HIGH YIELD                                                                                                                ...
BUSINESS OVERVIEWBally Total Fitness (“Bally” or the “Company”) is the second largest operator of fitness centersin North ...
times as many members per club, or 9,339, while monthly revenues per member ($23.26) areless than one-third that of TSI (s...
$36.00 per member per year, while retail product revenue has declined to approximately $12.50per member per year, as Bally...
additional indebtedness through a consolidated fixed charge coverage ratio of 2.0 to 1.0, butallows for the incurrence of ...
OWNERSHIP / MANAGEMENTFollowing a proxy battle at Bally’s annual                           Figure 5shareholder meeting in ...
EBITDA will decline to $146 million and $150 million from $164 million in 2005, and adjustedcash EBITDA will decrease mean...
to make a difference to the looming liquidity crunch; we suspect that Bally would have kept theassets if they hadn’t been ...
with a markedly bullish view), a subordinated convertible issue is more likely. We suspect thatincumbents will have the ch...
Figure 8                                                                            BALLY TOTAL FITNESS                   ...
RECOMMENDATIONBuy the 10.5% Senior NotesWe consider the Senior Notes favorably priced given their YTW of 11.1% (the worst-...
Figure 9                                                 BALLY TOTAL FITNESS                                              ...
Figure 10                                                                      BALLY TOTAL FITNESS                        ...
Figure 11                                           BALLY TOTAL FITNESS                                     Projected Quar...
Figure 12                                          BALLY TOTAL FITNESS                                           Going Con...
Figure 13                                               Recovery Analysis                                                 ...
Figure 14                                           BALLY TOTAL FITNESS                                      Historical Qu...
Miller Tabak Roberts Fixed Income/Convertible Important DisclosuresGeneral DisclosureMiller Tabak Roberts Securities, LLC ...
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Bally Total Fitness 061213

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Bally Total Fitness 061213

  1. 1. HIGH YIELD RESEARCH REPORT MILLER TABAK ROBERTS SECURITIES, LLC________________________________________________________________________ Bally Total Fitness Holding Corp. (BFT) Coupon Description Maturity Mdys/S&P Amt O/S Bond Price Curr. Yield Spread YTW 10.500% Senior Notes 07/15/11 Caa1/CCC- $ 235MM 98.000 10.7% 652 11.1% 9.875% Senior Sub Notes, Series D 10/15/07 Caa3/CC $ 296MM 91.625 10.8% 1,643 21.4%CUSIP # 05873KAJ7, 05873KAF5. Moodys outlook is negative. S&Ps outlook is developing. December 13, 2006 Ronald A. Rich (212) 692-5185 rrich@mtrdirect.comOPINIONWe initiate coverage of Bally Total Fitness with a BUY recommendation on the 10.5% SeniorNotes and a HOLD recommendation on the 9.875% Senior Subordinated Notes. Saddled witha declining membership base, anemic yields per member, substantial deferred reinvestment inits fitness center base, and declining unlevered free cash flow, Bally’s new leadership is facedwith executing an operational turnaround while addressing an October 2007 SubordinatedNote maturity. However, we believe that Bally possesses substantial intrinsic value and thatthe right management team should be able to turn around the Company. Given a YTW of11.1% and substantial value support in the event of a bankruptcy, we find the 10.5% SeniorNotes favorably priced. As for the 9.875% Subordinated Notes, we believe that theirrisk/reward is imbalanced given near-term downside trading risk and the significant risk ofimpairment in a bankruptcy.SUMMARY• We believe that Bally has been undermanaged and that it possesses substantial core value given its broad footprint, large membership base, brand recognition and relatively healthy industry backdrop. The Company’s new management team is linked to highly motivated investment groups and represents the first true change in leadership in two decades.• We believe that a successful turnaround of Bally will entail improving its members’ experience while positioning its product/service deliverable at the low-end of the market. Properly managed, Bally should be able to improve the lifetime value of its membership base by increasing member yield and retention and reducing expenses through payroll cuts and lowering customer acquisition costs.• Bally’s membership base declined 1.4% Y/Y to 3.56 million in 3Q06. Pro forma LTM adjusted cash EBITDA for the period ended 9/30/06 decreased 32.5% Y/Y to $94.1 million down from $139.5 million in the prior year period. We project free cash flow of negative $41.4 million and negative $47.1 million in fiscal years 2006 and 2007, respectively.• In the near-term, a solution to Bally’s October 2007 Subordinated Note maturity is further complicated by the sophisticated and active nature of its debt and equity holders. This dynamic should fuel the Company’s pursuit of raising equity and refinancing debt, but we believe that the pending maturity will more likely be addressed through either an exchange offer for a combination of new bonds and substantial equity or a convertible debt issue. Should an out-of-court restructuring not be achieved, a contentious bankruptcy case could follow. 331 MADISON AVENUE NEW YORK, NEW YORK 10017 (212) 867-7959 FAX (212) 867-6492 (800) 452-4528 (888) HI-YIELD www.MTRdirect.com Please refer to the last page of this report for important disclosures
  2. 2. BUSINESS OVERVIEWBally Total Fitness (“Bally” or the “Company”) is the second largest operator of fitness centersin North America. As of September 30, 2006, the Company operated 379 fitness centersconcentrated in the top 25 metropolitan areas in the United States and Canada, and served 3.6million members.According to the International Health, Racquet and Sports Club Association, total U.S. fitnessclub industry revenues have increased at an eleven-year CAGR of 7.7% to $14.8 billion in 2004,while U.S. fitness club memberships have increased at a CAGR of 5.1% to 41.3 million over thesame period. The fitness club industry is highly fragmented, with less than 10% of U.S. clubsowned and operated by companies that own more than 25 clubs; the two largest operators, 24Hour Fitness and Bally Total Fitness, accounted for only 14% of 2004 industry revenues.Over the past few years, Bally has experienced extensive turnover in its senior executive suite,and has weathered substantial road bumps, including a series of changes in accountingmethodology, a multi-year restatement of its financials, and recently, a change in board membersand managerial control. In August 2006, Bally’s two largest shareholders, Pardus CapitalManagement and Liberation Investments, entered into confidentiality agreements with the goalof facilitating a “strategic transaction.” Subsequently, the new Pardus-backed management teamrefinanced Bally’s senior credit facility, providing the Company with more liquidity andadditional time to address the October 15, 2007, maturity of its 9.875% Senior SubordinatedNotes. The old facility required Bally to have a plan in place to refinance the Subordinated Notesno later than April 15, 2007; the new facility allows until October 1, 2007.We note that our access to previous and current management has been very limited and many ofthe assumptions that drive our analyses have been extrapolated from estimates.Business ModelThe fitness center business model is straightforward: maximize the lifetime value of membersand minimize costs. The lifetime value of a member is a function of the annual revenuegenerated from the member, typically comprised of an initiation fee, monthly fees, in-centersales (all less bad debt), and the period of time over which the member is retained. Memberretention is maximized by providing a superior level of product and service, and, as is especiallythe case with Bally, attractive pricing. (The fitness industry has historically experienced arelatively high attrition rate, ranging between 40% and 60% per year.)Critical mass is a key concept for fitness centers, both in number of members per gym andconcentration of gyms in a region. Fixed operating costs are typically 70% or more of the totalexpenses of a gym, with each additional member yielding incremental marginal profitability.Store density is rewarded as well: people will not travel very far to go to the gym and oftenprefer to have a gym both near work and home. Clustering centers within a specific region alsoeases branding, makes advertising more efficient, increases local market expertise, and enablesmanagerial leverage.Historically, Bally acquired and retained members through a hard-sell approach that offeredlifetime memberships (usually financed by Bally) and very low monthly renewal rates (ratescurrently average $13 per month and were as little as $2 per month only ten years ago). Whilethe practice facilitated member joins and provided upfront cash through initiation fees and pre-paid memberships, it also compromised the lifetime value of a member. Compared to its mostcomparable public competitor, Town Sports International (TSI), Bally has approximately three 2
  3. 3. times as many members per club, or 9,339, while monthly revenues per member ($23.26) areless than one-third that of TSI (see Figure 9).Many of Bally’s 3.6 million members are non-users and maintain their low-priced renewalmembership purely as an option. Bally provides financing for the entire value of its membershipcontracts at an interest rate between 16% and 18% per annum. While the practice helps to drivemember joins, it has also created a collections problem and produced bad will between Bally andsome members. In addition, the reduced financial barriers to a Bally’s membership haveled to a less active and less leveragable membership base that has limited the company’sability to grow yield per member, which is comprised of initiation fees, monthly dues,product and service revenues, and finance charges.As lifetime memberships have been Figure 1made unlawful in most states and BALLY TOTAL FITNESS Business Model Driverscompetition has increased with the Weightedestablishment of more regional chains, No. Average Member Life Annual Initial Renewal Initiation Monthly MonthlyBally’s membership fees have Membership (millions) (months) Attrition Fee Fee Fee Non-Obligatory 2.17 55 * 19.9% * $0 $0 $13declined. Someone who joined Bally Contract (a)in 2000 typically paid an initiation fee Legacy New 1.24 NM * 39 36 26.8% * * 28.7% * 63 63 31 31 15 31between $630 and $2,175 and monthly Monthly 0.15 * 15 56.3% * 110 NA 35 * Total 3.56dues ranging from $3 to $20, as Source: Company reports and MTR analysis * Figure reflects MTR estimate.compared with a current average (a) Attrition rate and membership life do not include initial 30-day attrition estimated at 17%.initiation fee of $63 and monthly Totals reflect weighted average.charge of $31.With greater consumer choice in the marketplace, and none of the stickiness of its old lifetimemodel, Bally can retain members only through competitive service and offerings, and/or a lowprice. While Bally’s annual attrition rate of 32% is below the industry average, we believe itsattrition rate of active members is actually higher, given that 61% of its membership base iscomprised of non-obligatory members (post-contract). Membership churn not only reduces thelifetime value of the Company’s membership base, but also diminishes the potential value of thecommunity a given center services.We think that Bally’s legacy of hard selling and compromised quality has caused theCompany to burn through much of some older centers’ addressable markets, driving theircost of member acquisition higher or member yield lower. Based upon this constraint toprofitability, we assume that Bally’s older club locations are less worthy of capitalreinvestment and are well represented among those centers that have a high degree ofdeferred capital expenditures. Ultimately, we expect this dynamic may compel exitingcertain locations.According to the company: 1) in the three months ended September 30, 2006, new membersignups were approximately 68% value plan (Bally’s term for a contract membership comprisedof an initiation fee plus monthly charge), 13% paid-in-full memberships, and 19% month-to-month (zero initiation charge, but higher monthly charges than the value plan); 2) the weightedaverage life of a member who signs a contract is 39 months; 3) the majority of signed contractshave a 36-month term; 4) 90% of membership contracts are financed; 5) 61% of members arepost-contract and pay monthly fees on a non-obligatory basis, averaging $13.00 per month; and6) personal training revenue per member has recently trended upward and is approximately 3
  4. 4. $36.00 per member per year, while retail product revenue has declined to approximately $12.50per member per year, as Bally has reduced its allocation of center square footage to the category.CAPITAL STRUCTURE Figure 2Bally’s capital structure is comprised Bally Total Fitness Holdingof a senior credit facility, a senior noteissue and a senior subordinated note Senior Credit Facility 10.5% Senior Notesissue, each of which has been 9.875% Senior Sub. Notesborrowed/issued by Bally Total FitnessHolding Corporation, the parent entityof the operating subsidiaries. Restricted Op. Subs. Unrestricted Op. Subs.Senior Credit FacilityOn October 16, 2006, Bally amended Collateral for Sr. Credit Facilityand restated its existing credit Guarantors of Sr. Credit Facility Guarantors of 10.5% Sr. Notesagreement to provide for a $44.0million revolving credit facility, a Source: Company reports.$205.9 million Tranche B Term Loan, and a $34.1 million Delayed-Draw Term Loan, which canbe used to fund capital expenditures. The revolver and Tranche B Term Loan were drawn in fullto refinance the Company’s previous credit facility and enhance liquidity. The old facilityrequired Bally to have a plan in place to refinance the Senior Subordinated Notes due October15, 2007, no later than April 15, 2007; the new facility extends the deadline to October 1, 2007.All borrowings under the facility bear interest quarterly at three-month LIBOR plus 425bps andmature on October 1, 2010, provided that maturity accelerates to 14 days prior to the maturity ofthe current Sub Notes or any replacement debt. The Delayed-Draw Term Loan can be drawnupon through April 16, 2008. The Tranche B Term Loan amortizes quarterly beginning October31, 2007, at the rate of $2.1 million per annum.The new facility is secured by all of Figure 3Bally’s assets except 35% of the stock of Min. Consolidated Cash EBITDA ($ millions) Min. Amt. Minimum Liquidity Min. Amt.its foreign subsidiaries. The credit 8/1/06 - 11/30/06 $ 25.0 11/30/06 $ 15.0agreement’s covenants were constructed 8/1/06 - 12/31/06 35.0 12/1/06 - 10/31/07 25.0 8/1/06 - 1/31/07 40.0 11/1/07 and thereafter 30.0to make it easier for Bally to refinance or 8/1/06 - 2/28/07 45.0extend the Subordinated Notes, including 8/1/06 - 3/31/07 50.0 8/1/06 - 4/30/07 55.0provisions allowing Bally to give Sub 8/1/06 - 5/31/07 60.0Note holders stock, a higher interest rate, 8/1/06 - 6/30/07 65.0 7/31/07 - 6/30/08 70.0and/or reimbursement of out-of-pocket 7/1/08 - 12/31/08 75.0expenses. Financial covenants under the 1/1/09 - 6/30/09 80.0 7/1/09 and thereafter 90.0credit agreement include a minimum Source: Company reports.LTM consolidated cash EBITDA andminimum liquidity maintenance tests. The Company must maintain a minimum LTMconsolidated cash EBITDA for the trailing twelve months ending on the designated date(provided that, for any fiscal month prior to August 1, 2007, the period will commence onAugust 1, 2006) equal to or greater than the amount specified in Figure 3, and a minimumliquidity equal to or greater than the amount specified for that month as listed above in Figure 3.10.5% Senior NotesIn July 2003, Bally issued $235 million of 10.5% Senior Notes (the “Senior Notes”) to refinanceits then-existing credit facility. Senior Notes are general unsecured obligations of the Companyand are guaranteed by its restricted operating subsidiaries. The Senior Notes’ indenture limits 4
  5. 5. additional indebtedness through a consolidated fixed charge coverage ratio of 2.0 to 1.0, butallows for the incurrence of Permitted Indebtedness that includes, among other items, $50.0million of capital lease obligations, $50.0 million of other debt, and restricted payments limitedby a senior leverage ratio of 2.75 to 1.0. The Senior Notes are callable on or after July 15, 2007,at 105.25; the call price drops to 102.625 on July 15, 2008, and to par on July 15, 2009. TheSenior Notes carry a change of control put at 101.9.875% Senior Subordinated NotesIn 1997 and 1998, Bally issued $300 million in aggregate principal amount of 9.875% Series Band Series C Notes and, in June 1999, it exchanged them for the presently outstanding $296million of 9.875% Series D Senior Subordinated Notes (the “Sub Notes”). The Sub Notes aregeneral unsecured obligations of the Company and are contractually subordinated to the SeniorNotes and other Bally Total Fitness Holding Corporation senior debt (including to the extent ofpost-petition interest) and structurally subordinated to all operating subsidiary obligations, asthose subsidiaries do not guarantee the Sub Notes. The Sub Notes’ indenture contains an “XClause.” Additional indebtedness is limited by the Sub Notes’ indenture’s consolidated fixedcharge coverage ratio of 2.0 to 1.0; the indenture provides for the incurrence of permittedindebtedness that includes, among other items, $25 million of capital lease obligations and $50million of other debt. The Notes are currently callable at par and carry a change of control put at101.Leverage / LiquidityWe have calculated Bally’s net leverage ratio Figure 4based on pro forma LTM adjusted cash BALLY TOTAL FITNESS Pro Forma Net Leverage *EBITDA, net of the change in deferred Figures as of September 30, 2006, pricing as of December 13, 2006revenues and non-recurring items and adjusted Amount Net Lev Net Lev ($MMs) Thru Thru Mktfor the January 2006 sale of Crunch Fitness. Revolving Credit Facility $ 30.0 - -“Cash EBITDA” is often referenced because Term Loans 205.9 1.8x 1.8xEBITDA has been artificially inflated due to an Delayed-DrawNotes Loan 10.5% Senior Term - 235.2 1.8x 4.5x 1.8x 4.4xacceleration in revenue recognition; as attrition Other Senior Obligations 21.7 4.5x 4.4xhas increased, the average life of a Bally 9.875% Senior Sub Notes Total Debt 294.5 787.3 7.6x 7.6x 7.4x 7.4xmember has shortened, reducing the time Cash 70.2period over which deferred revenue is Net Debt 717.1amortized. We have presented Bally’s total Pro Forma LTM Adj. Cash EBITDA 94.1debt figure pro forma for the October 16, 2006, Pro Forma LTM Adj. EBITDA 151.3 Source: Company reports and MTR estimates.refinancing of the senior credit facility, and we * Net leverage calculation is based on adjusted cash EBITDA.have assumed that $21.7 million of balance * Debt balance is pro forma for the new credit facility. * Senior Sub Note unamortized discount has been estimated.sheet “Other Obligations” are structurally * Cash EBITDA is pro forma for the Jan 2006 sale of Crunch Fitness and reflects an adjustment to adjusted EBITDA for thesenior to the Subordinated Notes. As of change in deferred revenues.September 30, 2006, Bally’s pro forma netleverage ratio was 7.6x, up from 6.8x in the prior quarter. The Company’s pro forma LTM cashinterest coverage ratio at quarter-end was 1.3x, down from 1.4x in the prior quarter. Net ofrevolver borrowings of $30 million and outstanding LC’s of $14 million, we calculate pro formaliquidity of $104.3 million at the end of the third quarter of 2006, comprised of $70.2 million ofcash and $34.1 million available for capital expenditures under the Delayed-Draw Term Loan. 5
  6. 6. OWNERSHIP / MANAGEMENTFollowing a proxy battle at Bally’s annual Figure 5shareholder meeting in January 2006, Bally BALLY TOTAL FITNESS Common Share Beneficial Ownershipshareholders elected activist investor Pardus’s Shares (MM) % Class Filingdissident slate of board members, Barry Elson, Don Pardus Capital 6.1 14.8% 8/25/06 Liberation Investment 4.6 11.2% 8/29/06Kornstein and Charles Burdick, who now constitute Wattles Capital 3.8 9.3% 4/13/06a majority of the soon-to-be four-member board. At Dimensional Fund 3.1 8.2% 2/6/06 S.A.C. Capital 2.4 6.4% 2/14/06the same meeting, Liberation Investments Everest Capital 2.4 5.8% 2/14/06unsuccessfully attempted to oust Bally’s CEO, Paul Morgan Stanley 0.4 1.0% 10/10/06 Holders of 9.875% Senior Sub NotesToback. However, in August 2006, Mr. Toback was Amount % Issue Filingforced out of his position as CEO, Barry Elson was Tennenbaum Capital $129.2 43.1% 3/22/06 Everest Capital 19.2 6.4% 3/22/06appointed acting CEO and Don Kornstein was made Pardus Capital 10.5 3.5% 3/22/06interim chairman. As of the filing dates noted in Source: Company reports and public filings as of 10/20/06. Since Ballys 10-K filing, Liberation Investment hasFigure 5, investment firms accounted for a majority increased its Common holdings, while Morgan Stanleyownership of both the outstanding common shares has decreased its holdings.and the Sub Notes.FINANCIALSRecent ResultsBally’s recent financial Figure 6performance has worsened as Historical Annual Figures *member attrition has risen and 1,100 250gross profit per member has 1,000 200declined. These declines have been EBITDA Revenue 900 150partially offset by improving 800 100operating margins in the 700 50Company’s retail product lines (seeFigure 10). LTM adjusted cash 600 -EBITDA declined 32.5% to $94.1 97 98 99 00 01 02 03 04 05 M LT 19 19 19 20 20 20 20 20 20million for the period ended Revenue Adjusted EBITDA Adjusted Cash EBITDASeptember 30, 2006, from $139.5million in the prior year’s period, Source:- Company reports. 1999-2001 membership revenue and related costs from a * 2001 Company restatedwhile LTM adjusted EBITDA * 2002 - Adjusted cash EBITDA figure is not meaningful. gross to net presentation.decreased 9.7% to $151.3 million * 2003 - Restated financials, changed accounting.over the same period. LTM * LTM through September 30,and 1Q04. * 2004 - Restated 2000-2003 2006.unlevered free cash flow decreased$20.7 million year-over-year to $39.0 million. The adjacent Figure 6 displays historical annualfigures for the period from 1997 through the latest twelve months.ProjectionsWe project that fundamentals will stabilize in 2007, as cost reductions offset continued slowingin membership joins (see Figure 11). Our specific assumptions include: 1) gross member joinswill continue to decline (2,909 new members per center in the twelve months ending September30, 2007, versus 3,019 in the prior-year period), 2) monthly revenue recognized per member willincrease from $19.06 in 3Q06 to $19.26 in 3Q07, 3) attrition rates will remain steady, drivingnegative net member joins, 4) variable and fixed operating expenses will be reduced, 5) deferredrevenue will continue to be recognized at high rates, increasing the delta between cash EBITDAand EBITDA based on GAAP revenue, and 6) capital expenditures will increase as managementbegins center improvements. For fiscal 2006 and 2007, respectively, we project that netrevenues will fall slightly to $994 million and $982 million from $1.0 billion in 2005, adjusted 6
  7. 7. EBITDA will decline to $146 million and $150 million from $164 million in 2005, and adjustedcash EBITDA will decrease meaningfully to $87 million and $85 million from $124 million in2005.Bally’s new credit facility should assure sufficient liquidity to fund operations and capitalexpenditures through fiscal 2007. Assuming capital expenditures of $41 million and $50 millionin fiscal 2006 and 2007, respectively, we project unlevered free cash flow of $33 million in 2006and $28 million in 2007, down from $50 million in 2005. The Sub Note maturity on October 15,2007, and the credit facility maturity it may trigger, remain significant challenges for theCompany.TURNAROUNDMarket/OperationsGoing forward, Bally Total Fitness must choose between two strategies: increase pricing whilecontinuing to deliver a mid-level product, or embrace the low end of the market: keeping priceslow, reducing costs, and marketing the Company as a high-value alternative.Given Bally’s hard-sell, low-service culture and the low average yield of its membershipbase, we believe that the positioning of Bally at the lower end of the market better suits alarge geographic footprint and the consolidating industry backdrop, and will be mucheasier to execute, all else equal, than a higher end strategy.Competitors such as Planet Fitness and Curves have recently shown that a profitable businesscan be built at the low end of the market. Garnering a monthly membership fee of $29 and less,and an initiation fee of around $50, a low-end offering entails a well-equipped, clean workoutspace that does not offer any extras such as fitness classes or childcare. According to ourconversations with industry consultants, the model has produced lower membership churn atsome chains than that of higher price point chains because of the high-value product offering andthe more tolerable carrying cost of the membership to non-users.Successful implementation of the low-end strategy should result in a higher number of membersper center, a higher degree of inactivity among the membership base (which is beneficial interms of marginal contribution and less crowded centers), lower ancillary revenue per member,reduced personnel costs, and a low acquisition cost per member. (Acquisition costs will bereduced by a better return on advertising, higher lead conversion and much decreased salescommissions.) The inherent drawback with this model is that by not driving a higher yield permember, operating leverage is not maximized and profit margin is limited by the high fixed coststructure associated with a fitness center.We know that executing at the high end of the market is difficult for Bally, because it has triedand failed in the past with Bally Sports Clubs, The Sports Clubs of Canada, Pinnacle Fitness,Crunch and Gorilla Sports. In January 2006, Bally sold all twenty-one Crunch clubs, two GorillaSports clubs and two Pinnacle Fitness clubs to an investor group led by Marc Tascher, the formerCEO of Town Sports, for $45 million, half of what the Company had paid for nineteen Crunchclubs in 2001. With ten Bally Sports Club locations, it is not readily apparent that Bally hasplans to expand the sub-brand. The Company’s exit from Crunch and the other high-end clubswas probably due to their poor performance and was likely an acknowledgement by Bally’sprevious management team that the Company lacked the competencies to properly execute at thehigh end of the market. (While the cash from the sale was doubtless welcome, it was not enough 7
  8. 8. to make a difference to the looming liquidity crunch; we suspect that Bally would have kept theassets if they hadn’t been performing poorly.)During the Company’s third quarter earnings conference call, management discussed thepossibility of a joint venture as part of the restructuring of Bally’s centers. While details werenot provided, we envision Bally partnering with another large player in markets that it deemsnon-core whereby the partner provides managerial services in exchange for a fee and a share ofcash flow. One sticking point in an arrangement such as this might be the brand that these JVcenters would carry; a partner may find managing centers that continue to carry the Bally nameto be unhelpful to the competitive posture of their owned stores in the same market.While we believe a bankruptcy filing would provide Bally with some helpful tools forrestructuring operations, an out-of-court restructuring could achieve the same ends with onlymodestly greater difficulty. In any event, the investment firms that own the equity will exert anextra effort to keep Bally out of bankruptcy.Deferred Capital ExpendituresIndustry observers mostly agree that Figure 7Bally has underinvested in its fitness BALLY TOTAL FITNESS Deferred Capital Expenditures Analysiscenter base over the years. Our ($ millions) OUTPUTconversations with industry consultants Req. Annual Maint. CapEx as % Rev 4% 5% 6%have yielded estimates of fitness center Calc. Deferred Capital Expenditures $58.3 $165.3 $272.2 Inflation Adj. Calculated Actualdeferred capital expenditures that vary Cum. Def. Avg Req.Maint. Up./Maint. Actualgreatly, ranging from $100 million to Year Cap Ex/Club No. Clubs Cap Ex Cap Ex Cap Ex$300 million. In Figure 7, we have 1995 $ 0.12 316 $ - $ - $ - 1996 0.19 322 32.0 128.1 20.6calculated a midpoint estimate for 1997 0.23 317 33.1 244.7 27.1deferred capital expenditures of $165 1998 0.20 320 37.1 427.1 76.4million, based on a required annual 1999 0.17 343 43.1 488.7 119.1 2000 0.13 376 50.4 576.3 108.4maintenance capital expenditure level 2001 0.14 387 42.6 386.9 91.2equal to 5% of annual revenues; the 2002 0.16 412 45.7 342.9 75.1 2003 0.23 414 47.7 191.4 47.9cumulative total has been adjusted for 2004 0.29 416 52.4 287.4 49.7inflation. A number of industry 2005 0.34 412 53.6 343.5 37.9 2006 0.43 382 50.0 245.0 35.0consultants have commented that Source: Company reports and MTR analysis.Bally’s deferred capital expendituresare concentrated among the bottom third of its clubs, due to management selectivelyunderinvesting in markets that are either too competitive or that have experiencedexcessive membership churn. Some of these centers should logically be exited rather thanrevitalized, reducing the requisite cash outlay for deferred capex.Balance Sheet RestructuringWe are guardedly optimistic that Bally’s new management group will be able to refinance theSub Notes on time, given Bally’s support level of revenue and EBITDA. The presence of a newmanagement team is also important; it is the first truly new regime in two decades. We estimatethat Pardus’s invested cost basis is in the range of $25 million, a stake likely to be greatlycompromised in a restructuring.As a leading holder of the Sub Notes, we expect that Tennenbaum Capital will be a strongadvocate of Sub Note holders. We doubt that the restructuring will come in the form of newstraight subordinated debt from new investors, given the high senior leverage. While acombination of new straight debt and new equity is possible (with the latter supplied by investors 8
  9. 9. with a markedly bullish view), a subordinated convertible issue is more likely. We suspect thatincumbents will have the chance to step into the deal through an exchange offer for the SubNotes or a rights offer to one or more of the current classes of investors.VALUATION OF THE COMPANYIn the following section, we value Bally on a going concern and M&A basis. We also present, asan alternative, the recoveries from a hypothetical workout process triggered by the inability tofind a buyer or capital to refinance the Sub Notes before they mature. The two valuation casesand the workout all assume (the M&A case implicitly) that Bally can and will be restructuredsomewhat successfully: that the business will be able to sustain its capital structure, but willcontinue to materially underperform its competition with regard to member yield and cashEBITDA margin. Our M&A analysis is based on comparable transactions and is intended toreflect what a buyer with the resources to address the Sub Notes’ maturity and make turnaroundinvestments would pay today.Going ConcernOur base case going concern value calculation assumes that Bally 1) addresses the Sub Notes’maturity on time, 2) exits 95 centers through sales and closures, with a portion of the members ofclosed centers transferring to other local Bally centers, 2) refurbishes the remaining 284 centersat a cost of $55 million and improves their management to a competitive low-end market level,enough to allow for a $4.00 increase in average monthly active membership and a $2.00 increasein the average monthly revenue of less active members, 4) grows monthly personal trainingrevenue per active member to $7.00 from $5.00 per month, 5) increases cash EBITDA margins to17%, 6) spends $20 million on one-time deferred information technology projects and 7) takes 42months (3.5 years) to complete the turnaround. We note that our projected refurbishment costsare lower than our estimated total deferred capex as per our assumption that Bally will closethose centers with the most disinvestment.Based upon the foregoing assumptions, we project in Figure 12 a 2010 cash EBITDA of $151million and a 2010 enterprise value of $1.0 billion. Discounting the enterprise value 10% perannum, we arrive at a present enterprise value of $742 million, or 4.9x LTM (as of September30, 2006) adjusted EBITDA and 7.9x LTM (same period) adjusted cash EBITDA. Thisdiscounted enterprise value fully covers current debt, and leaves $24.4 million in equityvalue after current net debt ($717.1 million as of September 30, 2006, pro forma for the October2006 refinancing), or $0.59 per common share.M&AAs the fitness center industry continues to consolidate, M&A valuation becomes an increasinglyrelevant data point. In its current state, Bally is by no means an easily sold business, asevidenced by the failed attempt to sell a large minority stake in January 2005 and the abortedsale process in March 2006. Industry watchers had speculated that during the latter processBally would sell for between $1.0 billion and $1.6 billion. Given the Company’s decliningadjusted cash EBITDA, we think a buyer would pay 80% of the revenue run-rate, or a purchaseprice of $796 million. This is a better valuation than Bally was able to get for Crunch, but lowerthan some of the other comps shown in Figure 8. The purchase price we model is 7.3% higherthan our base case going concern valuation, reflecting the value of a well-capitalized buyer’sgreater flexibility in addressing balance sheet and operational challenges. 9
  10. 10. Figure 8 BALLY TOTAL FITNESS M&A Comparables ($ millions) Purchase No. No. EBITDA Price / Price / Price / Price / Target Acquirer Date Price Centers Members Revenue EBITDA Margin Center Member Revenue EBITDAHolmes Place Virgin Active Sep-06 280 47 0.2 NA NA NA 6.0 1,474 NA NACrunch Fitness Angelo Gordon Jan-06 45 25 0.1 71 5 7.1% 1.8 570 0.6 9.0xEquinox The Related Companies Dec-05 505 32 NA 168 NA NA 15.8 NA 3.0 NAThe Sports Club Co. Millennium Partners Oct-05 80 5 NA 99 13 13.2% 16.0 NA 0.8 6.1x24 Hour Fitness Fortmann Little & Co. May-05 1,600 345 3.0 1,100 178 16.2% 4.6 533 1.5 9.0xGolds Gym * TRT Holdings Jul-04 158 550 2.5 NA 21 NA 0.3 NM NA 7.5xEquinox North Castle, JW Childs Dec-00 100 11 NA NA NA NA 9.1 NA NA NASource: Company reports and MTR estimates.* At the time of the acquisition, Golds Gym owned 37 facilities, as well as 513 franchised locations.Possible Recoveries in the Event of a WorkoutWe believe that the Bally story is straightforward enough for its key stakeholders to structure asolution to the Sub Note maturity without resorting to bankruptcy. However, the investmentclimate could sour, and even if it doesn’t, stories even more straightforward than Bally’s havefound their way to Chapter 11 before.In Figure 13, we analyze hypothetical recoveries from a workout triggered by a Sub Notedefault. As mentioned above, we continue to assume that Bally can improve cash EBITDA.Extrapolating backward from Figure 12’s 2010 projected $151 million LTM cash EBITDA, weproject an LTM cash EBITDA of $120 million as of an April 2009 exit from bankruptcy. Thisenables us to project distributable future value of $874 million, comprised of enterprise value of$840 million, net proceeds from fitness center exits of $48 million, and excess cash build duringbankruptcy of $62 million, reduced by investment in deferred capital expenditures andinformation technology of $75 million. This distributable value would be sufficient to fund acomplete par, pre-petition and post-petition interest recovery on the Senior Notes and a recoveryon the Sub Notes of 97% of par, presumably through equitization. (The Senior Notes would beable to recover post-petition interest on theories of “solvency” for the OpCos, with the SeniorNote post-petition interest backstopped by the subordination clause of the Sub Note’s indenture.The Sub Notes should be able to get post-petition interest prior to any recovery to equity ifthere’s enough value for the holdco to be solvent.)Figure 13 gives us a fairly high degree of confidence in the Senior Notes’ recoveries. For juniorclasses, though, our confidence level is quite a bit lower. The sensitivity analyses in Figure 13show that small downward variations in EBITDA or in our valuation multiple would crush SubNote recoveries. The same forces that could compel a workout in the first place (a difficultinvestment climate, lack of cooperation among classes of stakeholders) could dramaticallyreduce the actual (or assumed normalized) EBITDA. It is also possible that the bank lenders andSenior Note holders might be able to take advantage of transitory difficulties to muscle Sub Noteholders (to say nothing of shareholders) out of recoveries they might otherwise receive.A Note on Sale Values of Individual CentersAll of our valuation models envision that some centers will be exited. We believe that there ispotential for modest proceeds from those exits. As footnoted in Figure 12, Bally owns the realestate for fewer than 40 centers, and some of these 40 are mortgaged. However, exit value for acenter also can be found in its membership list, its substantial investment in fitness equipmentand leasehold improvements, and in the equity value of its long-term leases (particularly forcenters that have been open for a while). It’s obviously easier to access individual center valuein a bankruptcy, but even out of court we expect meaningful realizations. 10
  11. 11. RECOMMENDATIONBuy the 10.5% Senior NotesWe consider the Senior Notes favorably priced given their YTW of 11.1% (the worst-case returnin our going concern or M&A scenarios) and a workout model showing the bonds quite likely tobe money good. In our base case workout, we project an IRR to exit from bankruptcy of 11.4%(including post-petition interest and partial payment of the Notes’ call premium). As shown inour sensitivity analysis (see Figure 13), Senior Note recoveries don’t dip below par until wereduce projected cash EBITDA to $80 million and the valuation multiple to 6.0x.9.875% Senior Subordinated NotesOur HOLD recommendation on the Sub Notes is based on our belief that the Sub Notes’risk/reward at current pricing levels is unfavorable. We are somewhat optimistic that a solutionto the Sub Note maturity will be reached and bondholders will have an attractive 21.4% YTW inthat event. However, we believe the Sub Notes could trade down considerably in the event of adefault. Additionally, our base case workout hypothetically delivers an IRR of 4.0%, withreturns quickly turning negative below our base case.RISKSThe principal risk to our BUY recommendation on the Senior Notes is that we are incorrect inour belief that there will be a successful operational turnaround of Bally. While we believe thatthere is a lot of “low-hanging fruit” for a competent management team to exploit, a turnaround ofBally will be difficult and lengthy.As for our HOLD recommendation on the Senior Sub Notes, we expect volatility as eventsunfold leading up to their maturity, as both positive and negative news could result in significantprice movement. Volatility could be exacerbated should management choose to limit guidanceleading up to the outcome. Additionally, our HOLD recommendation is at risk if in fact we havebeen too conservative in our assessment of company fundamentals in our base case turnaroundscenario. 11
  12. 12. Figure 9 BALLY TOTAL FITNESS Competitor Analysis As of December 8, 2006 Bally Town Sports Life Time Sports Club Weight Equinox($ millions) Total Fitness International Fitness Company Watchers HoldingsTicker BFT CLUB LTM SCYL WTW PrivateData Through Sep 06 Sep 06 Sep 06 Mar 06 Sep 06 Sep 05 VALUATION RATIOSEV / Adjusted Cash EBITDA 8.5x 7.0x 14.2x 13.0x 13.8x NAEV / Adjusted EBITDA 5.4x 7.6x 15.0x 13.9x 14.2x NAEV / Revenue 0.8x 1.6x 4.4x 2.2x 4.5x NAEV / Club $2.1 $4.8 $41.2 $30.8 NA NAEV / Member ($) 227 1,599 5,432 5,238 3,623 NA FINANCIAL METRICSEnterprise Value $811 $689 $2,101 $123 $5,434 NARevenue/Member/Month ($) 23.26 81.40 102.55 202.59 66.61 175.20Membership Rev/Member/Month ($) 18.95 67.00 72.69 135.64 38.94 115.01Prod/Ser Rev/Member/Month ($) 3.97 13.39 27.53 66.94 27.68 59.93PT Revenue/Member/Month ($) 2.97 9.13 NA NA NA 39.36Retail Revenue/ Member/Month ($) 1.00 4.26 NA NA NA 20.57Revenue / Club 2.6 2.9 9.3 14.3 NA 6.7Revenue / Club / SF 87 122 93 159 NA 224Membership Revenue / Club 2.1 2.4 6.6 9.6 NA 4.4Product/Services Revenue / Club 0.4 0.5 2.5 4.7 NA 2.3Personal Training Revenue / Club 0.3 0.3 NA NA NA 1.5Retail Products Revenue / Club 0.1 0.2 NA NA NA 0.8Total Expenses / Club SF 75 96 74 133 NM 171Cap Ex / Club 0.1 0.4 4.7 1.2 NM 1.5Cap Ex as % Revenue 4.1% 15.0% 50.0% 8.4% 1.3% 22.0% LTM FINANCIAL DATARevenue $998 $421 $476 $57 $1,199 $168Membership Revenue 814 347 337 38 701 110Product/Services Revenue 170 69 128 19 498 57Personal Training Revenue 127 47 NA NA NA 38Retail Products Revenue 43 22 NA NA NA 20Total Expenses, excl. D&A 865 330 376 48 NM 128Adjusted EBITDA 151 91 140 8.8 383 39Adjusted Cash EBITDA 94 99 148 9.4 395 47Adj. Cash EBITDA Margin 9.4% 23.5% 31.1% 16.5% 32.9% 28.0%Capital Expenditures 41 63 238 5 15 37 OPERATIONSMembers / Club 9,339 3,003 7,584 5,875 NM 3,196Club SF / Members 3.2 8.0 13.2 15.3 NA 9.4Joining Members / Club 2,901 NA NA 1,663 NA NAAvg. No. Clubs 383 144 51 4 NM 25Avg. Club Square Feet 30,000 24,000 100,000 90,000 NM 30,000Avg. No. Members 3,577,000 431,000 386,792 23,500 1,500,000 79,909Joining Members 1,111,000 NA NA 6,650 NA NA MARKET Northeast, New York, Mid-Atlantic, Midwest, Northeast, Mid- Los Angeles, California,Geographic Footprint California, Mid-Atlantic, International Atlantic New York Chicago, Florida, Southwest Florida MidwestPrice Level Low Mid Mid High Low HighProduct / Service Level Mid Mid High High Mid HighSource: Company reports and MTR analysis. 12
  13. 13. Figure 10 BALLY TOTAL FITNESS Adjusted Historical Quarterly Operating Statement (In Millions of Dollars) INCOME STATEMENT 1Q05 2Q05 3Q05 4Q05 (a) 1Q06 2Q06 3Q06 2004 (a) 2005 (a) LTMNet Revenues Membership $ 207.1 $ 211.5 $ 202.6 $ 193.0 $ 208.8 $ 207.3 $ 204.5 $ 850.5 $ 814.2 $ 813.6 Personal Training 29.1 31.8 30.1 34.4 30.9 32.2 29.8 125.4 125.4 127.3 Retail Products 13.3 12.6 11.5 9.5 11.9 11.5 10.2 53.3 47.1 43.1 Miscellaneous 4.3 3.6 3.7 3.4 3.6 3.6 3.9 18.7 15.0 14.5Total Net Revenues 253.8 259.6 247.9 240.3 255.2 254.6 248.3 1,048.0 1,001.6 998.5Membership Services 167.6 170.7 165.9 165.6 171.1 170.2 167.3 732.7 669.9 674.3Retail Products 12.8 13.4 12.6 10.8 11.0 10.7 10.5 54.5 49.7 43.0Advertising 17.1 14.6 12.9 8.7 18.9 16.2 13.0 61.6 53.4 56.8Information Technology 5.3 5.5 5.2 3.5 5.1 5.3 4.9 18.3 19.5 18.8Other G&A 12.9 16.1 14.0 20.9 16.5 15.9 18.7 57.7 63.9 72.1Depreciation and Amortization 14.9 15.0 14.9 10.0 14.2 13.2 13.4 69.8 54.9 50.9Total Operating Expenses 230.7 235.4 225.6 219.6 236.9 231.5 227.7 994.6 911.4 915.8Operating Income 23.1 24.2 22.3 20.7 18.3 23.1 20.6 53.4 90.2 82.7Addbacks: Depreciation and Amortization 14.9 15.0 14.9 10.0 14.2 13.2 13.4 69.8 54.9 50.9 Non-recurring Items 0.9 4.7 4.3 8.9 3.6 (0.2) 5.4 - 18.8 17.7 Change in Deferred Revenues 3.0 (14.4) (9.9) (18.5) (6.2) (14.8) (17.6) (22.7) (39.7) (57.1)ADJUSTED CASH EBITDA $ 41.9 $ 29.6 $ 31.6 $ 21.1 $ 29.9 $ 21.4 $ 21.8 $ 100.4 $ 124.2 $ 94.1LTM Adjusted Cash EBITDA - - - 124.2 112.1 103.9 94.1Net Sales Growth, Y/Y NM NM NM NM 0.6% -1.9% 0.2% - -4.4% -Membership Services as % Membership+P/T Revenue 71.0% 70.1% 71.3% 72.8% 71.4% 71.1% 71.4% 75.1% 71.3% 71.7%Retail Products Operating Margin 4.0% -6.2% -9.7% -13.7% 7.8% 6.9% -3.0% -2.2% -5.7% 0.3%Adjusted EBITDA Margin 15.3% 16.9% 16.7% 16.5% 14.1% 14.2% 15.9% 11.8% 16.4% 15.2%Adjusted Cash EBITDA Margin 16.5% 11.4% 12.7% 8.8% 11.7% 8.4% 8.8% 9.6% 12.4% 9.4%LTM Adjusted Cash EBITDA Margin - - - 12.4% 11.2% 10.4% 9.4% SOURCES AND USES OF CASHCash EBITDA $ 41.0 $ 24.9 $ 27.3 $ 12.2 $ 26.3 $ 21.6 $ 16.4 $ 100.4 $ 105.4 $ 76.4Cash Interest Expense (16.8) (18.9) (18.0) (22.2) (18.5) (21.4) (15.1) (62.3) (75.9) (77.1)Cash Income Taxes (0.1) 0.1 (0.2) (0.0) (0.1) (0.2) (0.4) 1.0 (0.2) (0.7)Change in Operating Assets/Liabs (2.0) 2.9 (20.8) 2.6 4.8 (3.0) 0.0 (2.5) (17.3) 4.5Capital Expenditures (8.4) (6.0) (10.2) (13.2) (11.6) (7.3) (9.1) (49.7) (37.9) (41.2)Total Uses of Cash (27.3) (21.9) (49.2) (32.8) (25.4) (31.8) (24.5) (113.5) (131.2) (114.5)FREE CASH FLOW $ 13.7 $ 3.0 $ (22.0) $ (20.6) $ 0.9 $ (10.2) $ (8.1) $ (13.1) $ (25.9) $ (38.1) LIQUIDITYCash Balance $ 33.3 $ 29.5 $ 12.8 $ 17.5 $ 16.0 $ 15.2 $ 30.2 $ 19.2 $ 17.5 $ 30.2Revolving Credit Facility Availability 86.3 90.3 66.0 51.4 60.9 55.9 24.6 91.3 51.4 24.6TOTAL LIQUIDITY $ 119.7 $ 119.8 $ 78.7 $ 68.9 $ 76.9 $ 71.0 $ 54.9 $ 110.5 $ 68.9 $ 54.9Revolver Borrowing Capacity 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0Amount Drawn 4.0 - 20.0 35.0 25.0 30.0 60.0 - 35.0 60.0LCs Outstanding 9.7 9.7 14.0 13.6 14.1 14.1 15.4 8.7 13.6 15.4Revolving Credit Facility Availability 86.3 90.3 66.0 51.4 60.9 55.9 24.6 91.3 51.4 24.6 CREDIT METRICSBased on Adjusted Cash EBITDA:Net Leverage Ratio NM NM NM 6.1x 6.3x 6.8x 7.6xNet Senior Leverage Ratio NM NM NM 3.6x 3.6x 3.9x 4.4xCash Interest Coverage NM NM NM 1.7x 1.5x 1.4x 1.3xSource: Company reports and MTR estimates.(a) Income statement figures for 4Q05 and YE05 have been estimated to reflect the January 2006 sale of Crunch Fitness; Uses of Cash Flow figures for these periods have not been adjusted. YE04 figures have not been adjusted. 13
  14. 14. Figure 11 BALLY TOTAL FITNESS Projected Quarterly Operating Statement (In Millions of Dollars) DRIVERS 4Q06 1Q07 2Q07 3Q07 4Q07 2006 2007No. of Centers, EOP 379 379 379 379 379LTM Join.Members/LTM Avg Centers 2,900 2,900 2,900 2,900 2,900Avg. No. of Members (MMs) 3.52 3.52 3.55 3.53 3.48Avg.Mo.Recognized Rev. / Member $ 18.39 $ 19.54 $ 19.41 $ 19.26 $ 18.59Deferred Revenue Balance 810.3 802.7 787.9 768.0 745.8 INCOME STATEMENTNet Revenues Membership $ 194.3 $ 206.4 $ 207.0 $ 204.1 $ 194.0 $ 814.9 $ 811.5 Personal Training 29.3 29.3 29.6 29.4 29.0 122.2 117.4 Retail Products 8.4 10.6 10.3 9.3 7.9 41.9 38.1 Miscellaneous 3.7 3.7 3.7 3.7 3.7 14.8 14.8Total Net Revenues 235.7 250.0 250.6 246.6 234.6 993.8 981.7Membership Services 162.9 168.3 168.1 166.8 162.5 671.5 665.6Retail Products 10.2 9.9 9.6 9.3 9.0 42.3 37.7Advertising 10.0 15.7 15.7 15.7 10.0 58.0 57.0Information Technology 5.0 5.0 5.0 5.0 5.0 20.3 20.0Other G&A 14.5 14.3 14.1 13.9 13.7 65.7 56.0Depreciation and Amortization 12.9 12.9 12.9 12.9 12.9 53.8 51.6Total Operating Expenses 215.5 226.1 225.3 223.5 213.0 911.6 887.8Operating Income 20.2 23.9 25.2 23.1 21.6 82.2 93.9Addbacks: Depreciation and Amortization 12.9 12.9 12.9 12.9 12.9 53.8 51.6 Non-recurring Items 1.0 1.0 1.0 1.0 1.0 9.8 4.0 Change in Deferred Revenues (20.3) (7.6) (14.8) (20.0) (22.1) (58.9) (64.5)ADJUSTED CASH EBITDA $ 13.8 $ 30.3 $ 24.4 $ 17.0 $ 13.3 $ 86.8 $ 85.0LTM Adjusted Cash EBITDA 86.8 65.5 68.5 85.5 85.0Net Sales Growth, Y/Y -1.9% -2.0% -1.6% -0.7% -0.5% -0.8% -1.2%Membership Services as % Membership+P/T Revenue 72.8% 71.4% 71.1% 71.4% 72.8% 71.7% 71.7%Retail Products Operating Margin -21.7% 7.1% 6.7% 0.7% -13.5% -1.0% 1.2%Adjusted Cash EBITDA Margin 5.9% 12.1% 9.7% 6.9% 5.7% 8.7% 8.7%LTM Adjusted Cash EBITDA Margin 8.7% 8.8% 9.3% 8.7% 8.7% SOURCES AND USES OF CASHCash EBITDA $ 12.8 $ 29.3 $ 23.4 $ 16.0 $ 12.3 $ 77.0 $ 81.0Cash Interest Expense (19.8) (17.8) (19.9) (17.7) (20.0) (74.7) (75.5)Cash Income Taxes (0.1) (0.1) (0.1) (0.1) (0.1) (0.8) (0.4)Change in Operating Assets/Liabs (4.4) 1.6 (0.6) (0.7) (2.6) (2.5) (2.3)Capital Expenditures (12.5) (12.5) (12.5) (12.5) (12.5) (40.5) (50.0)Total Uses of Cash (36.7) (28.8) (33.1) (31.1) (35.2) (118.5) (128.1)FREE CASH FLOW $ (23.9) $ 0.5 $ (9.8) $ (15.0) $ (22.8) $ (41.4) $ (47.1)Revolving Credit Facility (60.0) - - 7.9 20.7 (35.0) 28.6Term Loans 70.0 - - - (0.5) 70.0 (0.5)9.875% Senior Sub Notes - - - - (292.0) - (292.0)Net Proceeds from Sale/Leaseback 10.0 - - - - 10.0 -Other - - - - - 5.3 -NET CHANGE IN CASH $ (3.9) $ 0.5 $ (9.8) $ (7.1) $ (294.6) $ 8.9 $ (311.0)Beginning Cash Balance 30.2 26.3 26.9 17.1 10.0 17.5 26.3Ending Cash Balance 26.3 26.9 17.1 10.0 (284.6) 26.3 (284.6) LIQUIDITYCash Balance $ 26.3 $ 26.9 $ 17.1 $ 10.0 $ (284.6) $ 26.3 $ (284.6)Revolving Credit Facility Availability 28.6 28.6 28.6 20.7 - 28.6 -Delayed-Draw Term Loan Facility 34.1 34.1 34.1 34.1 34.1 34.1 34.1TOTAL LIQUIDITY $ 89.1 $ 89.6 $ 79.8 $ 64.8 $ (250.5) $ 89.1 $ (250.5)Revolver Borrowing Capacity 44.0 44.0 44.0 44.0 44.0 44.0 44.0Amount Drawn - - - 7.9 28.6 - 28.6LCs Outstanding 15.4 15.4 15.4 15.4 15.4 15.4 15.4Revolving Credit Facility Availability 28.6 28.6 28.6 20.7 - 28.6 - CREDIT METRICSBased on Adjusted Cash EBITDA:Net Leverage Ratio 8.4x 8.3x 8.1x 8.7x NM 8.4x NMNet Senior Leverage Ratio 4.9x 4.9x 4.8x 5.2x NM 4.9x NMCash Interest Coverage 1.2x 1.2x 1.2x 1.1x 1.1x 1.2x 1.1xSource: MTR estimates. 14
  15. 15. Figure 12 BALLY TOTAL FITNESS Going Concern Analysis ENTERPRISE VALUE Future($ millions) Current Low Base High No. of Fitness Centers 379 284 284 284 Avg Net Proceeds per Exited Center (a) - $ - $ 0.5 $ 1.0 Members per Center 9,393 9,500 9,500 9,500 No. of Members (MM) 3.56 2.70 2.70 2.70 No. of Active Members (MM) 2.11 1.60 1.60 1.60 No. of Inactive Members (MM) 1.45 1.10 1.10 1.10($) MONTHLY MEMBER YIELD (b) Active Membership © 23.08 25.00 27.00 29.00 Personal Training 5.02 5.00 7.00 9.00 Retail 1.70 1.25 1.25 1.25 Total 29.81 31.25 35.25 39.25 Inactive Membership 13.15 14.00 15.00 16.00 Personal Training - - - - Retail - - - - Total 13.15 14.00 15.00 16.00($ millions) GOING CONCERN CALCULATION Annual Revenue (incl. Misc.) $ 998.5 $ 799.1 $ 889.1 $ 979.1 Cash EBITDA Margin 9.4% 12.0% 17.0% 22.0% Cash EBITDA 94.1 95.9 151.2 215.4 Multiple 6.0x 7.0x 8.0x Enterprise Future Value 575.4 1,058.1 1,723.3 Net Proceeds from Center Exits (a) - 47.5 95.0 Deferred Cap Ex / IT (75.0) (75.0) (75.0) Net Enterprise Future Value 500.4 1,030.6 1,743.3 WACC 6.5% 9.9% 14.4% Turnaround Period (yrs) 3.5 3.5 3.5 Present Going Concern Value $ 401.4 $ 741.5 $ 1,088.8 Current Net Debt 717.1 717.1 717.1 Current Equity Value - 24.4 371.7 Current Equity Value per share - 0.59 9.02Source: MTR analysis.(a) Net proceeds from center exits is estimated and is loosely extrapolated from Ballys 4Q06 sale/leaseback of four centers for net proceeds of $10 million. Bally owns fewer than 40 clubs, some of which have mortgages.(b) Current figures are estimated.(c) Includes membership financing fees. 15
  16. 16. Figure 13 Recovery Analysis (In Millions of Dollars) Distributable Value (see right) 874.4 Exit Enterprise Value (Base Case) LTM Cash EBITDA at Exit $ 120.0 VALUE ALLOCATION Multiple 7.0x Revolving Credit Facility $ 15.0 Enterprise Value at Exit $ 840.0 Term Loans 205.9 Delayed-Draw Term Loan 15.0 Distributable Value Capital Lease Obligations 2.1 Exit Enterprise Value $ 840.0 Other Secured Debt, estimated 6.9 Net Proceeds from Center Exits 47.5 Total Secured Claims 244.9 Deferred Cap Ex / IT (75.0) Value Remaining for Unsecured Claims 629.4 Cash Build (detailed below) 61.9 Total Distributable Value 874.4 General Unsecured Claims 10.5% Senior Notes plus pre- and post- Cash Build / DIP Financing petition interest + partial call premium 279.2 Filing Date 10/15/07 Trade Payables (non-priority) 9.5 Length of Bankruptcy (months) 18 Membership Rejection Claims 10.6 Rejected Lease Claims 35.5 Beginning Cash Balance $ 10.0 Other Unsecured Debt, estimated 6.9 Working Capital - Upfront (detail below) 19.0 Total Senior Unsecured Claims 341.7 Ongoing Cash Build (detail below) 29.4 Value Remaining for Subs 287.7 Subtotal 58.4 Interest Income less DIP Interest Expense 3.5 Subordinated Unsecured Claims Total Cash Build / (Burn) $ 61.9 9.875% Senior Sub Notes plus pre- and post-petition interest 351.3 Annual Cash Build / (Burn) (Notional) Value Remaining for Equity (63.6) Avg Near-Term Cash EBITDA $ 105.0 Post-Petition Interest, secured debt (22.8) BOND RECOVERIES Professional Fees (20.0) 10.5% Senior Notes Capital Expenditures (42.6) Initial Value Allocation $ 279.2 Working Capital - Value Allocaton from Sub Notes - Annual Cash Build / (Burn) $ 19.6 Total Recovery 279.2 FV recovery as % of face value 118.7% Working Capital - Upfront Breakdown Days Beginning Payables 25 9.875% Senior Subordinated Notes Payables Post-Paydown 5 Net Value Allocation $ 287.7 Payables Rebuild 30 FV recovery as % of face value 97.2% Change in Cash RECOVERIES SENSITIVITY ANALYSIS EBITDA: $ 80 $ 90 $ 100 $ 110 $ 120 $ 130 $ 140 $ 150Senior Notes 6.0x 91% 113% 119% 119% 119% 119% 119% 119% Multiple 7.0x 119% 119% 119% 119% 119% 119% 119% 119% 8.0x 119% 119% 119% 119% 119% 119% 119% 119%Sub Notes 6.0x 0% 0% 16% 36% 57% 77% 97% 117% Multiple 7.0x 3% 26% 50% 74% 97% 119% 119% 119% 8.0x 30% 57% 84% 111% 119% 119% 119% 119%Equity (Notional) 6.0x (342) (282) (222) (162) (102) (42) (64) (4) Multiple 7.0x (262) (192) (122) (52) (64) 6 76 146 8.0x (182) (102) (22) (24) 56 136 216 296Source: MTR analysis 16
  17. 17. Figure 14 BALLY TOTAL FITNESS Historical Quarterly Balance Sheet (In Millions of Dollars) 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06Cash $ 33.3 $ 29.5 $ 12.8 $ 17.5 $ 16.0 $ 15.2 $ 30.2Deferred Income Taxes - - - 0.2 0.3 0.2 0.9Prepaid Expenses - - - 20.8 18.4 18.3 17.8Other Current Assets 34.4 30.7 34.0 17.4 13.9 13.2 12.2Current Assets Held for Sale - - - 0.3 - - -Total Current Assets 67.8 60.2 46.7 56.2 48.7 47.0 61.1PP&E, net 353.2 340.9 335.2 314.7 311.1 303.1 294.1Goodwill, net 41.7 41.7 41.7 19.7 19.7 19.7 19.7Trademarks, net 9.8 9.7 9.5 6.9 6.9 6.9 6.8Intangible Assets, net 7.5 7.0 6.7 2.9 2.7 2.5 2.4Deferred Financing Costs, net - - - 29.5 50.6 41.2 34.9Other Assets 27.4 27.7 46.2 10.3 12.4 10.5 10.2Non-current Assets Held for Sale - - - 39.9 - - -TOTAL ASSETS $ 507.4 $ 487.2 $ 486.1 $ 480.1 $ 452.1 $ 430.9 $ 429.3Accounts Payable 49.7 43.3 47.4 57.8 49.8 49.2 48.2Income Taxes Payable 1.5 1.6 1.7 1.7 1.7 2.0 1.8Deferred Income Taxes 0.5 0.6 0.7 - - - -Accrued Liabilities 106.7 111.4 97.4 96.4 126.9 100.9 99.8Current Maturities of LT Debt 20.2 18.0 15.7 13.0 9.3 180.4 8.1Deferred Revenues 332.4 327.4 325.4 299.4 290.6 279.2 279.8Current Liabilities Assoc. w/Assets Held for Sale - - - 7.8 - - -Total Current Liabilities 511.0 502.4 488.3 476.2 478.3 611.6 437.8Long-Term Debt 731.9 727.4 743.8 756.3 713.3 542.8 739.2Deferred Rent Liability 108.8 105.9 102.9 87.3 90.0 89.9 89.1Deferred Income Taxes 0.8 0.8 0.8 1.4 1.7 1.7 2.4Other Liabilities 29.1 28.1 29.9 28.1 29.9 29.6 28.4Deferred Revenues 598.3 588.6 583.8 566.5 569.0 565.6 550.7Non-current Liabs Assoc. w/Assets Held for Sale - - - 28.0 - - -Stockholders Equity (1,472.5) (1,466.1) (1,463.4) (1,463.7) (1,430.0) (1,410.3) (1,418.3)TOTAL LIABS. AND STOCKHOLDERS EQUITY $ 507.4 $ 487.2 $ 486.1 $ 480.1 $ 452.1 $ 430.9 $ 429.3Source: Company reports 17
  18. 18. Miller Tabak Roberts Fixed Income/Convertible Important DisclosuresGeneral DisclosureMiller Tabak Roberts Securities, LLC observes the fixed-income securities research rules of the NASD, SEC, Ontario Securities Commission, and Investment Dealers Associationof Canada.The firm does no investment banking or investment management business with any person; however, the firm may from time to time act as broker or dealer on the account ofcompanies covered in its research reports. Neither the firm nor the author of this report is aware of any factors or relationships with respect to any personnel of the firm or itsaffiliates which would reasonably be expected to indicate a potential conflict of interest, including, without limitation to matters of compensation, ownership and service as anofficer, director or adviser, except as set forth in detail below.SRO DisclosuresCompensation DisclosureThe firm and its affiliates have not received compensation from the subject of this report, or persons known by this firm to be affiliates of the subject, in the prior twelve months forthe performance of services. Neither the authoring analyst, nor any supervisory or executive person with the ability to influence the content of this report, nor any member orprincipal officer of the firm, nor any of their respective households or immediate families, has received compensation from the subject of this report in the prior twelve months.Ownership DisclosureNeither the author of this report, nor any member of the authors household or immediate family, has any financial interest in any of the securities of the subject(s) of this report.Neither the firm nor its affiliates beneficially owns in excess of 1% of any class of the common equity securities of the subject(s) of this report.Officer/Director DisclosureNeither the author of this report nor any member of the authors household or immediate family, has served or serves as an officer, director or advisory board member of thesubject(s) of this report.Valuation MethodsPlease see page 9,10 of this report for an explanation of the methods of valuation utilized by the analyst.Risk FactorsPlease see page 11 of this report for an explanation of the risks utilized by the analyst.Dissemination of ResearchThe firm distributes research by electronic mail and U.S. mail, and at meetings with customers. Our research distribution lists include only employees and our customers, and aresegregated by market segment (convertible, high yield and distressed, and emerging market). From time to time we provide research to prospective customers and employees.We do not provide, or authorize the redistribution, of our research to the general public. We do not seek retail investors as customers.Market MakingAs of the date of this report, firm makes a market in some or all the fixed income and convertible securities (if any) of the subject(s) of this report. The firm reserves the right tostop, or start, making markets in any securities (including, without limitation, securities subject of this report), at any time, without notice.Suitability and ReliabilityAlthough the information contained herein has been obtained from sources Miller Tabak Roberts Securities, LLC believes to be reliable, its accuracy and completeness cannot beguaranteed. This report is for information purposes only and under no circumstances is it to be construed as an offer to sell, or a solicitation to buy, any security. Anyrecommendation contained in this report may not be appropriate for all investors. Additional information is available upon request.Research Ratings and DistributionBUY describes a security that we expect to provide a total return (price appreciation plus yield and any distributions) in excess of securities with a similar risk profile.HOLD describes a security that we expect to provide a total return (price appreciation plus yield and any distributions) comparable to securities with a similar risk profile.SELL describes a security that we expect to provide a total return (price appreciation plus yield and an distributions) below that of securities with a similar risk profile.NO RECOMMENDATION describes a security in which we believe there is insufficient information to support a specific opinion or we have expedited publication to address near-term customer needs for factual information. Absence of an opinion should not be inferred to mean a HOLD.Percentage of Securities Covered by the Firm Receiving this Recommendation since 1/1/04:(MTR undertakes no investment banking operations.)BUY 51.6%HOLD (5.9%)/No Recommendation (24.7%) 30.6%SELL 17.8%Other DisclosureVisitsThe author of this report has visited locations that may or may not be representative of a typical Bally fitness center.bAnalyst CertificationI, Ronald A. Rich, hereby certify that the views expressed in this report accurately reflect my personal views about thesubject company(ies) and its securities. I also certify that I have not been, am not, and will not be receiving director indirect compensation for expressing the specific recommendation(s) in this report.

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