because if you've got a thousand stores and you're opening a hundred stores per year, it can be really easy in the short term to kind of cover over, oh, some of these stores are underperforming, or a lot of these stores are underperforming because you can pull things in and out of same source sales, you can say, oh, if you've got some really good source, they can cover up the economics. So let's start talking about those. I think the first economics question they come out with is, Hey, maybe XPOF is reporting great growth and great units, but they have a tone of franchisees losing money. And if you're a franchise and your franchisees are losing money, that's always going to come back to get you, right? Because either you're going to have to give them concessions or eventually they're all going to go bankrupt and your business is kind of going to be gone. And so this was a really concerning one, right? The franchisees, their economics always look great until their franchisees are gone. what do you think about the franchisees losing money piece of the report?
Zachary: Again we found very different results than I think what was presented in the report. We talked to a ton of different people and we believe that 90% or over 90% of franchisees are profitable. And the vast majority of franchisees that are not profitable are mainly because they're just getting started. And Xponential has very rapid studio openings. And so there's a decent percentage of the studios that are currently open that have only been open for a year or less. And it does take six to 12 months for most franchisees to get profitable. But after that one-year period, 90% plus of the franchisees are profitable today. And importantly, I would say the concepts that are doing really well are where there will be more studios opening going forward. So there definitely is a dispersion between the success of various franchisees.
Club Pilates, which is the largest it's about 45% of those system-wide revenues is extremely profitable. The Club Pilates franchisees are very, very happy. And I would consider opening a Club Pilates myself like the economics look great on Club Pilates. Stretch Lab is also over 10% of the system. The Stretch Lab franchisees are also very happy. Stretch Lab is doing extremely well. And the short report it did show that those two are profitable. The biggest thing that it did is it mischaracterized the labor cost by about two times. So I think it overstated the average labor cost per studio by about two times and was also using a last 12-month revenue calculation, which 2022 was not nearly as strong of the year as 2023, mainly because people were still recovering from the pandemic. And so same-store sales have been 20% in Q one because those studios are improving very, very rapidly on a year-over-year basis coming out of the pandemic. And so to look at things on an LTM basis instead of a normalized basis mischaracterizes it a bit because revenues have improved pretty dramatically.
Andrew: It's easy to forget now because officially as a federal emergency, COVID is over, right? But it's easy to forget now early 2022, especially like Q one and Q two, yeah, you could go to a lot of public stuff, but a lot of people were still very concerned about going to public stuff. Like Delta comes through late 2021, early 2022, like if you're talking about where are germs and diseases going to spread, like I love going to the gym. One of the saddest things about COVID was all my gyms being straight down. But when you were worried about catching COVID, the easiest place to avoid it was, Hey, let's not go to this exercise studio where 30 people are going to be packed together in one room, breathing heavily, sweating all over each other. Like it's really easy to forget that.
So I'm with you like 2023 even if you were just run rating the back half of 2022, there could be some economic questions there. I guess the other thing is they used to support it, right? You and I can say, hey, we can go dig through the franchise Fair Disclosure stuff and everything and say, hey, we think you've over-represented their labor costs. But I guess the other thing they would probably point to is they'd say, Hey, we found lots of examples of the ultimate proof is in the pudding, right? If franchisees are doing well, they're going to open more stores and they're not going to close stores and XBOF would say we're opening lots of stores. But I think they would say, fine, you're opening lots of stores, but you are hiding permanent closures, which is a disaster in terms of franchisees, right? When your franchisees can't make something note or you're either hiding the permanent closures or you're buying a lot of your franchisees out for kind of a dollar, just like taking it over so you can, again, high permanent closures, how would you respond to that?
Zachary: So I would say first and foremost, it's very normal to have transfer rates at any franchise network. So healthy franchise networks have significant transfer rates amongst franchisees over time. So unfortunately people die if they get divorces. They have various things that make it where they need to not run their business anymore and not own their business anymore. And so we looked across the transfer rates of a lot of different franchise concepts and the published franchise rates for Xponential are literally right in line with the other franchise concepts, whether it's McDonald's or Planet Fitness, European Wax. So I think what the short report did is it took norms within the franchise industry and tried to make them appear like a big deal. So it took equipment sales, which is a normal thing. They have a 32% gross margin on equipment sales, which is completely normal within the franchise industry. And they tried to make it Xponential, is vastly overcharging their franchisees and that's just not true. They're just doing what's normal within the industry.
Andrew: So this is different from the closure rate. This is the kickbacks and overcharge rate, right? They've got something in there where it's like, Hey, your average Peloton costs $1,500 and because XPOF makes you buy the bike, if you're doing their spin brand, they make you buy the bike through XPOF, they charge you 2200. So they were saying, Hey, they're overcharging you kickbacks, overcharge, that type of stuff. I'm with you. Like anybody who's seen the franchisees, it's completely common for you to have to go buy the equipment from the franchisor because the franchisor, if it's a thousand studios or whatever, they do get some pricing power, they want brand uniformity, and they just kind of figure, I do think they can make some profit on it, but like Planet Fitness is the most famous example of this, right? Like Planet Fitness does it. Domino's, I think you're required to buy all the dominoes pizza dough from Domino's headquarters. Somebody can check me on that. I think that used to be the case. I'm not sure if it is, but it's pretty, pretty common practice. I was a little surprised by that.
Zachary: It is. And again, they were taking a lot of things that were just normal within the industry and trying to make them a big deal. I think going back, to what we were talking about, I think the most important thing is the unit economics are very healthy and Xponential and the store closures are completely in line with industry norms. If anything, they close less than industry norms. I don't think Xponential is hiding store closures. I think there are some stores that are either being transferred or being taken in by corporate.
And frankly I hope that Xponential does start to close stores because they've had this policy of we're never going to close a store. And I just don't think that makes sense. And I think they're coming around to that as well I don't want to speak for them, but I wouldn't surprise me if we start to see them start to close some stores and it's completely reasonable on a system of 2,700 plus studios to close 30 studios a year. I mean that just sometimes you're not going to have a perfect location. Sometimes you're going to have people struggling for various reasons. Like, I don't think you need to try and keep all those stores alive.
Andrew: I could be wrong, but I also think a lot of the arguments on the, both the financials and the store closures relate to some of the brands that are clearly struggling a little bit like Row House is a brand, I think there used to be like three in New York City and I think they've really been struggling. AKT it seems to me has been struggling. So I think a lot of the closures, non closures, brand issues might relate to the brands that yeah, you'd hope they do better and you'd like them to grow. But at this point this is really a pure bar Club Pilates stretch lab or those are the growth drivers, the main engines. And from all I can see it does seem like those are doing really well. Do you think I'm thinking about that correctly?
Zachary: Yeah, totally. Yeah. There's 10 brands in total at Xponential. There's no question that Rowhouse, AKT and Stride are struggling. But when you add those together, they're less than 3% of system-wide sales by my estimates. And so the reality is they don't really matter. And so I think, again, what the report did is it, of course there's going to be unhappy franchisees in a network of 2,700 studios. And so it found those unhappy franchisees and then tried to display them as being representative of the entire system when that just wasn't true. And if you did enough research and talked to enough franchisees the way that we did, you could get very comfortable that the vast majority of franchisees are happy, even though there are unhappy franchisees. But there are always unhappy franchisees in any system. There's always tension between the franchise or, and the franchisees.
They're business partners, but they're also negotiating, right? Because the franchisees are paying the franchisor over time. If the franchisees are doing really well, the franchisor wants to charge them more. I mean, those are all natural understandable things. I would like to see Xponential charge the Club Pilates franchisees more because they're doing so well as a shareholder and Xponential, and obviously the Club Pilates franchisees don't want to get charged more. So it's natural for there to be tension, but the vast majority of people in the system are doing very well. And I think that's what's most important for people to take away.
Andrew: If I remember correctly, Club Pilates, they just boosted the franchise rate or I guess the royalty or whatever to 8%, right? So the historical clubs were paying less, clubs going forward are going to pay 8%. But you see that and you say, Hey, if you're actually raising rates like that is all straight margin, straight off the top. If you're raising rates and new clubs are accepting that's probably a pretty good sign that people are really enjoying the economics of this thing.
Zachary: Yeah, I honestly, I'm surprised they didn't raise it by more. I mean, I think the Club Pilates people are just doing so well and Club Pilates is 45% of the system like it's a meaningful portion of the system. they're at over 800 stores today or studios today and they're going to be over 1300 studios over time. So there's still a lot of growth left in Club Pilates.
Andrew: Another kind of scary one, I've looked at gyms a lot, so I don't think I was too concerned by this one, but I did hear of people who were worried about these billing practices and BBB complaints. So I'll just flip that over to you.
Zachary: Yeah, I think again, BBB complaints are normal within a large system certainly I don't think there is an unreasonable amount. When you look at the BBB complaints the complaints per year are basically 0.3 or 0.4. So I don't think 0.3 or 0.4 complaints is a big deal in a large system. But Xponential, there's a lot of franchisees and, they're imperfect human beings who are employing imperfect human beings who are dealing with imperfect human beings. So of course there's going to be disagreements, of course, there's going to be complaints. Buffett always talks about that within Berkshire, right? Berkshire is a large company that has a tone of employees that serves a tone of customers, and not everything is going to go perfectly across every single Berkshire line within every single Berkshire subsidiary. There's of course going to be problems over time, but there was nothing that I saw that looked unreasonable or out of a normal amount of complaints.
Andrew: My experience here might be tainted by the old New York Sports Club. I don't know if you ever when you lived in New York, if you ever subscribed to them or not, but like they were famous for, you could sign up so easily, but if you ever wanted to cancel, it was like, send a certified letter that it has to be delivered to this office at this exact time. And if all the i's aren't dotted and the T's aren't crossed, then we won't acknowledge your cancellation. And they got me several times, right? It would take like three months to cancel, But they would have BBB complaints out of the wazoo. And it wasn't that they were, I kind of thought they were shady, but it's not that they were like lying to people. They were just difficult to cancel and people would complain. So I always kind of thought gyms with recurring memberships and people who like might lose the desire to go to a gym or something. I always just kind of thought, yeah, you're naturally going to get one or two of those.
Zachary: I mean, I know people that we're Equinox members and absolutely hate Equinox now because of cancelling on Equinox.
Zachary: So it's normal to have tent, right? Gyms have high churn and they're going to try not to have their customers churn over time.
Andrew: Oh, go ahead. Go ahead.
Zachary: Yeah, and there's going to be tension between the customer and the gym because the customer trying to leave the gym and the gym trying to keep the customer. So I think averaging one BBB complaint in the last three years, that seems like good performance to me and not indicative of a system wide or pervasive gym theft scheme or any type of improper billing practices.
Andrew: Not to call anyone out, but are you familiar with the information the newsletter service?
Zachary: No, I don't think so.
Andrew: It's like a tech, like they give all the details of tech especially in 2020/2021 when just like tech was going crazy. Like they will have excuses every now and then, I subscribe, anyway I tried to cancel this year, for some reason my cancellation didn't go through. I got hit with the charge and the moment the charge hit I was like, Hey, I tried to cancel this, I don't want this. And they were like, no, too bad. You've got another year of this and it's like's $500 a year for a subscription. I was like, that's pretty expensive for something I don't want. So I'm in dispute with them right now and I've actually thought about submitting a BBB complaint or whatever just because it's so ridiculous. Like this service, I don't want, I tried to cancel one second after it hits and you're like, no, take the service $500 as a consumer seems crazy.
Anyway it happens with subscriptions, right? You want to cancel, you can't, that's kind of where you get it. This goes back to the hiding closures point, but there is one other point I particularly wanted to address in their financial covenants packages, right? It says, I can't remember the exact number, but if they close more than I think it's 30 franchisees or 50 stores over time, if they break that, then they are actually out of compliance with their financial covenants. And a lot of reasons that they might be trying to hide store closures, but one of the reasons that I think is pretty concerning is if they're trying to hide store closures to avoid a financial covenant default. And I guess I just want to talk about that quickly.
Zachary: Sure. Yeah. So first I just want to point out that Xponential fitness is not in default on its debt covenants. The short seller referenced the wrong indenture. It's a retired debt instrument in the short report when they were saying that XBOF would be in default on its debt if the stores were permanently closed. So I think that's just the most important point is that what they were referencing and the indenture they referenced was a retired indenture. So we have no concern about them being in default in their covenants.
Andrew: Cool. Let's talk about what we're trading for here, right? So the sock has come back, call it a little over 32 as you and I are talking it's trading for $21 per share. I guess I just want to quickly talk about if I just pull up a simple Bloomberg, I'm looking at it right now. It's got a billion dollar market cap, it's got about $1.5 billion enterprise value. Bloomberg's kind of showing me, hey, it's 15 ish times this year's EBITDA. And I think a lot of people might say, oh, on the bull side you might say this is a growth franchise concept, right? Capital light, it's going to scale really quickly. A lot of cash flow coming behind that 15 times EBITDA. On the bare side you might say, this is the pushback I gave on our first podcast. Hey these brands tend to rise and fall pretty quickly. I think I gave the Curves example 15 times EBITDA in a world with 4.5%, 5% interest rates. Maybe not as attractive as two years ago. Like, kind of talk to me how you're thinking about fair valuation these days.
Zachary: Yeah, sure. So I guess just as a clarifying point I think enterprise values, the way we calculate it little bit under 1.5 billion, it is close but just slightly under. I think on our numbers for this year that's like roughly 14 times EBITDA today. And then when we look out to next year we're closer to like somewhere between 10 and 11 times on our next year's numbers. When we look at the kind of the comp group we use Papa John's Plan of Fitness Dominoes, European Wax, Joint Wingstop, Yum Brands, QSR and McDonald's. The average of that group today is 19.8 times EBITDA. And so it's trading at about a six turn discount to the average of what we use for the peer group or the comp group.
And within that comp group it's growing the fastest with the highest projected growth. So the farther you go out in the future, the cheaper it gets. Again, this year, obviously it's 14 times, but when you look at next year it could be as as little as 10 times but somewhere between 10 and 11 times. Most of the peer group is growing let's say roughly 10% a year, and so the average of the peer group for next year is 18 times EBITDA and Xponential is 10 to 11 times. So it's trading at a huge discount to where the peer group is, and I do think it should be camped at the peer group. When you look at Planet Fitness in its growth phase, Planet Fitness traded between 20 and 25 times EBITDA the entire time it was growing and it was growing less quickly than Xponential was at that point in time.
So we think there's actually pretty significant multiple expansion. And also keep in mind the free cash flow conversion is very high. And so it's 60 to 65% free cash flow conversion, we think Xponential could do close to $2 a share in free cash flow next year. So you could be looking at a business that's trading at roughly 10 to 11 times free cash flow on a forward basis or on a 2024 basis. And for a very high-quality recurring revenue business that's growing rapidly. we think that's extremely attractive.
Andrew: Let's talk capital allocation, and this dates back to before the IPO and everything, they've got kind of a funky cap structure where these convertible preferred, which they've been, I think they did a pretty big buyback at the convertible preferred earlier this year. But let's talk capital allocation like this is going to start, if they continue to grow, they're past the franchisee, like break the breakeven point, right? EBITDA is going to be a hundred million this year. If they keep growing, it's going to be 140, 150 million next year. They're going to generate a lot of cash. How do you think the company is going to be approaching capital allocation going forward? Because they could look to go buy another brand though they generally buy smaller brands and kind of spin them up or do they look to start becoming a return of capital story in some way?
Zachary: Yeah, I think they have multiple different options. I think my first choice would probably be retiring more of their preferred shares and simplifying they have a little bit of a confusing cap structure and so to the extent that they could retire all the preferred equity of the preferred shares, I think that would be preferable from my standpoint.
Andrew: It's really confusing because I was brushing up my model to prepare and it's like they've got 30 million diluted shares outstanding if you look at it. But then it's 60 million once you do the flips and the class A and class B and, it's really confusing. I feel like they used to do a better job of providing you here's the share account, here's the net debt than they did, at least in their Q one.
Zachary: Yeah. I agree with you. I mean it's definitely something that I think could be simplified and I think they're aware of that. So I would think, and I would expect for the preferred shares to get taken care of next. And then my guess after that I think at some point they would look to acquire another brand, but I don't want to put words in their mouth. I don't know exactly how they're thinking about capital allocation, but my best guess, and my hope would be number one, the preferred equity, and probably number two the acquisition of another brand because some of their returns on these brands have been amazing, right? I mean they acquired Club Pilates when it was 25 studios and now it's over 800 studios on its way to 1300. So just the potential return on investment for them in a successful acquisition is just huge. And so I would love to see them do another really successful acquisition.
Andrew: And we talked about it more on the first podcast, but the interesting thing with them is they're rolling out XPS, which is they're, hey, you subscribe to this and you can go do. I remember correctly, you would get like 50 credits and you can use 12 of them to go to a Club Pilates class and then four to go to a row house class, an eight to get a stretch lab class, or something along those lines. And it is interesting because if that works out, every brand they do, they will have a competitive advantage because they can just go buy a brand and say, hey, we're going to plug you into this huge XPS network and it will instantly juice your numbers, you'll get more users. It's just kind of interesting. Am I thinking about that wrong? They didn't mention XPS as much as I thought they'd be hammered on the Q one call, to be honest.
Zachary: Yeah, I don't know how impactful XPS is. I don't want to overstate it.
Zachary: I think there's definite value to XPS, but I don't think that just having XPS and plugging people in a new studio is really what's going to drive it. I think it's more that they found a system with Club Pilates of really making boutique fitness of a really attractive and successful business model. And I think they're taking that same playbook from Club Pilates and applying it to all these other verticals. And I think that's really the value is that they've found a very successful and profitable way of if you follow this system, you're going to have a very profitable studio. And so to the extent they can apply that to other verticals, I mean, I think a really interesting one is something like, obviously people are really getting into, especially in the podcast community, like cold plunges and infrared saunas I think it'd be super interesting for them to get into like a rejuvenation type of modality, right? If there was a place in, I live in Miami Beach, if there was a place in Miami Beach where people could go and do a cold plunge and then a sauna I think that would be a really successful concept.
Andrew: That's interesting though. You're almost getting into a spot at that point, right? Like, don't you want something that people are going to go to multiple times per week and spend some time in, like to me, a cold plunge, you hop in for five or 10 minutes or something, is that really going to lend itself to a 200, 400, 600, 800 unit franchise location?
Zachary: I think it's possible. I mean, people all the studies recommend four saunas a week, and most people do a cold plunge every single day. And if you look at buying an at-home cold plunge, I think it's like five K.
Andrew: It's like three K.
Zachary: Yeah. And I've seen it for five. So in terms of, I think the value proposition of can I? If there was a cold plunge sauna place near my office that I could pop into for 20 minutes, three or four times a week, that's something I would be interested in. I don't know for sure and I'm just throwing out a modality as an option.
Andrew: Yeah, I guess we don't need to break down the Zach Buckley cold. I like it though. I'm just kind of like at that point, you're just a capital cost, right? Like there's no person, A stretch lab has one person, a pure bar, you're going because you get the instructor and the community a cold plunge, you're just replacing the capital cost, but unrelated stuff. So you and I are talking August 1st and what's interesting is they have the short report come out at the end of June. Again, the company goes into a quick blackout date, but they do announce in the beginning of July, hey, we're going to host an investor day. Sometime in September, I can't remember the exact date.
Zachary: September 6th.
Andrew: Say again.
Zachary: September 6th in New York.
Andrew: Yeah. So you've got two catalysts here, right? First they're going to have Q two earnings in two days now, but by the time we release, that'll probably be one debt and that'll be the first time they can address this. They can go into their unit, breaks down, try to say, Hey, we're not having mass closures, our business is going really well, all that type of stuff. And then B investor days, everyone knows when a company hosts investor day, it's really interesting because especially if it's their first time or their first one in a long time, it's a reintroduction. A lot of times the company will announce their growth plans, capital allocation things that people didn't know, all that sort of stuff. And it can serve as a big catalyst for shares. Like one company, I followed two Cals[?], I don't know if them, TCX.
Zachary: I do. Yeah, we were long in like 2012.
Andrew: I think Elliot's it going to be in the near future, he's one of the best CEOs I've ever seen dated an investor day earlier this year. Stock goes from 18 to 30 in 24 hours and I only own a little bit of it and kick myself, but that type of thing, like, it's not uncommon to see around investor days when they reintroduce people to their business model reaffirm it, reveal some new information. So my question is, we've got these two catalysts coming up, what do you expect or kind of hope to see from them, either alongside the earnings or maybe with a more full, like kind of open the kimono September investor net?
Zachary: Yeah, I mean, just as a starter we have a highly correlated alternative data source that is showing roughly like a six or 7% beat for Q two and, roughly a 6% beat quarter a day period in Q three. So the data that we have is very likely to be right and it's trending I would say very positively for them. So I think certainly on a top-line basis I can't speak to margins, but on a top-line basis I think they're likely to report very solid quarter and probably have a solid, at least top line guide.
Andrew: Obviously that's an alternative data source. And I'm always curious about that. I know you've done great work with them and continue to do great work, but when you see that, like a lot of times my worry is you have that and that's almost like the whisper number where everybody kind of has that and says, oh, it's going to be a 6% beat. And then if it's a 4% beat, it's actually a miss because everyone thought it was a 6% beat. Like do you think yours is like really proprietary or do you think a lot of people are kind of looking at the same beat miss number?
Zachary: Definitely a lot of people have that. But with that being said, you'd be surprised how often a lot of people have the data and the stock still trades up when the numbers are good.
Andrew: That's the classic thing. Like sometimes you'll talk and I'll be like, oh, everybody knows this quarter's going to be a disaster and the quarter's a disaster, but it's maybe less a disaster than I thought it was going to be. And the stock's still down 15% because the quarter was a disaster and it's never obvious to everyone. Go ahead.
Zachary: Just to add to that, I think it's important where the stock is trading, right? Like basically the stock has reacted well on every single earnings call that they've had until the one that they had in April of this year. And the stock was at like over 30 when that earnings call came out. And so even though that was a beat and raise quarter with the stock at like, I think it was at 32 or 33 when they reported there was just a big expectation embedded in the stock price.
Andrew: Do you think it was valuation? Because I went and reread the Q one call and prep for this pod and I actually thought it was pretty positive. I thought things were going pretty well.
Zachary: Yeah. I mean look, the company was trading at a high valuation, right? Put $33 a share into your model. Like that was at the high end of the peer group at that point in time. And so here, I'm just doing it right now. So that was basically a call it a $2.1 billion enterprise value. And so at that point in time it was trading at roughly 20 times 40 EBITIDA. And so that's at the high end of where it's ever traded from a valuation standpoint. And so even though they had a great quarter, I think it was mostly just valuation.
Zachary: But in terms of now we're going into it at more like 14 times. And so I think that's the difference between the two. Is if you have a beat and raise quarter when the stock is already undervalued that can lead to obviously a much better earnings reaction than if you have a beat and raise quarter when all of that's already priced into the stock.
Andrew: What about, what do you hope to see at the investor day?
Zachary: I'm sure they'll do a lot to address what came out of the short report. I'm sure they'll talk about a lot of the same things that you and I talked about on this podcast. I'm sure they'll spend a lot of time on franchisee economics. I'm sure there'll be a lot of franchisees there to talk about franchisee economics. On that note the people that we spoke to were really interesting, right? Like we talked to one of the former employees who basically used to be in charge of franchisee sales. So their whole job was talking to new franchisees, but also helping franchisees who wanted to relocate or or resale their store helping those people resale or sell their store. we talked to someone who basically was in charge of selling franchise concepts to people who were interested in becoming franchisees. Those two people gave us a lot of confidence in Xponential because they were wildly positive about the business, right? They were saying everything very positively about Anthony's character and also just about the business economics. The guy who obviously he brings his clients to whatever franchise concept he thinks makes the most sense and very frequently he's bringing to a tone of his clients to Xponential and his clients are doing extremely well. So obviously if Xponential is a failing system, that would never be the case.
Andrew: I said at the front you did a tone of research and I think one of the things you did was you talked to franchisees from eight of their 10 brands, if I remember correctly. Obviously all the big ones.
Zachary: Yeah, we Stride and a KT just because those are less than 1% each.
Andrew: Yeah. So you talked to franchisees from eight to the 10 to get a like kind of Up-to-date feel for how that they're going. And as you mentioned, a few people who are in the franchise community, but maybe not direct franchisees. The most interesting one to me was if I remember correctly, that franchise Placer that you talked to, I think he said, oh, I read the short report and the stock went down. So I went and bought a bunch of stock because I'm so confident in the Xponential story and kind of the culture there.
Zachary: Totally. Yeah, that's exactly what he said. And I think he was one of our strongest calls just because he has the option of working with anyone.
Zachary: And he actually chooses to work with Xponential and he felt like the report was extremely misleading given all of his personal experience with the company.
Andrew: And I think he said he had personal experience with like people at the top and he said that his view of their character and obviously some people you interact with them and you're completely wrong on it, but his view of their character was completely different. Not financial advice that he went and bought the stock or anything, but I just thought that was a, anytime you hear somebody who directly works with a company and they say, oh, they're so good, when some bad news came out, I went and bought the stock because it's so diametrically opposed to what I'm seeing on the ground and my interactions with them. I always find that really interesting. It's one of those classic stories that seems to work out well.
Zachary: Yeah. It wasn't just one person that said that, it was the compilation of we talked to over 20 people and it was just the compilation of all of those people put together all backing Xponential. The unhappy franchisees were like, I talked to someone at Roja that person wasn't happy and they talked about some people at Roja also struggling. So it's not to say that every single person was perfectly happy with Xponential, but the vast majority of people were. And of course, you can empathize and understand that one of the struggling brands, of course, they're going to have franchisees that aren't doing well.
Andrew: Or as you said, like people forget these are huge concepts, and if you've got 800 stories, of course, a couple of them aren't going to work. And I've done work on franchisees where I'll talk to someone about the franchises, they'll be like, oh yeah, I talked to a franchisee and they're really struggling. So I'm passing on the stock and be like, dude, this is a 2000 count store I could probably find you eight people tomorrow who are struggling with it. Like, what I wan to know is, what kind of the 25th percentile units are doing. Because if they're profitable then this is probably working really well. If the 25th percentile and if the 50% are making a lot of money in trying to expand, this is working.
Zachary: And you have to ask like, why are there so many multi-unit holders like there's a tone of people that own multi-units? Like why would that be the case? Unless the business was doing well. Like why aren't the transfer rates higher? Like why are the transfer rates in line with industry norms? Like why does Xponential, like how have they been able to close so few stores, even if there are theoretically 30 stores that are closed? That's still an extremely small closure rate for a system of 2,700 studios. I mean, I don't think we talked a lot about the same-store sales in the AUVs, but like if you look at same-store sales, I mean they did 20% in Q one. I mean, that is a tremendous number
Andrew: It is, though we talked about the COVID Q one, 2022 was kind of the last, I think they're still comping a little bit of the reopening, if that makes sense.
Zachary: They are, but I still think they're going to comp high single digits even coming out of that. So same-store sales numbers are going to decline over the next four or five quarters as they're not comping COVID anymore, but I still think you're going to see 6% plus same-store sales comps and you're seeing AAVs that are significantly in excess now of pre COVID numbers.
Andrew: Yep. Nope, that's great. Look I think we hit everything in I had in my notes. Anything else you wanna talk about or anything?
Zachary: No, I think the main point is just that the business is doing extremely well. you have an opportunity to buy it because it's depressed at least temporarily from the short report and from some of the, I would say misunderstandings that investors had from the short report. And we feel really confident. We did a tone of research that the primary research we did came back very positive. And then the alternative data that we have, which is highly correlated, shows the business has done very well actually post the short report, right? So there's been no impact on the business performance after the short report. We've continued to see really positive results and we think the shares are really undervalued as a result of that.
Andrew: No, look, this is why I wanted to have you on, because, it's just an interesting time. The company's been blacked out and when somebody says, Hey, I've done 25 expert calls and I've got something to say, and this is very kind of timely, but in front of earnings in the investor day, just thought it was great. So Zach, look, I think you've done great work. We'll see how it plays out. We'll learn a lot more in 48 hours and then a lot, lot more in a month with the investor day. But I appreciate you coming on and looking forward to having you on again and tracking how this one continues to do.
Zachary: Yeah, thanks so much for having me. Appreciate it.