3 Lessons for Investors to Learn from California Fitness’s Bankruptcy

For those of you unaware, the Hong Kong-based gym chain California Fitness had recently shut down its operations in Singapore, creating a big hoo-ha. This came after the chain had to end its business in Hong Kong after running into bankruptcy.

In a previous article, I had touched on three possible reasons behind California Fitness’ failure. In this piece, I thought it’d be useful to draw some lessons from the saga. Here are three:

1. Always conduct due diligence before investing

California Fitness’s previous owner, Wong Ping Kuen, had invested HK$50 million (around S$8.5 million) to buy the gym chain’s parent company, JV Fitness, in late 2015. After his purchase, he went on to pump in a further HK$20 million.

Problem was, Wong had bought the company without seeing a key audit document for JV Fitness. The audit document pointed out that JV Fitness had net liabilities of HK$335 million in 2014. In other words, the gym company owed HK$335 million more than it owns.

As we now know, Wong ended up paying for his oversight given that California Fitness has slipped into bankruptcy. His experience is a great reminder for stock market investors in Singapore: Due diligence is needed, whether you’re buying one share or an entire company.

2. Doubling down may be risky in some cases

As I mentioned in the first point, after Wong sunk in HK$50 million, he went on to inject a further HK$20 million to ‘save’ JV Fitness. He was in effect, doubling down on his investment.

But, the extra investment would have had very little effect. To put HK$20 million into perspective, California Fitness’s Hong Kong operations had monthly operational expenses of HK$37 million. Wong’s extra investment of HK$20 million was not even sufficient for the gym to stay open for a month.

Thing is, doubling down can be risky if the wrong investments are chosen, which Wong unfortunately did. Commodities trader Noble Group Limited (SGX: N21) serves as a good example in our stock market.

Noble’s shares were trading at a price of S$0.65 each on 22 July 2015, after falling by 54% since 22 July 2014. But, the company’s shares are worth just S$0.17 apiece today, a sharp decline of 74% from where they were just a year ago on 22 July 2015.

An investor who bought Noble’s shares on 22 July 2014 and then doubled down on 22 July 2015 would be sitting on some very painful losses now.

3. Cheap companies may end up as a disaster too

One of JV Fitness’s former directors, Cheng Kar-tat, tried to lure Wong into buying the company. Wong said: “[Cheng] told me that it’d be a bargain to buy that many outlets at a price of HK$50 million.”

We now know that the bargain wasn’t to be. It’s a good reminder for us stock market investors that companies can be cheap for a good reason – not every ‘cheap’ looking company turns out to be a legitimate bargain.

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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 writer Chong Ser Jing doesn't own shares in any companies mentioned.