Zack Buckley on Xponential Fitness $XPOF (podcast #129)

Zack Buckley discusses his investment thesis for Xponential Fitness (XPOF), including why he thinks the company is set for continued rapid growth.

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Transcript begins below

Andrew Walker: Hello. Welcome to Yet Another Value Podcast. I'm your host, Andrew Walker. If you like this podcast, it would mean a lot if you could rate, subscribe, and review it wherever you're listening. With me today, I'm happy to have Zack Buckley. Zack is the founder, portfolio manager, and maybe a couple of other titles at Buckley Capital Partners. Zack, how's it going?

Zack Buckley: Good. How are you? Thanks for having me.

Andrew: Hey, thanks for coming on. Really happy to have you on. Let me start this podcast the way I start every podcast. First, a disclaimer to remind everyone, nothing on this podcast is investing advice. Please consult a financial advisor, do your own due diligence, all that type of stuff. Then the second way I start every podcast is with a pitch for you, my guest. We've been talking for several months. You're a super-sharp analyst. I wish I had listened to you a little bit more seriously because we were in a name and you called me up. You're like, "I'm having a lot of worries." I think we're missing the story. I think the company is going to be a lot weaker than…" Sure enough, stocks are down about 50%, but we've been talking for months. You did great work on, especially retail and consumer-focus name. I'd say at least that's what we mainly talk about. But you do fantastic work, I really enjoyed talking to you. I'm really happy to have you on the podcast today. I think we're going to talk about stock in depth today, but I don't know if you wanted to go a little bit deeper into your background and kind of your unique approach and everything.

Zack: Yes, definitely. I started getting interested in investing when I was sixteen. My dad was a doctor. My mom was a psychologist. My dad, unfortunately, very smart guy but was a horrible investor. He was investing in stocks in the late 90s, sold out in the early 2000s. He started investing in real estate around 2002 through 2007. So just couldn't really time a worse investment approach than what my dad had.

My parents were always stressed about money and I wanted to be a doctor at the time, but I didn't want to stress about money the way that they did. And so I started getting interested in investing. I was a voracious reader, always have been, certainly was in high school. I was reading thirty to forty books a year. I just came across Benjamin Graham, Warren Buffett, and was just totally obsessed with value stuff, really, since I was seventeen or eighteen. My dad gave me 100,000 to manage in November of 2007, so I was nineteen at the time.

Andrew: You want to talk about times where it would have been pretty easy to blow 100,000. Woooh!

Zack: Yes. It was a great time to learn. I was kind of down with the market in 2008. I had a really good year in 2009. It was up triple-digits in 2009. I was trying to figure out a way to get into the hedge fund industry. I went to the University of Miami. It wasn't obviously a feeder school for the hedge fund industry, but I wanted to manage a hedge fund ultimately. And so, I actually taught myself to play poker. I was playing poker professionally to pay bills, and then that allowed me to not immediately have to get a job. Basically, I filed the formation documents for the fund my second semester in senior year and launched with half a million dollars, basically, 6 months after I graduated in January 2011. So I had a really good year in 2011 and was able to get to that 25 million in assets at the beginning of 2012. Then we've grown it from 25 million in 2012 to just under 100 million today.

Andrew: That's awesome, man. That's really cool. I didn't know you had that poker background. You and Evan Tindall, you all came out at the same time, poker backgrounds. It's funny how many investors have that poker overlap.

Zack: Yes. There's a ton of overlap, which I'm sure we could spend an entire episode just talking about, but definitely, a lot about expected value and how to think about probabilistic range of outcomes and bet sizing. So, definitely, there are a lot of parallels between the two.

Andrew: There is a monthly finance poker gathering, which I just got an invite to the first time. I know you're in Chicago, but next time you're through New York, maybe we'll see if you can come through and probably take all of our money.

Zack: I'm actually Miami-based.

Andrew: I thought that you were in Chicago for some reason.

Zack: No, because I grew up in Chicago, so my phone number is a 630. I play in that New York Finance Poker Game, I believe.

Andrew: Okay. We'll talk about that offline. That's a great background. I guess the next thing to turn to is just the company we're going to talk about today. The company is Xponential Fitness. The ticker is XPOF. I'll pause there and just ask, what's Xponential Fitness and why is it so interesting?

Zack: Yes. Xponential Fitness is a boutique provider of fitness. They have ten different brands in total. People are essentially... It's been a huge trend recently, where there's been huge growth across their different locations. They have 2,300-plus locations at this point. Their primary brands are Club Pilates which has 750 studios, Pure Barre which has about 620, then their third largest is CycleBar which is just over 250. Out of those three, you have about 1,600 of the 2,300 plus total. Those three are the majority of the business, but you still have ten brands in total. They've been growing extremely well. They IPO'd last year, so July 2021. We just think that it's a perfect business to own in this environment because it's inflation-resistant because they're a franchisor. And so, they're basically getting the top line revenue of all their franchisee's payments. So, it's very inflation-resistant. It is recession-resistant because there are customers, an affluent enough customer base, where they're not really being impacted significantly.

If they're paying $130 a month for their fitness and they're making an average of $130,000 a year, they're not going to change their fitness. Or they're not going to decide to stop going to the gym just because things have gotten a little bit tougher in the recession. They can handle a recession and fitness is a priority for their customer base. Yeah, we think they're really perfectly positioned and we don't think it's been fully recognized yet by the investment community. I think people are worried about the typical things that people worry about when businesses first IPO. Planet Fitness had a lot of the same concerns. We actually think that Xponential Fitness and Planet Fitness will kind of have a similar path where Planet Fitness was trading at a pretty low multiple in the first fifteen months after it IPO'd. Then in months sixteen through thirty-eight, the multiple more than doubled and the stock was over 200% in that timeframe.

Andrew: That's a really interesting comp because as you said, Planet Fitness, there were lots of doubts about it. It's fitness. There were lots of bad claims. I'm looking at it right now. Obviously, it's gotten a much bigger even odd number, but it used to trade for pretty small and now, it's trading for well over 20 times, even though I would say which would be a nice path for Xponential same franchise model, all that sort of stuff. Lots of stuff I want to pull on there, but I guess I'll just start with one thing. I think a lot of people, when you say, "Oh, I'm investing..." I was very skeptical, and so I started reading it last night. These are real brands. They've got real history. The management seems real.

Even some analysts I saw at conferences will say, "Hey. If we invest in Xponential Fitness, history is kind of against us." They're not a history of a lot of successful publicly traded fitness companies. Kind of the only one that I can think of is Planet Fitness actually. At this point, a lot of time it's a disaster, but even before that, there were histories of New York sports clubs and all these other things. They come out. They'd be public. After a year or two, it would start to work against all the stuff, and the stock would just kind of crash, and eventually, bankruptcy or restructuring, all that sort of stuff. Why do you think with Xponential Fitness, history is different this time?

Zack: Yes. I think there are a few things. Definitely a fair point. I point out F45 as one of their main competitors or perceived competitors. F45 came public almost the exact same time that they did and is done horribly.

Andrew: I tweeted out yesterday, I was looking at F45 to prep for this podcast and I think they had the worst miss I've ever seen a company do, where at the start of this year they were saying, I think it's "We're going to grow store base by 1,500" and I'm trying to find the exact number that they said. At the start of this year, they said they were going to do 1,500 maybe bigger before that and now it's like under 400. I mean, it's unbelievable how bad the miss was.

Zack: Sure. Yes, and I guess this is probably a good time for me to talk about... We use alternative data sources in a lot of the analyses that we do. And so, with Xponential Fitness, we're definitely following the data on a week-to-week basis to make sure that we understand what the trends are and how the business is doing. We have no expectations and I think there are good reasons to believe why they should grow well over a long period of time, and why they won't be like F45 is and like other failed fitness brands are. But we are very careful and basically following the short-term results to make sure that our long-term thesis ends up playing out. So, the reason why I think the long-term thesis will play out. So, the first thing is, there's a diversified portfolio of very successful brands. So, Club Pilates is nine times larger than its nearest competitor. Pure Barre is eight times larger. CycleBar is three times larger. So they're buying the dominant players in their various verticals. BFT was their most recent acquisition. That's one of the most dominant fitness basically Boutique Fitness Concepts and Australia, and Southeast Asia.

So they're buying the best concepts in various areas and then they're managing them and growing extremely well. But it's also a diversified portfolio of brands. I'm sure not every concept is going to be perfect, but they have 10 concepts. Their main concepts are doing extremely well. So I think that's the first thing, I think, just looking at their track record. So, Club Pilates had 12 Studios seven years ago and has 750 studios today. It had AUV of 250,000 in 2015 and has AUV of 750,000 so they have done an exceptional job of managing these brands. I think management's really important. Tony Guy has been doing this since 2001. He's been very successful in the industry. He's probably the only person that's been in the industry for over 20 years. So I think we're betting on the right person, the right management team, and the right brands within Boutique Fitness. I think the other thing is just the industry in general. It's been growing at a 6% kegger since 1999. So, the Boutique Fitness industry itself is growing very rapidly and is projected to grow to 6% kegger for the next four or five years or so. The industry itself, I think, is very strong and I think they're very strong within.

Andrew: That's perfect. I think you did a nice job addressing it, but I just want to go back one thing to the sustainability of the brands, because I did some work on it and I am a little concerned there. You mentioned Club Pilates. I mean, that's been tremendous, right? I believe it was 12 units five years ago, and that's when they acquired it, right? And now we're five years later, it's 750 units, AUV has absolutely exploded, all that sort of stuff, maybe it's because of Club Pilates. But I remember my mom, ten or fifteen years ago, love to go to this brand curves, right? Curves had similar exponential growth. It went from under 100 units at its peak in 2009. I think it was approaching, it was getting up to 8,000 or 9,000 units. Then, seven years later, the thing is approaching 1,000 units, right? It was just exponential up and exponential down. I was just wondering, is that the history of these types of new things? I think CrossFit has had some ways cycling. I don't know if that's a new form of exercise, but the brands have come and gone and I just worry, "Hey, great. You did Club Pilates but it's not like there aren't other Pilates competitors out there." So, why do you think these brands in particular are kind of sustainable?

Zack: Yes. I mean, I think it's really just based on the history and track record that they've had so far. And of course, there's no guarantee that they couldn't have trouble in the future. I think all investing we have to look at is what's happened historically, and is that reasonable that it should persist? Club Pilates has resonated extremely well with consumers. That is by far the best brand that they have and probably the strongest that they have. It's obviously experienced exceptional growth in the past seven years. Is it possible that it flares out over some period of time? I think it's very unlikely, but that is why we follow the data so closely because we're always seeing if we could be making a mistake. We're always second-guessing and trying to be as critical of our position as possible. But I would say there are flare-ups, there are blobs in every business. I think you mentioned a few in the fitness space but there's nothing that makes me think that their brands should experience them.

Andrew: Let's quickly talk valuation and I think there are actually more interesting things to the story, but valuation can always serve as a baseline, right? As I look at it, they've got a little bit of a complex CAP structure which we can talk about if we want to. I've got them at like a 1.3-billion-dollar enterprise value. Their midpoint of guidance is about 70 million of EBITDA this year. So you're talking about 19 times EBI to EBITDA with this. Again, this is a franchise model, right? So they don't own the units. I mean, this is very cash Richie, EBITDA is going to track really well into cash flow and all that type of stuff. So when I say 19 times EBITDA, that seems reasonable for a franchisor. I think like USR and a lot of other people who are much more mature– and that will come into play in a second– probably trade slightly cheaper multiple, but nothing crazy. As we said, playing it probably trades around 20. When I see those multiples, is there anything you would push back there, or is that kind of good for just an overview of the two-day 2022 valuation?

Zack: No, you got it right and I would point out the sell-side gets it wrong and other places get it wrong. Nice job.

Andrew: What do they get wrong about it?

Zack: A lot of times they'll leave out the preferred, or they'll get the share count wrong. So a lot of the sell-side has the enterprise value closer to a billion and that's not correct.

Andrew: Well, glad I could get that right. It is complicated though, right?

Zack: Very complicated.

Andrew: Like you mentioned, they got Class A, Class B. There are some rumble payout units. You have to decide if you want to put in there or not. So we've got the baseline established. I think the thing you're tracking obviously, 18 times, 19 times a franchisor, not cheap, not expensive. I think the thing you're really talking about here is the growth, right? So why don't we talk about the growth? They talk about how they've got a lot of growth in the backlog. A lot of this growth is absolutely baked in, so I'll just review. What's the growth and why do you think this is not 18 times but 10 times year's out or something?

Zack: Sure. Yes, no, I think next year, they'll probably do in a ballpark of 100 million dollars for just the EBITDA. So, I think it's probably 13 times on next year's numbers. That could and probably should flow into over a dollar a share in free cash flow. So, we think it's trading at somewhere in the ballpark of 19 times next year's free cash flow, which for a recurring revenue franchise business, that is inflation and recession-resistant. We think it's really attractive. You know, Planet is close as Peer Trays at 33 times and into your point, sort of the other dominant franchise businesses typically trades at 25 to 30 times. So that's kind of our near-term view. Longer term, looking out, five years, we think they'll earn between 250 and 3 dollars a share and UPS or free cash flow per share. We think that should trade it. I mean, the Peers today trade at 25 to 30 times earnings. Planet Fitness trades at 33 times earnings. So you can kind of pick what you think is a fair multiple. I think everyone has different views on valuation, but you can easily see how this could be a 75 to 100-dollar stock in five years.

Andrew: Yep. I mean, the very... I can sort of math 20 times 250, right, which is low into what you said, 20 times again for a franchise. It should be very inflation resistant. You just take that franchise up and actually, your margins go up because you're leveraging your GA a little bit more. I don't think anybody would argue with 20 times if you've got that stability. That's 50, that's more than double from a $19 stock price today. Okay, so that's great. Let's talk about management here. So you mentioned, and the CEO likes to tell everyone, "Hey, I'm the only person in the Boutique Fitness industry who's been here for over 20 years." We'll probably talk recession a bit but every time people talk recession, he says exactly what you said, right? "Hey, I had LA Boxing in 2008 and people were worried about this. I think one of his quotes was "people will go on welfare before they'll give up their Boutique Fitness". Anyway, I'm rambling a little bit. Let's talk about the management team because it's important for any franchise story. Management is the one shaping the brands. Management is the one driving it. There are probably going to be more acquisitions to come so I'll kind of pause there.

Zack: Yes. In general, we love to find obsessed and hungry owner operators and we think Tony fits that really well. He's been in the business forever. I think he knows it as good or better than anyone and I think he's done a phenomenal job in assembling a portfolio of really high-quality brands and monetizing that brand portfolio. So I know they've done a lot of smart things that I think we're creative. The B2B partnerships that they are exploring are really interesting. So they just signed with Princess Cruises, which is basically 23,000 staterooms that will get over a million views a year now. So, that's a million incremental people and their customer funnel, but they're essentially getting paid for. They partnered with Lululemon with MIRROR. So they have four at their brands now that are going to be on MIRROR. They partnered with LA Fitness, they have over 500 studios that are going to open within LA Fitness. So they're doing all of these creative and intelligent things. I'm hoping and sort of expecting that they'll be able to actually beat the guidance that they've laid out. I think they're very thoughtful about understanding that it's always better to be in a position where you can be in the race over time.

So I think even though the growth that has been set out is significant over the next three or four years, I actually think they intend to being raised across that guidance over time, and that it's pretty conservative based on their expectations. And the B2B partnerships are part of it. So going back to the management team themselves, I think I wouldn't want anyone else running this company besides Tony. I think he has a great team around him. Sarah, the president, and John as CFO are also really strong. So we spend time with all of them, I've been to the offices in Irvine. So, yes, I have been really impressed with the team and think they're kind of the right group to take this to the size that they wanted to. He's super ambitious like his aspirations. He talks about a 100-dollar stock price like that says expectation. That's what he wants to happen. He wants us to be a much larger business than it is today, and I expect it will be.

Andrew: I think he owns a ton of stock here, too, if I remember correctly from reading the proxy. I think some of its class being stuff but he certainly incentivizes to get up there.

Zack: It's confusing but he owns about 20% of the chairman. It was about 20%.

Andrew: Yes.

Zack: And the other insiders on about five so they're about 45% of the ownership of the company.

Andrew: So you mentioned the partnerships and I guess, let's quickly talk with partnerships. I was going to save it for later, but I didn't think they were interesting. So they've got the partnership with Princess as you mentioned, they're partnering on MIRROR. I thought they were interesting because as you said, that's a lot of... It seems like not just free. They're getting paid for these things, the ways drive traffic. But then I could see the pushback like, "Hey, people going on Princess Cruises isn't exactly the most targeted traffic." Maybe there's a little bit of management headache. Like I haven't really seen... There was another publicly traded company that does Medi-Spa on cruises. It's kind of tough to make good economics on cruise partnership, so I could see it going both ways. But you think the partnerships, the MIRROR, all this, you think they are smart, they are going to add value over time?

Zack: Yes, definitely. I mean, they're getting paid for them. So, at worst, they get extra money in their pocket. At best, they get extra customers in their acquisition funnel. I think Celsius and C4 is another partnership where they're paying people to have access. I mean, what would you pay to advertise in 2300 studios, right? That's a huge customer base that you get to have access to. So they actually hired the former brand partner of the Chargers because having access to a football team is a huge value as well. They wanted to bring someone that understood how to work with partners and basically grow that business. So I think they're just getting started there and I think they really expect to significantly ramp the B2B partnerships that they have. What they've done so far, I think it's really impressive.

Andrew: Let me add something on structure here. XPOF owns, I think, up to 12 franchises, right? You mentioned the big one; there's Rumble, which there are a couple of classes. I always focus on that one because there are a couple of boxes right by my house and I've been to a couple of classes. I have one friend who's obsessed with them. But 12 franchises under an umbrella does strike me as strange, right? I think about QSR which owns Burger King, Popeyes, Firehouse Subs, Tim Hortons, right? So that's four brands. I think about Yum. That's Pizza Hut, KFC and Taco Bell. Most franchises that I've seen have kind of maxed out at three to four brands, and these guys are already up to 12 and they clearly want to go do more. So, my first question there... We will talk synergies between the brands and ex-pats in a second, but my first question there is just like 12 brands underneath one umbrella, that does seem like a lot. It seems like there'd be kind of a lot of management distractions. Is that just too many brands? Are they actually going to be able to go buy more and kind of focus and grow all these brands?

Zack: Yes. They have management teams for each one of those brands. So they have a president, a CMO under them for each one of those brands. So far, I haven't really seen it as being an issue. I think the other thing that's important to consider is the top three are the vast majority of the business. So it really is still focused primarily on those three brands. Although I do expect them to expand to more brands over time. The other thing I would say is, there are plenty of conglomerate structures that work really well. Berkshire Hathaway is an easy example of having a very decentralized management structure where you have a portfolio of businesses that works really well over time. Obviously, private equity firms owned more than ten brands over time. While I agree that it's somewhat unique in a public company structure, I think there are plenty of examples.

Andrew: Look, I hear you. Nobody's going to say Berkshire Hathaway hasn't worked out well for people, but it does strike me like Berkshire wasn't just kind of capital allocating. And here, I do think you have a CEO whose skills are brand building and building companies and stuff. And that's a little bit more hands-on than the Berkshire model where you just have the CEO capital allocating?

Zack: Yes. I think in some of the models, he's not that hands-on. I think that's kind of the idea. I think he is really focusing on the high-level stuff, which is new brand partnerships, stuff like XPASS and XPlus. I don't think he's thinking about the day-to-day operations of CycleBar or Rumble. I think that's really the job of the president of CycleBar or the president of Rumble.

Andrew: Makes a lot of sense. Let's talk synergies. So, you got 12 Brands underneath this umbrella. I think the argument for having this many brands would be there are some types of synergies, and you can think of a couple right off the top of your head, right? Increasingly, it's important for any Boutique to have their own technology and stuff. Yes, you can license it. Like I go to a one-shop Boutique. They've got the same app that basically buries those, right? So you can license this stuff and everything but there are other synergies there too. So you can get lots of synergies on the GNA, all that type of stuff. I think the real synergy would come from something like XPASS, which is their thing where you sign up, you can pay a certain amount per month, and then you can use those credits to go to all of their studios. Right? So, instead of just having a 10-pack to go to Rumble, you have a 10-pack in one day; you can go to Rumble, one day you could go to Stretch Lab, one day you could go to their pure class and everything. So you could see how there could be synergies by giving you access to all the brands. I want to pause there and say just synergies overall on the cost side, do you think that's one of the drivers for XPOF? And then the XPASS, which is pretty unique to me, do you think that's a value driver long-term?

Zack: Yes, definitely. I mean, XPASS right now is about 15% of their new lead generation. So I think they're definitely driving a ton of new traffic and new leads from XPASS. So there's clearly going to be synergies on the customer acquisition funnel and obviously getting AUVs up as a huge part of the story over time. So their expectation is AUV should go from about 500,000, roughly where they are now, to about 600,000 over the next few years. And I'm sure part of that is going to be XPASS. So I think there are synergies on the revenue side with XPASS with certainly the B2B Partnerships that they're doing. And then, I think there are obviously synergies on the cost side, the back office, and being able to have shared services. We're going to see that the adjust lead to margins going to scale from roughly 30% to about 45% over the next few years. So you're going to see a very high-margin business emerge over the next few years as this business grows.

Andrew: How does the economics of XPASS work, right? So I sign up for XPASS, I think there's $250 a month would get me 15 classes. If I book one class at Rumble and one class at Stretch Labs through that, how much is corporate taking versus how much is the franchisee is taking? Because if I go by a Rumble 10-pack, Rumble keeps all that money outside of whatever they send upstairs in the franchise royalty, right? But if I buy through XPASS, is there a difference? Do you have this thing where Rumble is trying to encourage people, "Hey, don't buy XPASS, buy directly from us" or something?

Zack: No, you don't. They haven't disclosed exactly what the economics are between them and between the franchisees. But I'm sure you can assume that they are essentially figuring out a way to incentivize all the franchisees to sell the XPASS. I think, at the end of the day, the franchisees are going to want just more volume coming to their business. I'm sure XPASS is incentivizing them.

Andrew: Okay. Yes, I thought I saw somewhere that they were doing a 70/30 split but I could have been mistaken. It just strikes me as something, again, I love going to gyms and I've seen these before. It strikes me as something where you could have this really weird thing where like there's class pass in New York, I'm not sure if you're familiar with this.

Zack: Definitely.

Andrew: But you buy class pass like goes to gym and basically says, "hey, we'll send you Flex capacity" and every gym you go to, they like class pass because it gets new members in there. Obviously, that's not a corporate offering, that's a third party. But once you're in there, they're like "Hey, buy from us. Don't buy from class pass. Please, please, please. We don't want to get [inaudible] all that margin and stuff."

Zack: Sure. No, and that makes sense. There would be sort of a disincentive between, you know, just because class passes third party versus this is all in one ecosystem.

Andrew: Yep. Okay. I normally do this up front but I was so excited reading into the story and stuff yesterday that I kind of just wanted to dive right into the story itself, but let me back up a bit. My first question is, generally, the markets are really competitive place. We started diving into it but you've got to kind of have something differentiated in the market to generate risk-adjusted alpha going forward. So I guess my question to you would be like, what is the thing that you think you see with XPOF that the market is missing that will make this a risk-adjusted alpha generator going forward?

Zack: I just think that the market is not expecting the EBITDA multiple to expand over time. So it's a combination of things. I think the first thing is everything that you said about people are kind of doubting the model at this point. And so, I think for a business that's going to grow as quickly as it is over the next five years, it's trading at a very low multiple because you can look out five years and say this business with a very high degree of probability was going to do 250 plus in UPS. And so, if you could buy a highly recurring franchise revenue business at seven or eight times earnings. I mean, that's an incredible purchase because those businesses typically trade, like we said, at 25 to 30 times. So I think that's the first part. I think there's skepticism around the model and that's just creating a lower multiple than where it should trade. That's honestly most of what it comes down to. I think there's just a very clear roadmap to this business being significantly larger over the next five years. It's very easy to model out, it's very consistent and I think people just aren't trusting that. Generally, what happens is a company becomes public longer as it continues to be raised over time, people get more confidence on the model. And as people get more confidence, the multiple goes up.

Andrew: Obviously, they've done a lot of acquisitions. Club Pilates we mentioned is just an absolute homerun. They just did one, I believe it's Australia Focus BFT, they acquired Rumble late last year. Do you think there's more Acquisitions going forward and that's kind of a driver of the story as well, or do you think at 12 they're kind of focus on just growing the brands under their house?

Zack: Yes. So they have 10 right now and they definitely expect to grow that over time. So I would expect to see more acquisitions in the future.

Andrew: Okay.

Zack: And I definitely think that will be a part of the growth over time.

Andrew: I wonder where such wealth from. Yes, you're right, it's 10. I'm looking at the chart. I've got 12 up there. Bad me, bad me. Let's talk opportunity. Somebody treated out, "Hey, why buy XPOF at 20 times EBITDA when there's oil and gas stocks trading at two times EBITDA? So there is just the opportunity cost of the market as a whole, right? But I think the more relevant opportunity cost is, look, there are other franchise models out there, right? Planet Fitness would be the most direct one. That is a franchise model of gyms. Now those are lower-costs everyday gyms versus Boutique. Why XPOF versus Planet, which is kind of traded at a similar multiple on the nearer-term numbers? Or if you want growth franchise stories Joint JYNT is a very popular stock among value investors. That's franchise chiropractors and I don't know if you've done work on Joint or anything. Why XPOF over Planet, Joint, any of the other smaller franchisors?

Zack: Yes. I mean, we're just always modeling out what we think earnings are going to look like in five years and what we think the appropriate multiple for the businesses and then looking at the IRR. So, Planet is already trading at 33 times earnings.

Andrew: Yep.

Zack: And has probably high single-digit, low double-digit EPS growth. That, to me, is not that exciting of an IRR. I think Planet is probably going to... the IRR will probably be kind of what it's EPS growth rate is. So, maybe a 10% sort of base case IRR for Planet, my base case XPOF IRR the next five years is 30 plus percent. So I think to be able to buy a business is highly predictable, extremely stable, again, inflation resistant, recession resistant with a 30% plus IRR. I think that's really attractive. I think the Joint is probably an interesting investment. I haven't spent time on myself, but actually the CFO of XPOF, he was formerly CFO of the Joint. Actually, the only time I looked at the Joint was after meeting him. But the Joint could be interesting. I just can't speak to it. When I look at most other franchise concepts, they're trading in 15 to 20 times EBITDA or 25 to 30 times earnings and they're growing earnings and low double digits for the most part. And so, this is trading at lower multiples and growing three times faster.

Andrew: Yep. Let me ask you certain questions. So, these guys are obviously growing really quickly, and I was kind of wondering. Are they riding covid tailwinds too hard? Not that their intention to it, but the covid reopening has been such a tailwind for them. I've been wondering if their growth rate almost comes down as the world normalizes. I mean it in this way, right? I think they gave this at 30% of boxes went under during covid. They didn't have a single box closed, but that creates a heck of a lot of real estate for them to kind of purchase, add locations, all that type of stuff. A lot of excess equipment, a lot of particularly excess labor, right? The SoulCycle down the street closes and they even gave this example. SoulCycle closes, we go into that location, we split it into two boxes, guess what? There are eight SoulCycle instructors who are out of work, who are probably fantastic, very trained, who we can go and add to one of the boxes. So, no labor shortages facing them. No real estate shortages. It's almost like open space. I wonder, as the world normalizes more, as all that excess real estate is absorbed, is there almost like a brick wall coming in front of their growth where all of a sudden they say, "Oh, it's a lot harder to find instructors. Oh, all of the boxes that were empty have kind of been filled. So it's much more of a turf war to grow going forward"? Does that make sense?

Zack: Yes, it does. I guess, let me address two things. First is what they've guided to in terms of long-term growth just so you have a sense of that. Then, I also kind of just want to talk about the individual studio economics just so you can kind of understand how-

Andrew: That's the question so that's perfect. Yep.

Zack: Like how profitable they are because they're... the individual franchisees opening these up, get a 40% cash on cash return. So, labor could be a little bit tougher or rent could go up a little bit and maybe the cash on cash return goes from 40 to 37 but it's not going from 4o to 10 or something. It's going to stay very attractive. In terms of their long-term guide, so they're saying 500-plus annual new studio openings. So, on a 2300 base, they're talking about studio openings north of 20%. And so, they're also talking about mid to high single digit, same store sales growth. If you look pre-covid, that's what they were doing. They were doing most quarters between 5 and 9% same store sales growth. So if you sort of layer on the same store sales growth on top of the studio growth, you're in the mid to high 20s already on a revenue basis. And then, like I said, just leave it to margins if you're going to expand from 30 to 45 percent over the next few years. So the adjusted EBITDA growth is going to be well in excess of that revenue growth saying the 35% plus range. And so, those all seem like very reasonable goals to me, just given what they've done historically. Looking at their historical growth, looking at what they've done this year, they're going to open 500 plus studios this year, they have a pipeline already, basically double what their studio basis. So, I think they have another 2600 studios that have already been contractually signed. Those are already guaranteed to roll out so that's, I think, very predictable. Then, you have the pre-covid same store sales growth which, in my mind, there's no reason why I would think they wouldn't be able to achieve that. When I put all that together, I just have a high degree of confidence in their ability to meet that and I also think they've been kind of conservative. They talk about their revenue growth rate as low to mid tens, sort of on a longer term basis. I think they're talking like five years from now low-to-mid tens because I think for the next five years, it's going to be 20% plus.

Andrew: I think a lot of the pushback on the idea that I've seen particularly from the sell-side, I tend not to read a ton of sell-side research, but XPOF does a lot of conferences so you can see what the sell-side was really targeting. A lot of the pushback has been on the franchisees' economics, and I mean that in two ways. Number one, I think there's been a lot of pushback on the 40% cash on cash return number, which does make sense to me. You say, "Hey, we're opening the gym. We're paying a 6 to 8% royalty to the kind of corporate mothership, plus we're buying the equipment from them, all that sort of stuff." Like 40% cash on cash returns sounds very high for a gym that can be easily copied and everything. So that's one aspect: pushback on the 40%. Then the second aspect, and I think this bleeds into the 40% is a lot of people have said, "Oh, the franchisee base here is mainly made up of people who own one to three units." Not the McDonald's where everybody owns 20 or 30 units, or something. The pushback on that has been along two lines. A) If the cash on cash returns are really 40% plus, why aren't people like going all out and getting up to 40 units in a market or something, right? Four Rumbles, three Cycles, whatever it is, and be... If everybody's at 123, do you have an unsophisticated investor base that might think it's 40 percent cash on cash, but that's because they're not factoring in the value of their time. They're kind of getting paid the classic, "Hey, I get paid 100,000 a year for owning a laundromat but I work 100 hours a week or something." So, I basically make minimum wage. That type of thing, or maybe they're not factoring in depreciation of the equipment, all of that. So, I'll pause there, I threw a lot out there. What do you think about that? How people talk about the franchise base?

Zack: Yes. So the initial investment in the average store is about 350 tank. The average annual revenue in year two is about 500,000. Labor per month is about 10,000, so 120,000 years. Rent per month is in sort of the 10,000 range. Those are the two biggest expenses. So those combined are say about 250k per year. So you have about 250k after those to work with them, and they're kind of saying that most of the franchisees are making between 125k and 150k a year. So there's probably an additional 100 to 125k cost below that, which is going to be technology. It's going to be electricity, sort of all the other expenses that we have described. So I'm sure there's variability among the franchisees. I'm sure some franchisees do significantly better and some do significantly worse. Certainly, the Club Pilates franchisees have done exceptionally well, right? AUV's expanded from 250 to 750, and that's why they're raising the royalty rate. So if the franchisees were not doing well, they wouldn't be able to raise the royalty rate and still have basically double the current base already sold. So they have more than 750 Club Pilates already sold. The other thing is, they only accept about 2% of the franchisees who want to become franchisees. So if it really wasn't that attractive and if people really weren't doing well, I can imagine that you'd have 50 people for every one person that they actually accept in the program. A 2% acceptance rate for franchisees doesn't apply to me. That's a bad business to get into and actually, it strikes me as a pretty great opportunity.

Andrew: It reminds me of Chick-fil-A a little bit where they've got the classic. I think they take less than 1 and 100 or something, but they've got all sorts of things. And obviously, everybody loves to own a Chick-fil-A franchise because those things meant money despite being closed on Sundays. Let me turn to recession risk. We talked about recession a little bit, but we'll talk about recession for the overall business, just on the franchisee side I was wondering. Recessions, rising rates and stuff, obviously a franchisee needs, most of them get equipment loans to buy the equipment to set up a box, get the real estate, that type of stuff, its operating leases. You probably do need some type of business loans to get these set up. Does recession, interest rates rising make capital harder to come by and maybe slow the unit growth in some way on that side?

Zack: No, I don't think so. Most of the franchisees are not really using a significant amount of debt for opening it. So there might be some small amount of debt, but I don't think that's going to be changing that dramatically with the equipment financing. If they were able to gross 350 studios during covid, which was arguably the worst period in history for their business, certainly the worst period in the last 25 years. Then I'm not too worried about whatever recession might be coming for 2022 or 2023, which we still haven't actually seen a true recession, right? I mean the economy, you know, job market is still strong. So I think the stock market is obviously predicting a recession and that very well could end up being true, but we haven't actually seen it physically in the economy yet.

Andrew: I was about to say September definitely, the stock market is definitely predicting a recession in September.

Totally, and the stock market's forward-looking, that's the stock market's job. The stock market is not wrong in doing that necessarily, but it's just that the future is uncertain and we'll see where the economy goes.

Andrew: One thing we should have mentioned earlier, I think, before we talk about recession. The company likes to say, "Hey, you guys have bad risk." I obviously was hitting on the curbs parallels earlier. You guys talk about all this; we've never had a box closed in our history.

Zack: Yeah.

Andrew: Is that true? Because obviously, that speaks to the strength of the model and stuff. Still very young, but that's still pretty crazy.

Zack: I was absolutely shocked when he told me that. I mean, I don't have no reason not to believe it, but it is a shocking statistic. I think they do take, obviously, there is turnover. Someone, unfortunately, could die or there could be a reason why there might be turnover in the ownership of one of the fitness clubs. And so, they might take it over temporarily while they're basically reassigning and reselling that license. Aside from that, even that is a very small portion of the base. I think maybe they have like 50 that's our 49th at our corporate owned right now or corporate run. Yes, it's been very impressive and I did talk to people that were skeptical of the model. I talk to a former employee who was very negative on the company, a little bit critical of the management team, and everything that she said, I did channels it on and just didn't pan out to be true.

Andrew: What we're her main pushbacks?

Zack: I'm just kind of thinking, I want to be careful. She was arguing that the market potential of some of the smaller brands was not the same as some of the larger brands, which I think is true. I don't think yoga is ever going to be the same size as Club Pilates or Pure Barre. I think that's an absolute fact. She was critical at some of the management team, but her main critique honestly was just that Tony really likes to make money and he drives a hard bargain. And honestly, I'm okay with that. He sounds like a good businessman to me, so it wasn't critiques that I was necessarily overly concerned about. She basically was saying also that some of the franchisees were unhappy but when I realized that no store or no club had ever really closed. I mean, that sort of negates them. So I did look into a lot of sort of the bearish points on the name and just found them to be not consistent with the facts.

Andrew: It's one of the really tough things with talking to formers and I've made this point all the time. A lot of the former's, they are formers and some of them are very happy, right? They hit 65, they're ready to retire, the stock's gone up 10 times over the past 20 years. They retire wealthy, management gives them a watch as they attire, right? But a lot of the former's management gave them the axe and they have an axe to grind because maybe they had a bitter dispute with management. A lot of times it's "hey, it was me or that guy for the CEO job. He got promoted. So I had to leave" like there can be a lot of bitterness. So it's one of the tough things we're talking to former. As you said, they had zero boxes close especially through covid. At this point, we probably would have seen the results if boxes were closing left or right, or they were just doing desperate Hail Marys to kind of be a lot closer in covid. It hasn't seen any of that so that's interesting. More on recessions.

Zack: Just one other thing on former employees.

Andrew: Oh, go ahead.

Zack: I think, oftentimes, they also just lack the perspective of being like they might be a regional manager or they might manage 30 of the clubs within a network of 2300. They just might lack the perspective of being the CEO. They might just be thinking too small within the company and not thinking the larger picture of the business.

Andrew: I know you and I connected on Party City before but a lot of times, I just remember, I did one call with Party City which was someone who had managed like four Party City or something. They had this list of complaints and, as an outsider, I would say some of them were valid. And then, as an outsider, I would say some of them were like, "oh well, you're running this from the perspective of four stores and Party City is running this from the perspective of 500 stores nationwide. And some of the stuff you wanted to do just wouldn't be doable when you're trying to manage hundreds of stores and a supply chain and everything, right?" So I'm with you a hundred percent.

Zack: Yes, but that's our job as analysts, it's to filter out what's good former employee information versus not. That's investigative journalism style primary research like that's what you're trying to figure out, is what's true and what's not.

Andrew: Just on reception risk. So we talked about earlier how the CEO said, "Look, I did LA Boxing and I think UFC gyms in 2008. People were really worried about recession and I think a lot of these people love this so much that they would literally go on welfare before they gave up their Boutique gym membership." These people he's mentioned, hey, they make a lot of money. This is a drop in the bucket for them. They talked about the community, if you go to a lot of CrossFit you build community there. Rumble hosts single night so you're going to Rumble, not just for the exercise but to meet other people and stuff, right? So we've got all that going for them on recession but I do wonder. A recession in 2008 versus today. Today, people have been trained. If you can't go to the gym in person, we can all remember covid working out at your home and stuff, there are options today that there weren't back in 2008, right? A lot of people bought Peloton, a lot of people have Peloton memberships. You can get Boutique style classes for a lot cheaper with a Peloton app or any of the other apps that you can do. If you just did the Peloton app, that's $40 a month versus the in-person 200 or whatever it is per month, 150, 200. A lot of gyms have started offering Booty classes. I don't remember lots of them in 2008. So you could maybe join a lower-cost gym and get booty classes. Not quite as good, but there's a lot of substitution that I don't think was around in 2008. Again, I threw a lot at you. I'll just pause there to let you talk about recession risk.

Zack: Yes. I guess the substitution is tough, right? I think it's very difficult to find high-quality group fitness classes outside of something like Equinox. Equinox is more expensive.

Andrew: Equinox is a thousand more expensive than a Rumble membership. Yeah.

Zack: Yes. So I think it's tough to find the quality that they provide at a similar price point. I think you're going to go down in quality a lot and I think we definitely saw during a pandemic. I mean, people didn't like- I certainly didn't like working out at home. I mean, I think people worked out less. Obviously, people got in worse shape. I mean, people gained a lot of weight during the pandemic, right? And that was because we didn't have access to gyms. I mean, gyms are good for public health and I think that's really important. I think people also really got a sense of how much they appreciated gyms during the pandemic because once they were taken away, people really wanted to go back to the gym. So I think, certainly from my perspective, I hated not being able to go to the gym, and so that would be a huge priority for me. If there was a big recession and I had to cut expenses, a gym membership would certainly not be something I would cut. I'm sure there's some percentage of people that would cut gym memberships. I'm not saying zero, but I don't think it's the vast majority of people. I think the vast majority of people are really happy to be back in the gyms and don't anticipate that changing.

Andrew: I'm definitely with you there. My only worry on that side is, I think of my own personal experience at the height of covid, I was Peloton-ing all the time and I was like, "I love Peloton. I'm going to do the six times a week for the rest of my life." Then, once gyms reopened, I started going. My CEO always loves to tease me. As soon as the gyms reopened, my Peloton went to once a week as an alternative work out and I'm at the gym every day. "Look, you didn't even know your own behavior during covid. You couldn't predict your own behavior. How are you supposed to predict other people's behavior going for the future so unknowable?" I agree with your theory there, I just worry that maybe you and I are basing it too much on our own insights or just human nature is unknowable, you know.

Zack: Yes. They just got back to their pre covid AUVs, right? So I think it's not like they have this massive bursts as things reopen where they were significantly in excess of their pre covid AUVs. They actually just got back to pre covid AUVs. Inflation-adjusted, they're still probably below the pre covid AUVs. So I don't think there was this pent-up demand where there was this explosion and their gym use that's going to revert. I think the other thing that's worth pointing out is that if the average person is paying, say, 1500 dollars a year for the gym memberships and makes 130,000 a year, like it's just over 1% of their overall expenses. So I just don't expect that it's material enough where they're going to be changing that. They're going to need that extra 1% because of recession.

Andrew: Again, I talked about how things are different today than the recession 10 or 15 years ago or whatever. Do you know what else is different? A lot of people... I could be wrong. I wasn't around, going to Boutique gyms in 2008, but I do think gyms have fostered more of a sense of community now where 20 years ago, I think you just went to the gym, did your own thing. With these Boutique gyms, they generate a big sense of community. I know a ton of the people who go to my gym. If you drop that, yes, you’re saving the expense but you're also losing that community a little bit and paying for community is something that people will kind of, again, they'll stretch their budget to keep. We've talked about a lot of stuff here, I'm cognizant of time. I want to ask two last questions and then we can probably wrap this up unless there's anything else that you want to talk about.

Zack: If I can just jump in on one thing just related to recession. I think a lot of the fitness concepts that have gone bankrupt or had trouble were overleveraged. They were smaller gym businesses that were overleveraged going into recession, right? So like Town Sports which on New York Sports Club. That was like a few New York gyms and they were way too levered. XPOF is a franchisee, like, they're the franchisor, they have some leverage but it's a very appropriate amount of leverage. So I just think this is a different concept than other gym concepts that have really had trouble or struggled over time.

Andrew: I just laugh every time at New York Sports Club because they went bankrupt before covid and I actually think that would have been a really successful equity play. I got burned on a little bit because then covid came and destroyed them. They prove the value of subscriptions because I've never seen a company so difficult to cancel a membership from before. Signing up was easy but if you want to cancel, you like had to send a certified letter to some office. And if you didn't hit on the certain day or certain time... it was the worst. Two last questions. First, I always asked about share buybacks. This is a hyper growth story, they're just kind of hitting the EBITDA on cash flow inflection point. Obviously, they generate cash but it's going to be a lot more as the growth comes in and kind of they do. So I don't think we need to talk to you by that, but that does raise another question. Management obviously sees the value here. They are huge believers in the story. It's firing on all cylinders. You've got this quote from a conference in September. This last quarter was the best quarter the company has ever had in every KPI in every metric. Right? So they see the value, it's firing on all cylinders. Yes, there's significant shareholders but why are they buying shares on the open market?

Zack: I think they're more focused on being inquisitive at this point. So their main interest, I think, is building cash so they can be acquisitive at this point in time. But I think we'll definitely see stock buybacks in the future and I agree with you, I would love to see them buying back stocks, so I wouldn't take the other side of that. I think buying back stock would be a great use of capital for them.

Andrew: It would be the rare franchise model if at some point they didn't return capital shareholders, right? Because that's the beauty of a franchise model, all this cash flow comes in and eventually you have no choice but to return it to your shareholders, or else you'll just become a cash bank basically.

Zack: Yes.

Andrew: Last question here. Look, I've thrown a lot of risk at you. I threw recession risk. I threw the curves history, and the history of bad, and all this other stuff here. I guess you address them all but just to wrap it up, what do you think kills the story or where do you think you could be wrong? If three years from now, you and I are talking and we're pitching a new name and say "Oh, XPOF didn't do well." What's the big thing that keeps you up at night here?

Zack: I don't think there's anything specific, but I think you had on all the right points. I think it's the sustainability of the brands at the end of the day. So I think we have to be tracking those brands and making sure that they continue to be successful and make sure that the KPI's continue to head in the right direction. I think the probability of that is extremely high, but that's definitely something we need to be monitoring. There are certainly brands that the fail to million and so we just have to be making sure that their portfolio brands continues to do really well.

Andrew: I guess the other thing that could kill it is if they did kind of like transformative MNA. There's both on MNA where you go acquire business for 10 or 20 million and they just transformative MNA which is generally about the company or about the equity type story.

Zack: Sure.

Andrew: Obviously, these guys are going to be acquisitive but their acquisitions historically have been more along the Club Pilates line, right? Like buy something with 12 boxes and grow at 750. There are things they could do that are transformative. They could go buy CrossFit or something, but it seems to me the acquisition story's going to be more bolt-on's continued along that Club Pilates model. So, is there a risk they burn 10 million dollars on a bad acquisition? Yes, but I don't think we're talking company altering risk. Please feel free to tell me if I'm misinterpreting that.

Zack: No, I totally agree with you and they've stated that as their clear intention too. They're not going to go out and do anything huge. The chairman is very successful former private Equity. So they're smart financial thinking minds on the board, they're very careful, so we don't expect them to bet on anything.

Andrew: Cool. Hey, we've talked about a ton of stuff here but just wanted to turn it over to you. Anything that we didn't discuss that you think we should be thinking about, or anything we kind of glanced over that you think we should be thinking about harder?

Zack: No, I mean, I think you did a really good job of an overview of the business. I think people should really just focus on, like, it's highly predictable. It takes some time to get an understanding in the business. It definitely is worth the time though because once I studied that I was very confident and its ability to do extremely well in pretty much any environment. I think from a risk-adjusted perspective; you're getting an extremely high IRR. There might be IRRs that could be potentially higher in this environment, but I think this is a pretty low-risk investment, the probability of this outcome I think. A positive outcome is quite high.

Andrew: Look, I think I said it up front but we talked about a bunch of names, and when you said you want to do XBOF, I was like "Oh, fitness". I initially had that thought that at the sell-side led off with which "Oh, the history of Fitness companies in the public markets is really poor" and I thought I was going to get you with my curved thing. But when I was researching this last night, I was just surprised by how bullish I was and how much I was like, "Oh I can see what Zack really sees in the story. One day of research isn't enough for me, but it's a name. I love Fitness. It's a name I'm going to be diving a lot deeper on because I'm with you. 20 times EBITDA or as they said, if we never sign another deal, we've got so many boxes coming online, like we've got so much growth in store. 20 becomes 10 real fast and 10 times is not the right multiple for a franchisor.

Zack: Yes. Yes, I totally agree.

Andrew: Cool. Well, hey, this has been great. Zack Buckley. I'll include a link to your Twitter and the show notes. So if anybody wants to go find you on Twitter and kind of let you know their great experiences or how Rumble had a bad class and the instructor was 15 minutes late one time, they can slide on over to your DMs. Zack, thanks so much for coming on, and looking forward to having you again.

Zack: All right. Thanks so much. Appreciate it.

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