TEXT-S&P revises Equinox Holdings 'B' rating

Thu Nov 8, 2012 11:15am EST

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Overview
     -- U.S.-based fitness club operator Equinox Holdings Inc. plans to issue 
a new senior secured credit facility, consisting of a $100 million revolver, a 
$500 million first-lien term loan, and a $200 million second-lien term loan.
     -- We are revising our 'B' rating outlook to positive. We are assigning 
the proposed revolver and first-lien term loan our 'B' issue-level rating with 
a recovery rating of '3', and assigning the proposed second-lien term loan our 
'CCC+' issue-level rating with a recovery rating of '6'.
     -- The positive outlook reflects our expectation for an improvement in 
credit measures over the intermediate term.
 
Rating Action
On Nov. 8, 2012, Standard & Poor's Ratings Services revised the 'B' rating 
outlook on New York, N.Y.-based Equinox Holdings Inc. to positive from stable. 
The rating is affirmed.

At the same time, we assigned the company's proposed $100 million revolver due 
2017 and the proposed $500 million first-lien term loan due 2019 our 'B' 
issue-level rating, with a recovery rating of '3', indicating our expectation 
for meaningful (50% to 70%) recovery for lenders in the event of a payment 
default.

We also assigned Equinox's proposed $200 million second-lien term loan due 
2020 our 'CCC+' issue-level rating, with a recovery rating of '6', indicating 
our expectation for negligible (0% to 10%) recovery for lenders in the event 
of a payment default. Equinox expects to use the proceeds to refinance it 
existing senior notes and highly accretive pay-in-kind (PIK) notes at the 
holding company level.

Rationale
The rating outlook revision to positive reflects our expectation that Equinox 
may drive an improvement in operating lease-adjusted debt to EBITDA to about 
6x by 2014, which would be in line with a one-notch higher rating. We expect 
credit measure improvement from a combination of significant EBITDA growth 
over the next two years and the elimination of highly accretive PIK debt at 
the holding company level (which we historically included in our measure of 
Equinox's consolidated debt leverage). We believe Equinox can achieve solid 
EBITDA growth through new memberships and increases in ancillary services at 
existing clubs and anticipated club openings that are a part of the company's 
ongoing aggressive club expansion plan. While we believe the investments 
required to open new clubs will likely weigh on consolidated EBITDA margin 
until new clubs have built their membership bases to a threshold sufficient to 
absorb operating costs (which typically takes approximately 12 months at 
Equinox), we believe recently opened clubs will continue to ramp to full 
capacity and result in increased EBITDA. Furthermore, even though the 
company's club expansion plan will result in higher operating lease debt over 
the next few years (and higher overall adjusted debt levels), the elimination 
of highly accretive PIK notes following the proposed refinancing transaction 
will support leverage reduction and an increase in total lease-adjusted 
interest coverage over time. 

Our 'B' corporate credit rating reflects our assessment of Equinox's financial 
risk profile as "highly leveraged" and our assessment of the company's 
business risk profile as "weak," according to our criteria.

While we expect operating lease-adjusted debt to improve from 7.5x (as of June 
2012) over the intermediate term, our assessment of Equinox's financial risk 
profile remains "highly leveraged." This reflects our expectation for 
operating lease-adjusted leverage to be above 6x through 2013 and to improve 
to about 6x in 2014. Partly offsetting high leverage is our belief that 
adjusted interest coverage will improve to about 2x in 2013 and 2014 from 1.4x 
at June 2012. These measures fully consolidate the company's controlling stake 
in SoulCycle Holdings, LLC and Blink Holdings, Inc. Although Blink Holdings, 
Inc. will be an unrestricted subsidiary and its assets will be excluded from 
the collateral package supporting the proposed credit facilities, we believe 
Blink is likely to remain a strategic investment for Equinox over the next few 
years. 

Our assessment of Equinox's business risk profile as "weak" reflects the 
competitive nature of the fitness club operating environment as well as high 
levels of customer attrition inherent in the industry. We believe these 
factors are partially tempered by Equinox's relatively high portion of revenue 
derived from ancillary services, which we believe benefits EBITDA margin and 
creates a more loyal customer base, as well as Equinox's strong brand image.

In 2012, we expect revenue to increase 20% and EBITDA to grow by about 40% 
(adjusted for stock-based compensation and one-time charges) as a result of 
growth in memberships and ancillary services at existing clubs and at new and 
acquired clubs that are ramping to full capacity. Revenue and EBITDA grew in 
the high 20% and high 30% area, respectively, in the first half of 2012. 
EBITDA growth in the first half was driven in part by the October 2011 
acquisition of four clubs from The Sports Club Co. Inc. and comparable club 
revenue growth. Revenue growth in 2012 is anticipated to be greater than 
growth in compensation, and selling, general, and administrative expenses, due 
in part to the operation of incremental clubs in 2012.

Our ratings currently incorporate our expectation for low- to mid-teens 
percent growth in revenue and EBITDA in 2013 from continued club expansion 
that results in member dues and ancillary services growth. This is supported 
by our economists' forecast for continued modest growth in consumer spending 
of about 2% in 2013 and 2014 and a continued modest anticipated improvement in 
unemployment over this time frame. We believe modestly improving economic 
conditions may support demand for both memberships and ancillary products and 
services, which should drive comparable club growth. We believe EBITDA margin 
will decline modestly in 2013 and 2014 given incremental rent and occupancy 
expense related to new clubs, as well as our expectation that selling, 
general, and administrative expenses will increase modestly given the increase 
in club count. 

Equinox is an operator of full-service, upscale fitness clubs in nine 
metropolitan areas. The company also operates two yoga studios under the Pure 
Yoga brand, and as of June 30, 2012, five lower cost fitness clubs under the 
Blink brand. The company also owns the majority interest of SoulCycle Holdings 
LLC, which operates indoor cycling studios. As of June 30, 2012, excluding 
SoulCycle locations, Equinox had 58 Equinox clubs and five Blink gyms, 34 of 
which were in the New York metropolitan area.

Liquidity
Based on the company's likely sources and uses of cash over the next 12 to 18 
months and incorporating our performance expectations, Equinox has an 
"adequate" liquidity profile, according to our criteria. Our assessment of 
Equinox's liquidity profile incorporates the following expectations and 
assumptions:
     -- We expect the company's sources of liquidity to exceed uses by more 
than 1.2x.
     -- We expect sources would exceed uses even if our forecasted EBITDA 
declines by 15%.
 
As of June 30, 2012, Equinox had meaningful excess cash on hand, and full 
availability under its $45 million revolver, which is being replaced by the 
proposed $100 million revolver. The company generated cash balances from 
proceeds from debt and equity issuance in 2011, in addition to internally 
generated cash. We expect Equinox will rely partly on cash balances over the 
next several quarters to fund increased levels of capital expenditures related 
to club growth. We believe amortization of $5 million per year under the 
proposed first-lien term loan will be manageable, and any remaining available 
cash flow will be used for modest debt reduction given an excess cash flow 
sweep provision expected under the proposed first-lien term loan. 

The proposed revolver is expected to have a net leverage ratio covenant that 
will be tested only if at least 20% of the revolver is utilized. The first- 
and second-lien term loans are not expected to have financial maintenance 
covenants.

Recovery analysis
For the full recovery analysis, please see the recovery report on Equinox, to 
be published as soon as possible on RatingsDirect.

Outlook
The positive rating outlook reflects our expectation that continued EBITDA 
growth may drive an improvement in credit measures that we believe could 
support a one-notch higher rating over the intermediate term. We will consider 
higher ratings if we are confident operating lease-adjusted debt to EBITDA 
will improve to about 6x by 2014, and we believe management will size future 
expansion plans in a leverage neutral manner.

We could consider an outlook revision to stable if EBITDA growth is 
meaningfully less than we currently anticipate, resulting in an expectation 
that adjusted leverage would be sustained above 6x over the long term, or if 
adjusted interest coverage weakens to the mid-1x area.

Related Criteria And Research
     -- Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings, Oct. 
1, 2012
     -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
     -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
     -- Use Of CreditWatch And Outlooks, Sept. 14, 2009
     -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
     -- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008
     -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
 
Ratings List
Ratings Affirmed; Outlook Revision
                                             To                 From
Equinox Holdings Inc.
 Corporate Credit Rating                     B/Positive/--      B/Stable/--

New Rating

Equinox Holdings Inc.
 Senior Secured
  $100M revolver bank loan due 2017          B                  
   Recovery Rating                           3                  
  $500M fltg rate first-lien loan due 2019   B                  
   Recovery Rating                           3                  
  $200M second-lien loan due 2020            CCC+               
   Recovery Rating                           6                  

Complete ratings information is available to subscribers of RatingsDirect on 
the Global Credit Portal at www.globalcreditportal.com. All ratings affected 
by this rating action can be found on Standard & Poor's public Web site at 
www.standardandpoors.com. Use the Ratings search box located in the left 
column.
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