LIFTS Episode 129 - Wall Street's Fitness Investment Playbook: What Builds Value & What Kills Deals | with Aarti Kapoor

0:00One thing I think that people don't fully understand is you could still retain consumers who love your brand, but if they are coming with, you know, much lower frequency, that can have such a massive impact on your top line and overall business model. So, you know, if SoulSate will goers and you could, you know, fill the blank with any brand name, we're going, you know, three to four times a week for, you know, a lot of their valuable customers. and now they're going one time elite. I mean, that matters enormously in a pay-per-class model where you don't have that locked-in membership revenue.

0:36And this is a business that needs volume to drive operating leverage and make the unit economics.

0:46Matthew Januszek:Okay, we're live. Welcome to this week's episode of LIPS. I'm Matthew Januszek, and I've been reading, rereading a book again called The 80-20 Principle by a guy called Richard Koch. and I interviewed him many, many years ago. So I'm curious to see whether the book has any relevance to our conversation today. So I'm here with my co-host, Mohamed Iqbal Mo. How are you doing this morning? I'm doing good. I'm back in the home studio. I just got back from a couple days in Minnesota, which was always interesting. I have not been back to Minnesota in a few years. But for a lot of people that might not know, it's the home for some of the largest brands in the industry.

1:26So it's the home of Lyft brands.

1:30Matthew Januszek:Escape as well, you know, now. Escape to Minnesota too. I thought Escape was in Wisconsin. Well, Wisconsin. Well, actually, all right. Yeah. Now you're testing my geography. I fly into Minnesota and then I drive for about half an hour to Wisconsin. Yeah. So there you go. Let's just say you're close enough to Minnesota. A neighbor of some of the brands. Very much so a neighbor. But you've got Lyft brands on Snap Fitness, Lifetime Fitness, which is in Channing Hassan, and then Purpose Brands that owns Anytime in Orange Theory. So being able to go to all of them and see all of them in one week just felt like incredibly productive.

2:04It was really good. Before we bring in our guest today, I want to set this one up because I think the timing of what we're about to talk about is honestly too perfect, and it's a little bit personal too. We'll be talking about a few topics, but one of that is going to be around SoulCycle. This week, SoulCycle's CEO, Evelyn Webster, left after almost six years. She's not even staying in fitness. She's moving into a podcast company, of all things. But it's a highly rated podcast, and she has a media background, so it's just a perfect fit for her. But in addition to that, a couple of days, maybe the next day after she stepped down, they also announced the closing of, as far as I know, about eight studios.

2:46Even though the number is not really public, it could be highest 10. And in fact, today I saw that a studio in the UK, Notting Hill, shut down. And these are studios that I have actually ridden in. And for full disclosure, I mean, I think a lot of people who are listeners know that I was an avid SoulCycle rider. In fact, I've logged over a thousand rides. When I'm even out in the Hamptons or in the city, I used to kind of plan my mornings, sometimes which is kind of odd, around my favorite instructor or around rides. But it was even deeper than that because not only was I a rider, but I also had a very close working relationship with SoulCycle, working with their booking platform, the digital experience, and even the ill-fated Soul at-home bike.

3:31And I know we've talked about that a lot on the podcast as well. So when I talk about the brand, I'm not just delivering the news or reading the headlines, but I've actually had an inside view of it. And here's the thing. I think the investors saw it too. Equinox took a majority stake in SoulCycle around 2015. SoulCycle had even had plans to potentially go public. There was talk about they were going public, they were not going public, and then they were going public again. They got pulled out, but the IPO never happened. Equinox ended up buying the founders outright around 2016. And I think for the founders, they walked away with an incredible outcome.

4:10And the brand that left behind had around 100 studios. I think 99 was the most that they've ever had. Today, they sit around 57. And while that allure of SoulCycle is gone, I really think that it helped define boutique fitness. In a lot of ways, it created the category. A lot of the things that SoulCycle did, we see today in boutique brands, I could see remnants of it coming through and seeping through almost any boutique experience I go through. They defined the category. They were the trailblazers. And I think that, to me, the impact of SoulCycle is so much greater than the brand, and we can talk a bit more to that.

4:49In addition to that, over the last 12 months, we'll be talking about certain movements that happen in fitness. We'll be touching on brands like EOS Fitness, brands like Crunch Fitness, even 24 Hour Fitness, which recently was reacquired by our mutual friend Mark Mastrov. of. So how does this all happen? How does a brand that had such big cultural significance go on a decline? How do newer HVLP brands that really weren't the darlings 15, 20 years ago, now seeing all the investment money coming in? So there's some really interesting topics here. Look, I've been building in this industry since 2012.

5:30I was inside a lot of these brands. But today, I want to flip that lens with our guest today. We're going to be looking at it from the investor side. We spend a lot of time on this show talking to founders, operators, and innovators, but today we're going to be looking at it from the eyes of someone who's been in the room with some of the most significant transactions the industry has seen. Our guest today is a good friend, R.T. Kapoor, who is now the managing director at Cascadia Capital, where she leads the firm's multi-unit consumer services practice with fitness and wellness right at the core of it.

6:05She spent nearly a decade earlier in the industry where she launched the first health and wellness-focused investment banking practice on Wall Street with Moles and Company. I might not be saying that right, so RT, you could correct me on that. And that's where she did some of her earliest work and some landmark deals, including the sale of Flywheel, SoulCycle's biggest rival at the time, and the sale of Barry's Bootcamp. From there, she moved on to Goldman Sachs, where she worked on some larger deals and scale transactions, including the Exponential Fitness IPO and the F45 Trading IPO, plus some early work with Lifetime Fitness as well, before it returned to the public markets.

6:48She then crossed over to the investment side, spending four years at VMG, doing growth equity and backing middle market consumer companies where health and wellness were at the front and center. So she's seen both ends of it. She is now back on the banking side, and we are excited to have her on. Archie, we've been talking about this for a while now. I'm really excited to have you to list. But before we dig in, I'm curious, you are an avid fitness enthusiast, and you're also working in the categories on the banking side. How did you work on that niche? Did you have to go and push to say, look, I really want to focus on fitness and wellness because it's a passion of mine?

7:29Or did it just come to you naturally? Yeah, all great questions and great, great commentary. I'm super excited for today's conversation. So thank you for having me here. You know, it was back in 2012 when I saw my habits changing as a consumer and my foray into covering fitness professionally really just happened very organically. I, like many others, had a gym membership, decided to try out this thing called group fitness that didn't even have a label of boutique fitness at the time. Became completely addicted, saw my spending habits change, and kind of used that as a proxy for, hey, maybe something is happening that is broader than just me, and maybe this could be a business opportunity.

8:12I coincidentally went on 21st Street between 5th and 6th, next to the first Y-Will studio. So I remember falling out of my chair, seeing what they were charging for class because it was a lot more than I could afford at the time. And I decided to try it out anyway and then ended up completely reshuffling my spending habits. And I'd go back into the studio again and again. And it's ironic because I'm still in Habit Souls like we're now and I know they're direct competitors, but I'd go back and see the same folks showing up. And I kind of had an aha moment, one of those light bulb moments in the studio one day where I looked around, saw every bike full and did the math in my head in the middle of a class about what internet economics must look like and ran into work that day, told everyone we need to cover flywheel and fairies and this group fitness phenomenon.

9:03This is going to be the future of fitness. And I was frankly, politely told that I was a little crazy and people had no idea what I was talking about. and it wasn't a big enough industry and I should just sit tight and do my day job. I luckily had one person who, you know, was ready to think ahead and had an open mind. My mentor is now one of my best friends in the world, Roger Hoyt. He said, OK, let's go see what you could do. Don't drop the ball on your court job, but let's see what's out there. And he supported me in exploring the opportunities. And then working with Jay and Ruth and, you know, the team of Flywheel, That was my first M &A deal in the States.

9:41And it was amazing when I actually started to knock on doors and say, hey, guys, I see what you're doing. I think there's a huge growth opportunity here, but it is a capital intensive business. You need money to grow your business. Let's talk. You know, how many people wanted to talk? And so, you know, one door opened another and another. And being an early mover is definitely helpful. So I built a nice business that I, you know, still very passionate about today.

10:09Matthew Januszek:Mo's explained or given a nice explanation of some of the things that significantly change in the business. And as we've continued with this podcast, there's been quite a few surprises really that come over time. And as an investor or someone that is responsible for making relatively large bets on business, as I get to understand it, there's a lot of changes. There's market conditions as the brand expands. There's things like locations. There's founders. There's relationships that the founders have with other people or key people in the team, both within their business and also on the investor side.

10:52Matthew Januszek:So with all of that variability and making decisions not just for today, but things that are likely to be multi-year decisions and bets, what would you say are, let's say, the top three things that give you genuine confidence to back a business? and has that changed over let's say the last decade where the world seems to be a lot more in unstable than probably what it has been earlier in my business career yeah it's a great question it's a big question it's one that we're talking to founders and operators and shareholders about on a regular basis um i'd say you know if i were to distill it down to three main buckets i would say you know investors are underwriting to three things simultaneously.

11:43It's brand equity, it's unit economics, and then it's growth runway. And, you know, a business needs to demonstrate strength across all of those to be institutionally transactable. I think on brand, you know, this may appear qualitative, but there are plenty of ways to actually measure it. Folks look at consumer loyalty, net promoter score, repeat visit rate, retention curves. Those are the key proxies. And investors obviously want to see a brand that has staying power, you know, longevity with consumers is differentiated in what has become a very crowded landscape. And so there are a number of different ways to quantify the strength of a brand.

12:24The second piece is probably the biggest bucket, you know, because there are a lot of great brands out there, but it really comes down to unit economics. You know, AUV, which is average unit volume, that matters up to a point. I need to ensure that there are enough dollars to work when to make a business work. But at the end of the day, it's, you know, your four wall margin, your cash on cash return, and your payback period, which is essentially all a proxy for, you know, does it make sense to invest in building out new units? And people want to see that, you know, that story, you know, economic story is portable, and it's replicable.

12:59And that, you know, the portability is really one of the most scrutinized attributes, because think about how many concepts have worked well in a home market. But there's that big question of, you If I test this elsewhere, is it going to work? And many investors don't want to make that bet until they've seen the data points to support that it works in at least two or three markets. And there's consistency. And then extra bonus points if you can prove out urban and suburban because that just really broadens what your total addressable market could look like. And then growth, ultimately everyone's in it for work, right?

13:31That's how you make your money. So in the same store sales trajectory, you want to make sure that your existing units can continue to grow long term and you have, you know, levers that you can pull. But then obviously a lot of it is about new unit expansion, especially when you invest at the growth stage. And so that's why unit economics and the portability matter to say, can I keep building this out? You know, a lot of the businesses that have transacted recently in the gym category have checked the box on this. But revenue composition is important and referring revenue and adding that line in sight, you know, membership and visibility into what's coming in every month or year.

14:11That's another big piece. So I would say, you know, it comes out of brand economics and growth. If I really had to to bucket it in three things, of course, the list is extremely long when you go into an investment committee meeting. Those are the main tenets that folks are looking at. And then, you know, you asked, have things changed? I mean, absolutely. You know, the environment when I started covering this business, it was well before COVID in 2012, 13, 14. I think the flywheel deal was in 14 and berries in 15, you know, the first time they took capital. you know, boutique fitness obviously had a very different relationship, you know, that, you know, consumers had, had with, you know, fitness and because it was on the up and up and so early in the curve, people were willing to pay a lot more for a lot of those assets.

15:04I think execution in terms of growth ended up becoming a little more complex than some anticipated. And then the big thing was obviously COVID reset the environment in many ways and obviously gave consumers a chance to revisit their habits and diversify how they spent their time and their money. And it made everyone a little bit more cautious about potential disruptions to consumer behaviors and stickiness. And so I'd say, you know, scale matters more than it did before COVID. I think pre-COVID investors take a swing on a high quality boutique fitness concept with fewer proof points. I think membership recovery curves have become a lot more of a central diligence focus.

15:47Today, investors want to see membership that is not just recovered to pre-COVID levels, but grown well beyond it now. A little bit more diligence on real estate and lease liabilities than outs. And then, of course, and we'll talk about this when we chat more about SoulCycle, but just getting ahead of how consumer behaviors may change and making sure that there's confidence and longevity and that flexibility over time as consumers evolve, both in terms of their preferences and needs. Yeah, Artie, I didn't know that early story with you in 2012 and how you had to take the class and then go make the case with your manager.

16:30It was very similar to me. I founded Spartworks in 2012, and I literally had to go to Mountain to find Joe DeSena on Spartan Race to pitch my idea. I had to go find Harvey at a cocktail hour and talk about what I think, what I could do at Equinox. And I literally rode in the West Village to see Julie and Elizabeth at SoulCycle. So that's kind of, I think, from an entrepreneur perspective, and you certainly are as well, but you really have to go meet the decision makers where they are. And you don't stop and you don't take no, and it's never easy. But I did not know that about you. And it's interesting.

17:05We should chat more about that offline. but we were doing some of the same things at the same time. I'd love to compare notes. There's a lot that you talked about, and we've covered a lot of these things individually from an, I think, operation standpoint. Things like being smart about how and where you lease and long-term lease agreements. Things like recovery of the membership and of the consumer. What does that recovery curve look like? The fact that the consumer has changed post-pandemic, Like in a lot of ways, their behavior we knew was trending in that direction, but it was really pulled forward and that evolution accelerated.

17:42We talked about the change in boutique, and I want to – let's go to SoulCycle now. Obviously, SoulCycle, as we talked about in the beginning, defined the category in a lot of ways, created the category as well. It was iconic. I would run on the West Side Highway and see SoulCycle shirts for almost a decade. A lot of people were out there doing that. They, you know, created apparel as a component in fitness where I think before SoulCycle, it really wasn't a big driver. But here you are, you know, SoulCycle really being iconic and creating that brand. How much has boutique fitness changed since SoulCycle?

18:19And then maybe speak a bit about the mid-market and HVLP and how they've influenced the entire industry as well. so lots to unpack there and i think you know just starting off with soul cycle this one is also deeply personal to me i've been a writer for almost 15 years um i still go every saturday i think anyone who who knows me or has spent more than three minutes with me knows about my undying love for anthony winters and this you know taylor slipped classes on that free side um you know there there's still incredible pockets of community and i still have a ton of respect for the brand And when I think about this topic, I really look at it holistically as a professional and as a consumer.

19:01While SoulCycle has obviously hit some bumps in the road, I don't think it's at all a prophecy for boutique fitness no longer having a place in the overall fitness landscape. I think, you know, in this case in particular, it was just a perfect storm of compounding factors. You know, we've talked many times about the cultural shifts away from all cardio sweat culture, the consumer education around functional training and reformer workouts and strength. And, you know, as you know, I'm a Form 50 loyalist and, you know, how challenging and effective that workout is now firsthand. But, you know, we also talked about COVID and how, you know, COVID really reset habits.

19:46And one thing I think that people don't fully understand is you could still retain consumers who love your brand, but if they are coming with, you know, much lower frequency, that can have such a massive impact on your top line and overall business model. So, you know, if SoulSate will goers and you could, you know, fill the blank with any brand name, we're going, you know, three to four times a week for, you know, a lot of their valuable customers. and now they're going one time elite. I mean, that matters enormously in a pay per class model where you don't have that locked in membership revenue.

20:22And this is a business that needs volume to drive operating leverage and make the unit economics work. So I do think, you know, in SoulCycle's case, it's a perfect storm of, you know, cultural shifts, COVID resetting habits. And then, you know, this one's discussed a little bit less, but passage of time, you know, the riders who make SoulCycle what it was at its peak are nearly a decade older now. And so their bodies and priorities and their workout needs have evolved. And that's not a criticism. It's just reality. It's, you know, facts. So do I believe in the importance of the brand? Absolutely.

20:58I'm still a huge fan. The longevity of indoor cycling. Yes, there will always be a place for it. Boutique fitness overall, of course. It's just that consumer behaviors and preferences are a cyclical one. You know, soul cycle is in a tough part of that cycle right now. Oh gosh, that one was not intended, but certainly fits. So yeah, look, with SoulCycle, I think it was a perfect storm of those compounding factors, but I don't believe it's a proxy for boutique fitness not having a major future in this industry. I still believe in the Soul brand, longevity of indoor cycling, and most importantly, continued demand for group fitness, the communities that come with group fitness.

21:40It's just that consumer behaviors are cyclical and preferences change over time. We've seen so many different waves throughout so many consumer industries. And, you know, Seoul is just in a tough part of that cycle right now. Mo, you mentioned HVLP and the importance of HVLP and just all the, you know, mind share, dollars, attention that's been flowing in that direction. um hfp is you know unambiguously the most active segment for institutional capital right now you've seen recent deal activity that's been pretty high profile obviously leonard green and crunch tsg and eos um princeton and amp fitness obviously a smaller deal but um you know fairly recent earlier this year and the structural reasons are you know it's the largest ham in all of fitness total addressable market um we all know the stats around you know only 25 percent of American adults having gym membership.

22:35So there's just so many consumers that are available for conversion. People love the macro resilience, whether it's 10 bucks a month, 20 bucks a month, even 30, obviously, there've been multiple waves within HVLP, which we can talk about. And those price points still can hold through a downturn. There's been a lot of talk about the K-shaped economy and the impact on consumers with less discretionary income. And obviously, it's a pyramid. And so investors want to make sure there's not too much macro exposure. And then unit economics, of course, are great. And we talked about the importance of that.

23:12It's the crux of any business model. And I believe, obviously, Planet has done incredibly well, despite some pauses in that trajectory. And Crunch has done incredibly well, but there's still room for more. And there's still a lot of optimization that can also happen within those systems. And you've seen a lot of active deal flow at that franchisee level. So HLB is very attractive, size of market, long-term prospects, but I still think there's room for deals in boutique. And then we've obviously seen in the public markets how well Lifetime has done at that super premium price point for health clubs as well.

23:48And mid-tier, I know for many years now, mid-tier has been structurally challenged, losing share to players that have been specializing on both ends of the barbell. But I'll take a little bit of a contrarian view here and say that I think the lines are starting to blur. We had HVLP 1.0, then 2.0, then 3.0. And now these value players continue to add amenities and programming and they're increasing their pricing and offering new premium tiers as a result. And with enough of that, then you're not too far off from that mid-tier pricing model. So there may be opportunity there as well. And we've seen some deals get done.

24:27And, you know, what's bucketed as a traditional mid-tier, you know, with, you know, 26 North and One Life and, you know, Garden State and Garnet Station and Mountainside. I think, you know, undifferentiated metal, the concepts that are not cheap enough to win on price and not premium enough to win on experience, I still think those will be highly challenged. But there have been some operators who've, you know, cracked the code and been able to find the right balance there. And I say, you know, One Life and Mountainside fall into this ladder bucket. And that's why they were able to garner great institutional capital.

25:02Matthew Januszek:Getting investment from some of the big names like yourself clearly is going to have some impact on the brand names that the consumers and the industry people get to recognize. You've mentioned a couple there in the HVLP and in the boutique market. And depending on the moment in time you study them, again, as an outsider, without seeing the numbers like you do, you can see some of these as success stories or some of them as potential failures. If we look at the investment community, which is the world you're in, I did a bit of just research on Google, and it says somewhere between 20 % and 30 % of private equity investments don't deliver the returns that they were expected.