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Fitness First flies on takeover hopes

(Update) Fitness First is in talks with a third party that could lead to an offer for the troubled health club operator.

News that Fitness First's 'review of shareholder value' was making progress revived its shares which jumped 14.5p to 148p .

Last November the company revealed it was seeking offers after being approached by several private equity firms following its profits warning in October.

We reported at the time that Simon Ware-Lane, the financier who helped bring the company to market picked up a 5.1% holding, after the warning which more than halved its shares to 99p. The recovered to a high of 161p earlier this month.

Independent directors Walter Goldsmith and John Denning are supervising the talks.

The announcement accompanied full-year results that showed Fitness First has managed to meet the City's reduced expectations for the 12 months to the end of October but has yet to make it out of the woods.

Earnings before tax, goodwill and exceptional charges increased 17% to £24.1 million on turnover up 68% at £224.2 million. Earnings per share nudged up 3% to 13.9 million.

After £2.9 million exceptional charge, which related to the removal of potentially hazardous spa baths from 67 clubs and restructuring costs, and goodwill charges profits before tax came in at £18.5 million, just £400,000 up on last year.

The top line growth at the expansive chain did not come cheap.

Capital expenditure, mainly connected to the opening of 111 new clubs during the year, came in at £135.6 million which compares with 119.6 million last year.

The break-neck pace of growth, which saw the chain grow to 311 by the end of October, caused Fitness First run into trouble last year and planned capital expenditure this year has been reduced to £75 million.

At the start of last October the company was forced to announce that its operational management team had taken their eye off the ball and let costs get out of control while failing to get punters through the door as quickly as they used to.

A £1.2 million exceptional managerial restructuring charge should have dealt with some of the issues but other problems appear to be more endemic.

Fitness First today said it had scaled back the number of UK clubs it planned to open due to increased competitiveness. This has meant new clubs now take about three months longer to reach break even than the three to six month trend the company had got used to. Signs of increased competition is not good news for a company which has over 45% of its clubs in the UK and generates about the same amount of its total turnover from this market.

The company opened 42 new clubs in the UK during the year and has added a further eight since its year end to take the total to 150. Management now plans to focus on the profitability at these clubs rather than new openings.

In continental Europe, the Far East and Australia the signs were more positive, except for problems at the company's eight French clubs. These markets are less mature than the UK and although clubs are generally slower to break even growth prospects look better.

The company plans to open a further 55 clubs this year paid for out of its cash flows and £57 million of unused debt facilities.

The company reported a cash inflow from its operations of £44 million for the year and after capital expenditure and other costs it ended up with an outflow before financing of £106.2 million. Thanks to a fundraising early last year the net increase in Fitness First's borrowings was kept down to £43.9 million which left it with £142.9 million net debt at the year end.

Citywire Verdict:

The best hope for Fitness First's shareholders still appears to be a takeover as it offers the attraction of established overseas operations in a variety of markets to a potential buyer.

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