If the BDC Credit Reporter had waited just a few minutes more, we could have incorporated our last news item about 24 Hour Fitness Worldwide closing down a quarter of its locations for ever into the much bigger news of the day: the company’s Chapter 11 filing, just announced on Bloomberg. Obviously this was no surprise to anyone. What we learned today (Monday June 15, 2020) is that the company and its $1.4bn in debt was not able to agree a restructuring plan before filing for protection. We also learned that $250mn in Debtor In Possession financing has been agreed on, as the gym chain seeks to re-open many locations and operate as normally as Covid-19 allows.
We have downgraded the company from CCR 4 to CCR 5, i.e. non performing. Furthermore, the bankruptcy filing removes 24 Hour Fitness from the Weakest Links list now our projection has come true. For the only BDC with exposure – Barings BDC (BBDC) – this officially means no income is being generated on the LIBOR + 350 2025 Term Loan, a loss of under ($0.2mn) per annum. The value of the debt has already been written down by (80%) to under $1mn. For the BDC Credit Reporter, running from pillar to post with many other troubled names, the amounts now involved make this a Non Material investment so expect less coverage in the future.
This is the fifth BDC-financed company to file for bankruptcy protection in June. For BBDC this is a reverse for a loan booked in the IIIQ 2018 that must have seemed very “safe” given the pricing at the time. However, contrary to what management says, the troubles at 24 Hour Fitness predated Covid-19 . Over-building in the gym space; technological changes (“Peloton”) and the drag of high leverage had already caused BBDC to write down the debt by (25%) in the IVQ 2019. As a result, 24 Hour Fitness falls into our “first wave” of credit defaults – already weakened businesses given a knock out punch by the impact of the virus. Unfortunately that’s a reminder that we’re still at the beginning of a potential three waves of bankruptcies. Many more companies seem to be headed this way.
According to news reports, 24 Hour Fitness Worldwide is planning on closing a quarter of its locations permanently. This is likely related to bankruptcy plans underway. Prior to the closures – according to Marketwatch – 24 Hour Fitness had more than 400 gyms in 14 states, with around 22,000 employees. For our prior articles on the company, click here.
Add 24 Hour Fitness Worldwide, the well known gym, to the list of companies considering a bankruptcy filing. That’s the familiar “people familiar with the matter” are divulging. Moreover, Moody’s has downgraded the company and its debt ratings; the gyms are still closed and 24 Hour Fitness has only $1mn in cash. Frankly, Chapter 11 seems inevitable. In fact, looking back to our initial post on the company’s troubles in November 2019, we were projecting Chapter 11 back then, way before Covid-19 came along. The company is on our “Weakest Links” list.
For Barings BDC (BBDC) – the only BDC with exposure – the likely loss will be 70 cents or more on the dollar on the $4.7mn invested at cost in the company back in IIIQ 2018, or ($3.3mn). At that time, 24 Hour Fitness seemed a safe bet, as reflected in pricing of LIBOR + 350bps, and for which BBDC paid a premium.
We wouldn’t be surprised if the company actually pulls the trigger this week as there does not seem to be any support coming from either the government, its lenders or moneyed sponsor AEA Investors, whose slogan is “Relationships Matter”. Until they don’t.
The Wall Street Journal reported on March 24, 2020 that 24 Hour Fitness Worldwide closed all its locations due to Covid-19; drew down its Revolver for liquidity; withdrew earnings guidance and saw its 2022 bonds trade at 32 cents on the dollar.
All that’s bad news for the only BDC lender to the fitness chain: Barings BDC (BBDC). The BDC is a senior secured lender in a 2025 Term loan that was discounted (25%) at year-end 2019. At that point, the BDC Credit Reporter downgraded the company from performing (CCR 2) to Worry List (CCR 4). The latest news confirms our concerns that recovery of capital in full looks unlikely. That’s especially the case as 24 Hour Fitness was lagging even before the most recent crisis, and the 2025 Term loan is valued at only 33 cents on the dollar.
The saving grace for BBDC – in what was supposed to be a very safe loan (priced at LIBOR + 350 bps) – is its decision to lighten its exposure recently to just $4.7mn at cost from more than twice as much as of IIIQ 2019. If this loan defaults – and we expect that to happen – the income involved is only $0.200mn a year and the likely realized loss at 50% is ($2.4mn).
On November 12, 2019, Moody’s downgraded 24 Hour Fitness Worldwide,Inc. to a corporate family rating of Caa1 from B2. There were a series of downgrades as well of individual debt tranches on the company’s balance sheet, from secured to unsecured debt and involving $1.5bn of debt securities. We won’t get into too much detail about the reasons for the downgrade, which relate to business under-performance. This sentence from the Moody’s report speaks volumes by itself: “The Caa1 CFR reflects Moody’s forecasts that 24 Hour Fitness’ EBITDA will decline further resulting in funded debt/EBITDA (excluding operating leases) peaking at 8.2x while EBITA/interest expense (excluding operating leases) will erode to 0.3x“.
That adds a new company to the BDC Credit Reporter’s list of under-performing companies. However, exposure is thankfully limited to one BDC – Barings BDC (BBDC) with a $9.5mn at cost in the company’s 2025 debt. That was booked in the IIIQ 2018 before these current weaknesses became apparent (BBDC may have paid a premium for a loan that pays LIBOR + 350 bps) and was still valued at only a (4%) discount to cost as of September 2019.
This same debt appears to be currently trading – after the downgrade and after an unproductive investor meeting – at a substantial discount. We have rated 24 Hour Fitness right off the bat CCR 4 (Worry List) from CCR 2 (Performing). To be direct, given the level of debt versus EBITDA and the nature of the business, which is unlikely to see a surge in growth at this stage in its development, we expect to see a Chapter 11 or major restructuring occur. The company has no immediate liquidity pressure and no debt due till 2022, so there is unlikely to be a sudden rush to the courthouse steps. On the other hand, an operational improvement sufficient to change the outlook is highly unlikely. We imagine that we’ll be revistting this subject in the months ahead.