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Life Time Fitness (LTM) Assigned 'B' Corp. Rating by S&P

May 18, 2015 11:00 AM EDT

Standard & Poor's Ratings Services said it assigned its 'B' corporate credit rating to Chanhassen, Minn.-based Life Time Fitness (NYSE: LTM). The outlook is stable.

At the same time, we assigned a 'BB-' issue-level rating to Life Time's proposed $1.35 billion senior secured credit facility (consisting of a $250 million revolving credit facility due 2020 and a $1.1 billion term loan B due 2022) with a recovery rating of '1', indicating our expectation for very high (90%-100%) recovery for lenders in the event of a payment default. We also assigned our 'CCC+ 'issue-level rating to Life Time's proposed $600 million senior unsecured notes due 2023, with a recovery rating of '6', indicating our expectation for negligible recovery (0%-10%) for lenders in the event of a payment default.

Financial sponsors Leonard Green and TPG Capital, along with other investors, are acquiring Life Time for approximately $4.3 billion. The purchase price will be funded with approximately $1.7 billion in new debt issuance, equity contributions, and an anticipated $900 million in proceeds from an expected sale-leaseback transaction of approximately 29 of Life Time's owned clubs, which we expect the company to complete concurrent with the close of the acquisition.

LTF Merger Sub Inc. will be the original borrower of the credit facilities and the notes. Upon completion of the acquisition, Life Time Fitness Inc. will merge with LTF Merger Sub and Life Time Fitness Inc. will be the surviving borrower entity.

"The rating reflects our assessment of Life Time's business risk as 'fair' and our assessment of its financial risk as 'highly leveraged,'" said Standard & Poor's credit analyst Shivani Sood.

Our "fair" business risk assessment on Life Time reflects the competitive operating environment, low barriers to entry, and high member attrition rates that are characteristic of the fitness club industry. We believe these risk factors are largely offset by the company's good market position and unique product offering, which has led to lower annual attrition rates than those of rated peers in spite of the company's use of month-to-month membership agreements. Annual attrition at Life Time has been in the mid-30% area since 2012, compared to the low- to mid-40% area for rated peers. Additionally, we view favorably the comparatively high percent of revenue that Life Time generates from ancillary services, including personal training and children's offerings, as these services contribute to greater member loyalty and usage of facilities over time.

Our "highly leveraged" financial risk assessment reflects our expectation that lease adjusted debt to EBITDA will be in the 6x area and funds from operations (FFO) to debt will be in the high-single digit area through 2016. We also expect EBITDA coverage of interest expense will be good, above the mid-2x area, through 2016, partly offsetting high anticipated leverage. Our base case forecast incorporates new club openings over the projection period and that the EBITDA contribution of new clubs will ramp up over time, although we believe that EBITDA margin may be modestly pressured over the next few years due to these openings. We have also incorporated the higher fixed-cost base from higher rents due to the proposed sale lease-back transaction and future club openings, which we believe could increase operating volatility over the intermediate term. However, we believe that even pro forma for the sale-leaseback transaction, the owned club portfolio (about 45% of total
clubs) gives Life Time better financial flexibility than that of its rated fitness peers.

The stable outlook reflects our expectation that moderate consumer spending growth will support good same-store operating performance, and that good EBITDA growth from newly opened clubs will modestly offset the substantial amount of leverage that this transaction and the sale-leaseback transaction add, such that debt to EBITDA will remain around 6x and EBITDA coverage of interest will remain above the mid-2x area through 2016.

We could lower the rating if EBITDA coverage of interest expense declines to 1.5x or less as a result of operating performance that underperforms our forecast or additional leveraging transactions, including those to maximize shareholder returns.

We would consider a one-notch upgrade if we were confident that operating lease-adjusted debt to EBITDA would remain below 6x and adjusted FFO to debt would be sustained above 12%. A higher rating would also depend on our expectation that Leonard Green and TPG Capital would not engage in any significantly leveraging transactions that would increase leverage above these thresholds.



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