Dessauer: Working out with Bally

11/15/2002 12:00 am EST

Focus:

John Dessauer

President, John Dessauer Investments, Inc.

Trading at just 3.4 times estimated 2002 earnings, John Dessauer, editor of Investor's World, considers the valuation at Bally Total Fitness to be "ridiculous." For investors looking to "pump up" their portfolios, he considers the operator of over 400 fitness centers a buy.

"In October, Bally Total Fitness (BFT NYSE) said that earnings would not meet expectations for the third and fourth quarters, and so the stock collapsed. From the stock’s action, you would think that the company was losing money and on the brink of bankruptcy. Neither is close to the truth. Bally is profitable. Earnings are expected to be between $0.35 and $0.45 a share for both the third and fourth quarters, but that is below the $0.51 and $0.54 that was once expected.

"The news came as a shock. Even though Wall Street doesn’t like nasty surprises, the stock’s reaction is out of line. Earnings for this year are now estimated at $1.85 a share, rising to $2.30 in 2003. Just prior to the October earnings announcement, a Wall Street firm downgraded Bally, with a revised 2002 earnings estimate of $2.08 and a price target of $7. I have been in the investment business a long time, but never have I seen such a ridiculous set of numbers. The stock is currently trading at a p/e of 3.4 earnings for 2002.

"In response to the stock decline, management held a conference call. CEO Lee Hillman sounded frustrated, to say the least. In August, he talked about changes designed to satisfy investors. He said the company was cutting back on expansion and capital spending in order to raise cash and reduce debt. As previously promised, Bally has begun to sell its receivables. The first sale was for $24 million. More such sales will follow.

"Hillman also said Bally would be free cash flow positive in 2003, not counting cash from receivables transactions. Their debt is all long-term, and the company is not even close to violating any loan covenants. The CFO also said that there has not been any deterioration in receivables. In other words, cash flows remain strong. Bally has $700 million in long-term debt, which is 55% of capital. In this atmosphere, that raises a presumption of high risk. The antidote will be the news that the process of selling receivables has begun.

"What is Bally worth? The average p/e was 10.7 in 2000 and 10.4 in 2001. Once balance sheet fears are addressed, the stock will move back to that range. At only $210 million market capitalization, Bally stock has leverage. How much leverage? I look for a move to $18 within six months and $25 in 12 months. Bally is a buy."

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