Citron takes Lifetime Fitness (NYSE:LTM) for a workout
| stock ticker: LTM | ||
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Join the Club – At Your Own Risk
Citron receives email every day from investors asking us what to look for in companies to avoid. It is our opinion that in the current economic climate any company is that highly debt-leveraged with high fixed costs that depends on the US consumer will have big problems. Add into that equation a business model that NO ONE has ever proven successful and we have Lifetime Fitness. (NYSE:LTM).
Even though this stock is badly beaten down this year, we believe the equity will eventually go away as this chain of 77 health clubs will carry a debt load that will weigh on them like a 300 pound barbell and leave investors sweating.
Before we go into the financials, let us look at a few key fundamental points about the health club industry.
1. Health Clubs are the ultimate discretionary purchase. In 2007, as soon as the economy turned soft, gym memberships dropped for the first time in more than a decade. http://www.usatoday.com/money/advertising/adtrack/2008-11-16-gyms-recession-ads_N.htm
2. Lifetime’s strength is also their biggest weakness: their customers are not obligated to long-term contracts but instead pay monthly. As Lifetime’s CFO told the Denver Post, “When somebody looks at that Visa statement and they know that times are tougher, they’re making a decision a little bit quicker to leave the club if they’re not utilizing it,” http://www.examiner.com/a-1694083~Health_clubs_offer_discounts_as_economy_falters.html
3. Operating high-end health clubs is a business model that no public company has proven successful in the best of economic times. How will Lifetime hold up in these recessionary times? Lifetime’s model is also becoming increasingly dependent on “other income” – spa and trainer services, currently 1/3rd of total revenue, which are just as vulnerable to a spending downturn.
Attrition
From LTM’s recent 10-Q:
“During 2008, our attrition rate increased, driven primarily by inactive members leaving earlier than in the past.” The attrition rate of LTM is north of 40% and with industry high membership rates and a declining economy, one does not need tea leaves to guess what the next 12 months will look like.
Real Estate Play
As Lifetime builds out 110,000 sq. ft. mega-clubs at the cost north of $30 mil per club it has become more and more of a leveraged real estate speculation. Until now, they have been able to pay back some debt by executing sale-leasebacks. LTM’s actual piggy bank is its ability to execute sale-leaseback transactions to raise cash. It did this on six units during Q3, raising $107m. In a best case scenario, this raises cash while raising operating expenses. But with the explosion in CMBS rates currently in play, LTM’s ability to continue to execute these sale leasebacks at all is highly questionable and therefore the asset values on the books become suspect. After all, what is the liquid market for a 100,000 square foot health club in a bedroom community in Texas?
Debt
Even with Lifetime’s planned reduction in new centers it plans to open in 2009 (from 11 to 6), the company will require $400 million of new financing to hit these marks. That would take the debt of LTM of close to $1 billion. That is why Citron believes that even with a recent slide in LTM’s stock price, Lifetime’s overall condition is far more fragile than Wall Street currently recognizes.
With over $647 million of long term debt, Lifetime’s debt load amounts to over $8.25 million per health club. Expressed another way, Lifetime’s net debt is $1312 per member. In a time of collapsing discretionary consumer spending and tightening credit, Citron believes this simply unsustainable. If Lifetime holds to its plan of $400 million capex expenditures in 2009, this debt load will rise substantially.
Management
While we give CEO Bahram Akradi credit for building a chain of beautiful health clubs, we question his ability to navigate the company through these difficult times. Already due to margin loans that he could not meet, Mr. Akardi has had forced sales on nearly 2.5 million shares of stock over the past few months alone – approaching half his stake.
Citron also notes recent resignations of board members Sefton(director, audit committee) in October 2008, Halpin (October 2008), and more recently Raymond (November 2008).
Interestingly enough, management has experience in high capex spending.
CFO Michael R. Robinson hails from Next Generation Network, Inc . While he was CFO there, the company “capexed” its way into oblivion before being bought on the cheap by The Anschutz Company.
http://www.accessmylibrary.com/coms2/summary_0286-27341448_ITM
Chief Accounting Office and Controller John M Hugo hails from Completel LLC (Completel Europe NV). He was appointed Controller and Chief Accounting Officer in March 2000. By May 2002, it files for bankruptcy, having also “capexed” its way into Dutch bankruptcy court.
http://www.opticalkeyhole.com/eventtext.asp?ID=25303&pd=5/15/2002&bhcp=1
The interesting thing about these two former companies is that they met their demise in essentially the same way: building out a huge, expensive plant that could never justify the capital investment. Then things fell apart.
Cash is the bottom line
The game of capitalizing expenses and understating depreciation can go on for a long time. But in an environment where commercial credit is collapsing, access to real cash from operations takes on new significance. LTM’s cash flow from operations per member was at the lowest point for the year at the end of the last qtr. Free cash flow per member, after capex, is a solid -$129 per member.
Conclusion
These huge debt-heavy and capex-heavy club operations are the antithesis of the agile, nimble and cash-flow positive companies that will survive a severe downturn in consumer discretionary spending. Bally’s couldn’t do it, and Citron believes Lifetime won’t be able to either. In part 2, Citron will overlay the financials of Bally’s Total Fitness before they went bankrupt with those of Lifetime, and show what we believe the future holds.
Citron believes the company is caught between the pressure to offset declining membership rates with increased marketing, and market forces pressuring the company to regard deferred maintenance as capex.
Citron believes Lifetime’s free cash flow per member is an early warning of cashless paper earnings being buoyed up by unsustainable growth. Inability to perform sale/leaseback transactions on clubs will send it on a downward spiral from which it is unlikely to escape.
Cautious investing to all.
Citron Reports on Republic Bancorp (NASDAQ: RBCAA)
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“A man walks into a store to buy a toaster … and they gave him a bank.” - 2008 Humor
Republic Bancorp (NASDAQ: RBCAA) is a regional bank with operations in Kentucky, Indiana and Florida. What makes Republic interesting in they do not operate like a traditional bank, rather they have built a business on aggressive non-banking lending practices that extend to payday and social security advances to IRS refund anticipation loans. These businesses are combined with its traditional mortgage business concentrated in the Cincinnati/Kentucky region.
In this report Citron will show the signs of a bank that could be in for a double whammy. It is the opinion of Citron that not only is their loan portfolio significantly under-reserved compared to peers, but they also operate lending practices so abusive that there is great risk they will soon become heavily regulated or ended entirely by government intervention.
Republic’s Tax Refund Business
Over the last twelve months, 33% of RBCAA’s net income has come from tax refund operations.
As stated in their own 10-K:
“The TRS (“Tax Refund Solutions”) business segment represents a significant operational risk, and if the Company were unable to properly service the anticipated growth in the business it could materially impact the earnings of the Company”
The lion’s share of this business is generated by refund anticipation loans (“RALs”), which have been decried by the IRS and Congress for their abuse of consumers, including very high fees for very short term loans, and undisclosed consumer risks. Nearly 2/3rds of RAL consumers are Earned Income Tax Credit (EITC) recipients – not a class of customer with a lot of economic clout.
In 2008, the IRS issued a proposed rule that would effectively shut down tax preparers from being involved with RAL’s.
The enthusiasm that the government has to shut down all RAL programs is most clearly expressed in this letter from the US Government Accountability Office.
This would separate RBCAA from tax preparers like its current partner Jackson Hewitt (NYSE: JTX) and cut the company’s earnings by a third. JTX’s shares took an immediate hit since the IRS announcement and are down 62% this year.
By contrast, RBCAA’s shares have increased over 40% this year. It is the opinion of Citron Research that with future regulation of the RAL business and IRS’s large-scale implementation of its new CADE system, (which further streamlines refund issuance) the writing is on the wall for all in the tax refund business.
Republic’s “Currency Connection” Business
In 2006, Republic was chased out of the payday loan business by the FDIC:
http://louisville.bizjournals.com/louisville/stories/2006/02/27/daily30.html
The FDIC did not think the usurious nature of payday loans was appropriate for member banks to be involved in. The agreement with the FDIC expired in the early 2008.
Republic is back with a product called Currency Connection, lurking in the shadow of the regulators’ intent, loading Social Security payments directly to a debit card or a check for those without a bank account or credit history.
Interestingly enough, at the same time Republic is attempting to move away from the FDIC and trying to become regulated by the Office of Thrift Supervision. In a 100 page letter from consumer advocacy groups to the OTS, the nature of Republic’s Currency Connection business is discussed in detail.
It has been suggested that Currency Conversion violates section 207 of the Social Security Act, which prohibits the assignment of benefits to pay debts. If that holds true, than this is another part of Republic’s business that can simply go away. Moreover Citron finds it disturbing that RBCAA does not mention this business in any of their recent filings, creating a complete lack of transparency.
What is most worrisome to Citron Research is the nature of the business. If you are marketing RAL products and benefits advance products to lower income, high risk credit individuals, what does your loan portfolio look like? Does the aggressive nature of the bank’s lending spill over into their accounting? Only time will tell.
Overleveraged and Under Reserved?
Let us first give the notice that Citron Research is not a specialized banking analyst … not that the analysts were all that impressive at predicting the consequences of aggressive lending indulged in by a plethora of banks. This following commentary simply asks the difficult questions about numbers that are obviously outlying competitive norms.
In the following analysis of a comparison of regional banks that operate in the Kentucky/Indiana region we find some startling revelations.
RBCAA appears to be startling 251% over levered vs. its peers. Further troubling is is that the loss allowance for total loans is 51.95% under-reserved vs peers.
And conditions in the region aren’t getting better so fast. Just last month the Federal Home Loan Bank Of Cincinnati, along with Republic, offered $500,000 to establish a program that helps with mortgage counseling and foreclosure mitigation.
Republic’s banking conditions appear to be troubled. Non-performing assets are up over 120% year-over-year while its reserves for loan losses are down substantially as a percentage of non-performing loans (see attached model). It is the opinion of Citron that the reason the reserves have gone down against a higher rate of non performing is to make the numbers look better for the short term.
In the recent earnings release we see that the allowances for loan losses are over 50% lower than other regional banks with almost identical loan books. If RBCAA were to increase its reserves to the average, the company would need to have a $15.4 million write-down of assets. This would cut RBCAA’s net income in half.
Conclusion
It is the opinion of Citron that companies making a business model in abusive consumer practices carry business risks. When you combine that with a bank that might be over-leveraged and under-reserved, investors should take notice.
Cautious investing to all.
Emcore (EMKR)… Nothing plus nothing = nothing
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It has been 6 months since Citron has been covering Emcore (EMKR:NASDAQ). Oil has made its unprecedented round-trip from $100 to $147 a barrel and back. Mainstream solar stocks have achieved record profits — and record valuations — in the anticipation of $200 oil …but Emcore is yet to book a single commercial size order from a verifiable counterparty. Compounding its credibility problems, management was forced to acknowledge that its largest claimed commercial order to date, PR’d with much ballyhoo, was a total write-down – months after Citron had exposed it as a fraud.
In the intervening six months, the company has burned through $20 million more of investor’s money as receivables and inventories have ballooned, leaving in its wake no tangible business accomplishments, only empty promises and even more “shadow customers” for their solar business. It is the opinion of Citron that if current management performance continues down this road, Emcore is on the fast track to becoming a penny stock.
What’s Changed? In our opinion, quite a lot.
- Prices for photovoltaic grade silicon have passed their peak, and consensus is they are headed lower as new supply comes on line to meet demand over the next eighteen months, as wide-scale commercial deployment of solar panel projects continue at a brisk pace.
- Emcore finally admitted that, as reported months ago by Citron, Green & Gold Energy’s huge orders are being written off the backlog, because the customer cannot pay for them.
- Emcore turned another horrendous quarter, losing $11.6m on operations, consistent with its $33.7m loss turned in for 9 months of 2008. The only thing keeping its “EPS miss” down was, ironically, a huge increase in the share count – up more than 50% in the last year alone.
- Analyst Scorecard: Canaccord, which had defended Emcore doggedly for months, admitted that Emcore’s Korea deals are a fantasy, and downgraded it to hold.
- Tobin Smith’s Changewave newsletter endorsed Emcore.
- Over this timespan of unprecedented oil prices, Emcore doesn’t have a single multi-megawatt order from a reputable and verifiable counterparty to show for it – only more “shadow customers”, whose ability to execute or pay can’t be verified.
Before we explain why this has happened to Emcore, let us first take a peek at the cash flow statement.
Follow the Money
The Truth is in the cash flow statement. Cash flow from operations remains consistently very negative. Quarterly free cash flow stands at about negative $12 million per quarter, roughly what it was a year ago in spite of spending $85 million on an acquisition and in spite of enjoying the best of times in the solar business. The accounts receivables portion was the main reason. Without further explanation from management, it appears to Citron as if Emcore continues to sell to fictitious companies (or at least fictitious orders), find a way to book it as revenue, and then reverse it by saying, as they did in this quarter, that the company in question is being sold so we have to cease the orders we have for them.
Unbilled revenues spiked from $6.4 million to $12 million quarter over quarter. That change is equivalent to 30% of the revenue growth quarter over quarter. Did something change with the way they do business or did management get more aggressive on recognizing revenues for some reason? And in spite of dealing with companies that seem to come and go such as Green & Gold Energy, EMKR’s allowance for doubtful accounts has dropped to an all-time low of just 0.7% of accounts receivable.
A report of earnings increase accompanied by unrelenting cash flow from operations losses spells trouble. Investors have to decide between the black and white – and management excuses.
Management vs Investors.
One question commonly posed to Citron is “why would companies ever commit fraud?” As an investor in the market, we are able to buy and sell companies as we see fit. But management doesn’t enjoy such flexibility. It has to wake up every day and face the enormous pressures of trying to make the best of what it previously sowed. Once overly optimistic claims cross the line into untruth and are subsequently exposed as falsehoods, loss of credibility becomes a slippery slope. We’ve seen this pattern over and over.
The Fantasy: Can two losing companies yield one profitable spinoff ?
Emcore still insists it is pursuing the strategy of “spinning off” its solar division into an IPO, somehow creating a profit from turning a dime into two nickels.
The harsh light of reality
The harsh reality is that Emcore’s terrestrial solar business is in deep trouble, having shown no signs of economic viability. In the quarter that may well mark the high point of pricing for oil and polysilicon, Emcore’s terrestrial solar division could book only $12 million in revenue. Emcore has burned $87 million in its solar business in the last six quarters. What’s more, it is Citron’s opinion after scrutinizing all available information about Emcore’s order announcements that at least 80% of Emcore’s current remaining backlog (even after dropping Green & Gold) will never be realized as revenue.
And the fiber division? Cliff diving at its finest.
Emcore has generated $38 million in losses in its fiber division since October 2006, averaging a loss of $5 million per quarter. The division they acquired from Intel was showing year over year revenue declines of 20% and 51% for the December and March quarters, and was unprofitable in June 2008, indicating no reversal of the pattern of declining revenues for the division — even though Intel was still performing the manufacturing and operations. Emcore will have to take over these activities by September 2008. Of course, management insists it will be able to run the operation better than Intel. Its track record, however, leaves little cause for encouragement.
When you back out Intel’s inventories of $31 million from EMKR’s balance sheet, it appears that inventories are at an all time low ($10 million less than last year’s $28 million inventory balance). This seems odd for a company that is about to blow the doors off.
The Blind Cheerleaders
Tobin Smith of Changewave investing recently published a glowing piece on Emcore.
http://www.moneyshow.com/investing/articles.asp?aid=tptp082108-15102
In his recommendations he seems to break the law countless times with a multitude of Reg FD violations.
For those of you who do not know Tobin, he is a newsletter writer with a sizeable following of the lowest common denominator of investors. This is not the first time Citron has encountered Tobin. He has been equally as bullish on three other stocks we profiled.
- The first was Interpharma, (AMEX:IPA) which Citron wrote about when it was $7. Tobin called it a “legacy buy”.
http://www.citronresearch.com/index.php/2003/09/22/
The “ legacy” of IPA is 5c per share.Marketwatch wrote the story of Tobin vs. Citron.
http://www.marketwatch.com/News/Story/Story.aspx?guid=%7BD2D8E0B3-CF81-450F-8AED-96A2E672ADFE%7D&siteid=mktw - Then there was Zeros and Ones (OTCBB:ZROS). In 2007, Tobin recommended this company that he claimed was going to revolutionize file transport speeds on the internet. His subscribers bought the stock up. Citron reported on ZROS :
http://www.citronresearch.com/index.php/2007/03/20/stocklemon-reports-on-zeros-and-ones-otcbbzros/ZROS is now VOYT and the stock now trades at .16 cents.
- American Superconductor (NASDAQ:AMSC) In June and July this year, Citron warned about this company, which Tobin went on to recommended just a few weeks ago at $38, with advice to “get more aggressive” at $35. Just three months later, today you can buy all you want around $21, and you don’t have to get aggressive about it, either.
So now we have our fourth stock to add to the list. Citron is so convinced of the terminal nature of Emcore’s problems that it makes this prediction: Not even Tobin Smith’s ego can save this company from its fate of ending up in penny stock land. Citron Research vs. Tobin Smith is like the Harlem Globetrotters vs The Washington Generals.
Stanford Group
Then Stanford Group published an analyst report more akin to a bulletin board glossy promo mailer than real research. Shockingly, they tabled each of Emcore’s terrestrial solar “orders”, an impressive list unless you apply even a modicum of critical thought. Then you see that the orders fall into 3 categories: unverifiable, proven fraudulent, and nearing completion.
- For example, included are ES Systems of Korea, which has announced projects greater in size than the total world implementation of CPV, yet its website hasn’t changed in six months, and research turns up not a shred of tangible evidence that the company has the capability to execute on any projects whatsoever.
- Then there’s SunPower a purported California investment group with no track record in solar projects, who claimed their project was dependent on tax credit legislation which was not law at the time of the announcement, and has since not become law.
- Then there’s XinAo Group of China, again PR’d as though it was a big deal, but which is in reality a tiny test system of 50KW – estimated order value $17,000 a scant 1/20th of what would be needed for a field-size test.
- And of course, Green & Gold Energy, which has already been written off by management’s own admission.
Of course, missing is any mention of Emcore’s cash burn rate or factoring further dilution into its valuation. Citron believes this is a fine example of analyst malpractice.
The hits just keep on coming.
Conclusion
It is the opinion of Citron Research that the analysts and cheerleaders are ignoring the reality that Emcore is still on a trajectory of running out of cash. Emcore is comprised of two terminally money-losing divisions, which cannot possibly justify a “spinoff IPO”. The PIPE investors in its last round have lost 50% of their money in a few short months. Yet the investment banking firms do what they do best — maneuvering for their next deal. This stock is headed for another dilutive round of financing, and the inevitable negative consequences for investors.
Cautious investing to all.
4C Controls (OTC:FOUR)
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Who gets them first SEC or IRS?
As much as Citron has been attempting to avoid OTC Stocks, occasionally one comes along that is so absurd that we can not help commenting on it. Enter 4C Controls. This $400 million company has spun a tale that leaves us with the daunting question:
What is worse about this company: “The Tale or the Truth” ?
Seeking Healthy Returns in Amedisys? (NASDAQ:AMED)
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Better get a Second Opinion….
Citron Research was first drawn to research Arthrocare because one division was running margins that wildly outperformed all their competitors. After working countless hours with private investigators and reviewing hundreds of documents, we were able to draw a line to what we believe explained the extreme outperformance: fraud on the insurance reimbursement system. Well… here we go again.
(Citron notes that within the last month alone, two companies — ARTC and BWTR both formerly reported by Citron — were forced to restate previous earnings, and their shares were cut in half.)
Citron updates American Superconductor (NASDAQ:AMSC)
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What is a Power Module Company Really Worth?
For the past two months, Citron has maintained its opinion that the business of selling power modules to the wind industry does not classify a company as a “wind play”, but more accurately an industrial commodity. Meanwhile, sell side analysts have ignored all warnings, as well as large insider selling and questionable SEC confidentiality requests cloaking the company’s single largest piece of projected business. Citron will now put forth the one piece of evidence that shareholders cannot afford to ignore. As for the analysts, ignoring things is standard practice.
Citron Research Updates Ener1 (AMEX:HEV)
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