22 February 2019
California Fitness had very limited cash flow each month, which was not enough to cover the rental costs of its outlets. Photo: Xinhua
California Fitness had very limited cash flow each month, which was not enough to cover the rental costs of its outlets. Photo: Xinhua

What really went wrong with California Fitness

California Fitness, the largest gym operator in Hong Kong with about 100,000 members, has closed all its 12 outlets across the city.

Many can’t understand why the company would suffer huge losses when it was earning a lot in the form of club membership fees. 

The business may be profitable, but most of the income is just “sunk profit”.

I was once a member of California Fitness, and spent around HK$10,000 to purchase a three-year membership.

Whenever I could find a two-hour break from work, I would hit the gym on Queen’s Road Central.

Generally speaking, I was quite satisfied with the services, and I thought spending several hundred dollars a month for membership was good value for money.

I also resisted staff who offered me all kinds of promotional packages, and so I did not have to pay for anything other than my membership fees during those three years.

Like me, most members went for the gym’s medium- or long-term membership plans, and they availed themselves of the free facilities and services offered by the gym.

Some would drop by the gym every day, taking a shower and reading newspapers in the air-conditioned rooms. The gym functioned like a clubhouse in a private housing estate.

However, different people pay differently. About a decade ago, one needed to spend only around HK$10,000 for a permanent membership, and they only had to pay a few hundred dollars each year to enjoy all the facilities.

By comparison, there were members who had to spend ten times that amount for a three-year package, which included various services and courses as well as pre-payment for vitamin supplements.

Marketing staff and private trainers were given a lot of flexibility in packaging the offers to suit the needs of different customers.

However, during my three years as a member at the Central gym, I wasn’t able to encounter a customer who accepted any of the special packages offered by the staff and trainers.

That was the problem. Most of the active members of California Fitness had bought medium- or long-term membership plans, and had little or no need to spend extra to use the facilities and services.

As a result, California Fitness had very limited cash flow each month, which was not enough to cover the rental costs of its outlets.

Court documents revealed that the chain operator lost HK$34 million in 2015, HK$43 million last year, and more than HK$14 million in the first five months of this year.

It’s now left with only HK$16 million in cash.

In the meantime, the gym chain has collected more than HK$1 billion in pre-payments from its members. That could have generated a lot of income even if they just put the money in a bank.

In business, there is such a thing as “sunk profit”, which is profit that can no longer be used or taken into account when considering business prospects.

Sunk profit can be transferred to the parent company or shareholders through various means.

It was learned that the ownership of the gym chain has changed hands twice over the last four years.

The precursor of California Fitness, 24 Hour Fitness, was sold to a private equity fund in 2012.  The private equity then sold it to its current owner in December 2015 for HK$30 million.

The company has incurred a debt pile of HK$130 million, and the current owner is now complaining that the seller had concealed the company’s real financial situation from him.

Anyway, the HK$1 billion sunk profit had gone down the drain during those two deals over the last four years.

The company has been left with a huge debt and limited cash flow. It’s fairly difficult to reverse the situation even if a “white knight” comes along.

This article appeared in the Hong Kong Economic Journal on July 14.

Translation by Julie Zhu

[Chinese version 中文版]

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Hong Kong Economic Journal columnist

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