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What Investors Can Learn from the 3 Reasons behind California Fitness’s Bankruptcy

California Fitness is a gym operator with clubs in Singapore, Hong Kong, and China. It’s a gym that some in Singapore are likely to be familiar with.

But just last week, the gym shut its Hong Kong operations. A few days later, California Fitness declared on Wednesday that all its gyms in Singapore will be closed with immediate effect. Provisional liquidators have been appointed for the gym’s Singapore business.

So in effect, California Fitness has gone bankrupt. I thought it’d be interesting to have a look at the possible reasons behind the gym operator’s demise as there may be useful learning points for stock market investors in Singapore. After all, buying a stock is equivalent to owning a small piece of a business.

After doing some research, here are three likely reasons I found that could have contributed to California Fitness’s fall from grace:

1. High debt

California Fitness is a private company, so its financial accounts are not readily available to the general public.

But one of its previous owners revealed that the gym had some net liabilities of HK$335 million (around S$60 million) in 2014. In other words, California Fitness had more liabilities than assets – to the tune of HK$355 million.

California Fitness’s experience with debt highlights the risks that can come with excessive borrowing.

2. Poor business model

California Fitness’s business model was to price memberships at a very low rate and hope to make up for the low subscription fees by pushing members to sign up for pricier training packages. In Hong Kong, California Fitness’s gym memberships could cost as little as HK$100 per month while personal fitness lessons can go for as high as HK$800 per hour.

Journalist Jason Ng from the South China Morning Post describes it as the “Gilette business model,” where razors (gym memberships) are sold on the cheap while profits are made by selling expensive razor blades (training packages).

But, California Fitness had problems with selling the training packages to members in its Hong Kong gyms, thus breaking down the model.

3. Wrong strategy to deal with competition

The gym business is highly competitive with many players wanting to gain market share from each other.

In Hong Kong at least, California Fitness resorted to even more pressure-selling tactics on its existing members when it begun to lose its more valuable members to rival gym chains. This would have likely eroded the gym’s brand.

One particular industry in Singapore that could see competition heat up pretty soon is telecommunications. Right now, there are three operators in the industry – that would be Singapore Telecommunications Limited (SGX: Z74), StarHub Ltd (SGX: CC3), and M1 Ltd (SGX: B2F) – but a fourth player may be joining the party soon. Investors may want to watch how the incumbents respond to any potential increase in competitive threats.

California Fitness’s brand-damaging strategy to deal with competition provides an important lesson for investors in the stock market: Is a company dealing with competitive pressures in a damaging manner, such as gouging existing customers to prop up profit margins in the short-term? If so, that may not be beneficial over the long run.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Ong Kai Kiat doesn’t own shares in any companies mentioned.