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