Soko Fitness & Spa (OTC BB:SOKF)

Added to the GeoBargain list on March 8, 2010 @ $4.00

Catalyst: Strong EPS growth; Fueled by an aggressive fitness/beauty center expansion strategy appeared to be in a position to continue its strong EPS growth.
Peak performance: Reached a high of $4.94 on March 23, 2010
Current Price: $4.01
 
Current road block: Internal control issues; Dilution could impact near-term EPS growth; No financial guidance.

We have high hopes for SOKF, but they have yet to put money from a recent raise to work, which has us moderately worried about short-term EPS growth. Although, the company should start seeing a positive contribution from facilities that are entering their prime growth cycle (starts in year two of operation).  Short-term, investors would need to gain clarity on the extent that the moderating growth from mature facilities will be mitigated by newer facilities.  We hope that SOKF completes an acquisition soon as this could be a way a to provide an immediate bump to EPS. 

Contributor Dan France brought a few more points  to our attention. He observed that the number of new clients joining SOKF centers seemed low relative to management’s business model assumptions. We posed this concern to management who said that tracking the growth in current client visits is more relevant to its business model and is within expectations. 

Additional observations Dan made:

• "I was also concerned about the average annualized revenue per fitness club member. I understand fitness center revenues only make up 20% of so of revenues but still the premium pricing model seems to be meeting resistance."  The average annualized revenue per fitness member was around $340 for the nine months ended Feb. 28 which is less than the annual membership fee of $441. Did SOKO have promotions offering discounted or even free memberships for new members or for member referrals? If so will they continue such promotions in the future?
  
• I recently heard a business report about Equinox’s plans to expand operations in China. SOKO claims to have a competitive advantage in the markets they are targeting. If global fitness industry players are also targeting China, will SOKO be able to compete with companies with far greater resources?

We are unsure of SOKF’s plan to tap the equity market:

"We have historically funded our operation primarily through bank loans and incoming cash from operations. Over the next twelve months, we intend to pursue organic and acquisitive growth in the future and increase our market share in China. We are also evaluating acquisition and consolidation opportunities in China’s fragmented fitness and beauty salon and spa industry. We believe that we have sufficient funds to operate our existing business for the next twelve months. However, in addition to funds available from our operating and short term bank loans, we may need external sources of capital for our expansion."

SOKF completed an equity raise in April 2010, after the release of its 2010 first quarter results. Investors would need to investigate whether or not the need to raise capital is now taken off the table. All and all, we were not too thrilled that SOKF raised $10 million at $3.20 in the April raise. However, upon further inspection it appears that to implement its aggressive acquisition strategy a raise was necessary:

• Cash balance only stood at only $4.8 million:
• Projected annual Free Cash flow stood at $3.8 million: (2010 annual cash flow from operations run rate of $13.6 – 2010 annual capital expenditures run rate of $9.8 million)

Our intent over the short-term is to build a check list to assess the risk position of firms in the ChinaHybrid space. For the time being this will consist of the following: (this list is likely to grow substantially)