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As background for the following piece, readers may want to peruse our basic descriptive piece, dated 3/27/18, available here:

It’s hard to miss the news that John Schnatter, founder, largest shareholder with 29% of the equity, and company spokesperson, has resigned from the Company. The circumstances have been widely documented in all kinds of press reports, and we believe have been amplified by the fact that everything in America is “politically charged”.

Opinions vary widely as to what the future holds for the Company and the stock. There are lots of obvious reasons why customers could shy away from the pizza, further weakening the sales trend that already turned down in Q1’18 and further penalizing the stock that is trading at 22x calendar ’18 estimates of earnings. Though the dividend yield is 1.75% at the current stock price, some could question whether a new CEO will maintain the dividend when earnings are down sharply, especially when long term debt is over $500M against negative equity as a result of stock buybacks. Uncertainty is always a substantial negative when evaluating the desirability of owning a particular stock.

The argument has been made perhaps no other consumer products company has been so dependent on the image of its founder, “Papa John” Schnatter who has consistently appeared on TV, with Peyton Manning and others, touting the “Better Ingredients, Better Pizza”. Observers have recalled that Steve Ells, Howard Schultz, Dave Thomas, and Jimmy John have been the face of their Brands, but not to the extent of Papa John.

However, we suggest that the “face” of PZZA has more been “Better Ingredients, Better Pizza” than the personality of John Schnatter. How long it takes PZZA to rebound from this PR nightmare is anybody’s guess, but nobody died (as with Jack in the Box), went to the hospital (as with Chipotle) or lived through the operational problems at Starbucks when Howard Schultz had stepped aside. Jimmy John’s sandwich shop have continued to prosper even after Jimmy’s hunting habit was criticized by the anti-gun lobby.

At Papa John’s, to the contrary, even after same store sales turned down by 5.3% in Q1’18, not only did nobody die, and we never heard that the product had deteriorated, the stores were dirty, delivery service was poor, or there was negligence from an operating standpoint. The delivery pizza business has always been competitive, especially in light of Domino’s technological lead, so the PR problem relating to the NFL, and the delay of rolling out a new campaign could well have cost a few points of same store sales performance. As for the latest press coverage relating to Schnatter’s inappropriate remarks, the reaction of his Board, and his own attitude toward the episode,  we believe it will fade as the 24 hour news cycle moves on. Ninety days from now, the concern at Papa John’s will be about new products, new marketing, how the search for a new CEO is coming along, and technological innovation that can help catch up with Domino’s. One can argue that the departure of John Schnatter will work out for the best in the long run because the brand will no longer be so dependent on a single personality’s reputation.

Meanwhile, the stock, while not what we would consider dirt cheap, is selling at a much lower valuation than its peers. There are over five thousand stores in 45 international countries and territories. The long term debt at $568M is only a little over 3X trailing twelve months EBITDA. Other well established franchise companies are carrying debt at 5-6X EBITDA, so PZZA could be leveraged further to buy back common stock or taken private at a premium to the current price. The current enterprise value at 12.5X trailing twelve month EBITDA and 22X calendar ’18 estimated earnings (even if those estimates come down) is materially cheaper than peer asset light franchising companies such as DNKN (17.9X and 26.0X), QSR (20.5X and 23.9X), DPZ (25.6 and 33.7), and WING (42.5X and 61.2X). DIN and JACK are selling at comparable multiples as PZZA but have had operating issues. YUM’s valuation is also comparable but is much more comples, with three brands, very dependent on China for future growth, and has an enterprise value fifteen times as large with 45,000 (9X that of PZZA) systemwide restaurants.

In summary, we think there are a number of ways to win here, and there is enough substance to avoid much downside risk over the intermediate to long term. There are hundreds of billions of dollars of private equity capital looking for a home, and everybody loves “asset light”, “free cash flow” stable situations.  Anything can happen in today’s environment that sometimes allows for outsized stock moves in unexpected, and sometimes irrational direction. Aside from possible short term volatility, we think there is more upside potential than downside risk with PZZA (“Better Ingredients, Better Pizza”) at this time.

Roger Lipton


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Our full descriptive report dated May 3rd


and our update on June 19th  ( )

after PLAY stock had run up 38% in one month, presumably because of enthusiasm from the Virtual Reality introduction, can be reviewed.

It seems to us that the hope surrounding a recovery in both amusement and F&B comps revolves around the recent introduction of the Virtual Reality game/ride based on Jurassic Park, and timed to coincide with the latest movie. Now that the game/ride has been in the stores for about a month, we have visited locations at both peak and light dayparts, so we present here our “anecdotal” observations.

In general, the game/ride is often located on the periphery of the amusement section, manned by at least one attendant to check people in with their special $5 ride card (which inconveniently has to be purchased separately at the front desk), seat them, and help them adjust their helmet/goggle. While many riders express enthusiasm as they are bounced around, “scan”, not “kill” the dinosaurs, and get wind blown on their face, we don’t find a great level of excitement by the onlookers. It seemed to us that the “buzz” seems less around this particular attraction than around many other amusements, even if there is a waiting line. While the attendants have indicated that some do come back, the departing riders seemed to have enjoyed it, but don’t seem to be wild about another ride immediately. Quite a few people wander by, look it over, and keep walking. Not many are intrigued enough to linger, though no doubt some will buy their $5 card and come back.

On June 19th, we went through a calculation to show that, based on four sessions per hour ($20.00 for the four seats) and five hours per day, $146,000 per year could be generated or 1.5% of sales in a $10M location. We have observed a waiting line at peak periods, but much lighter use at mid-week times (both day and evening) and some locations are closing it down at 8pm. (This possibly conflicts with a report by SunTrust Robinson Humphrey last week that their field research shows “PLAY is offering this game every day and most hours”, whatever “most” means.) Since the ride is only 5 minutes, we think more like eight sessions per hour (including changeover) is realistic at peak times, but we think an average usage of perhaps 2.5 hours per day (with all four seats occupied) would be a reasonable approximation. That would be 32 riders per hour for 2.5 hours or 80 riders per day generating $400 per day or the same $146,000 per year. We could obviously be off in this rough approximation, but we believe the order of magnitude is close enough. Even if we are low with this approximation over the first several weeks, and we might be, considering the successful Jurassic Park movie premier and the TV support from PLAY, we doubt that it will be any higher than this just a few months from now. One of the key observations by an attendant was that the frequency of use is not building materially, so the necessary word of mouth to build long term usage doesn’t seem to be in play. The “game” aspect of this game/ride does not seem compelling. Riders can “scan” the dinosaurs, and create a personal competition to outscore your co-riders, but the skill level or satisfaction from this aspect is hard to pinpoint. We have taken the ride, and the visuals are impressive. We are admittedly far from the “target audience” but feel like “you’ve seen one dinosaur, you’ve seen them all”.

An important consideration here is whether this new amusement, the updated software when it comes, and other Virtual Reality offerings will reverse the now established negative trend in the amusement section. Management also hopes that customers will stay longer, and spend more, as they wait for their turn with the VR experience. Our guess is NO and NO. Management, and optimistic analysts, have expectations that an exclusive “Halo” game (not VR) to be introduced in late July and additional chapters of Jurassic Park (for late summer and early fall) will re-establish momentum. We have no insight relative to amusements to come, but we don’t believe the Jurassic Park Virtual Reality game/ride, and its future iterations, if they are comparable to what has so far been introduced, will prove to be a “game changer”.

One last thought: Neither management, nor the analytical community, is talking about what the new VR platform has cost to develop, and what the depreciation schedule looks like. There is also a labor component on an hourly basis that is not a factor with most of the other amusements. An attendant, or even two, at peak times, is not a huge factor, but the necessary attendant even when there is light usage becomes a noticeable expense. There has to be an obvious attendant standing by, at virtually every moment of operation.

Roger Lipton

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As of December 31, 2017, YUM consists of three operating segments:

  • The KFC Division which includes the worldwide operations of the KFC concept.
  • The Pizza Hut Division which includes the worldwide operations of the Pizza Hut concept.
  • The Taco Bell Division which includes the worldwide operations of the Taco Bell concept.

YUM has over 45,000 restaurants in more than 135 countries and territories. The Company’s three concepts: KFC, Pizza Hut, Taco Bell develop, operate and franchise a worldwide system of restaurants. Units are operated by the concept or, by independent franchisees or licenses under the terms of a franchise or license agreement.

Each concept has proprietary menu items and emphasizes the preparation of food with high quality ingredients, as well as unique recipes and special seasonings to provide appealing, tasty and convenient food at competitive prices.

A brief description of each concept:


KFC restaurants across the world offer fried and non-fried chicken products such as sandwiches, chicken strips, bone-in chicken and other chicken products marketed under a variety of names. KFC also offers a wide variety of entrees and side items suited to local preferences and tastes. Restaurant décor throughout the world is characterized by the image of the Colonel. KFC operates in 131 countries and territories throughout the world. As of year-end December 31, 2017, KFC had 21,487 units; 97% of which are franchised.


Pizza Hut features a variety of pizzas which are marketed under various names. Each of these pizzas is offered with a variety of different toppings suited to local tastes. Many Pizza Huts also offer pasta and chicken wings; including approximately 5,900 stores offering wings under the Wing Street brand.

Pizza Hut operates in 106 countries and territories throughout the world. As of year-end 2017, Pizza Hut had 16,748 units; 99% of which are franchised.


Taco Bell specializes in Mexican-style food products including various types of tacos, burritos, quesadillas, salads, nachos and other related items. Taco Bell offers breakfast in its US stores.

Taco Bell operates in 27 countries and territories throughout the world. As of year-end 2017, there were 6,849 Taco Bell units primarily in the US; 90% of which are franchised.


In February 2018, YUM entered into an agreement with GrubHub, Inc., the leading online and mobile take-out food ordering company in the US. Under this agreement YUM has acquired $200M of GRUB equity. GrubHub will provide support in the US for the KFC and Taco Bell branded online delivery channels along with access to GrubHub’s online order platform, logistics and last mile support for delivery orders and point of sale integration to streamline operations.


 As of December 31, 2017 (10-K 2017), YUM’s global revenues were $5.9 Billion, consolidated systemwide sales were $11.6 Billion and margins on Company operated restaurants averaged 16.0%.

The following table breaks down systemwide revenues, systemwide sales and operating profits by divisions.

Operating Profit:

KFC Division – The increase in operating profit was driven by same store sales growth, international net new unit growth, lower G&A and higher renewal and transfer fees.

Pizza Hut Division – The decrease in operating profit was driven by increases in advertising costs associated with TV Pizza Hut US Transformation Agreement.

Taco Bell Division – The increase in operating profit was driven by same store sales growth, lower G&A and net new unit growth.


On October 11, 2016, YUM announced their Strategic Transformation Plans to drive global expansion of their Brands: KFC, Taco Bell, and Pizza Hut following the YUM China separation.

Major features of the Transformation and growth strategy involved being more focused, even more highly franchised and increasingly efficient.

Key Features:

  • More Focused. Four growth drivers form the basis of YUM’s strategic plans and repeatable business model to accelerate same-store sales growth and net-new restaurant development at KFC, Pizza Hut and Taco Bell around the world over the long term. The Company is focused on becoming best-in-class in:
    • Building distinctive, relevant and easy Brands.
    • Developing unmatched franchise operating capability.
    • Driving bold restaurant development.
    • Growing unrivaled culture and talent.


  • More Franchised. YUM intends franchise restaurant ownership to be at least 98% by the end of 2018.


  • More Efficient. The Company is revamping its financial profile, improving the efficiency of its organization and cost structure globally, by:
    • Reducing annual capital expenditures to approximately $100 million in 2019;
    • Lowering general and administrative expenses (G&A) to 1.7% of system sales in 2019; and
    • Maintaining an optimized capital structure of ~0x Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) leverage.


From 2017 through 2019, YUM planned to return an additional $6.5-$7.0 billion to shareholders through share repurchases and cash dividends. They intend to fund these shareholder returns through a combination of refranchising proceeds, free cash flow generation and maintenance of their five times EBITDA leverage. YUM anticipates generating proceeds in excess of $2 billion, net of tax, through their refranchising initiatives.


On October 31, 2016 (the distribution date) YUM completed the spinoff of their China business (the separation) into an independent publicly traded company under the name YUM China Holdings, Inc. (YUM China). On the distribution date, YUM distributed to each of its shareholders one share of YUM China common stock for each share of common stock held as of the record date. The distribution was structured to be a tax-free distribution to US shareholders for federal income tax purposes in the United States. YUM China’s common stock trades on the New York Stock Exchange under the symbol YUMC. After the distribution, YUM does not beneficially own any shares of YUM China common stock.

Concurrently, with the separation, a subsidiary of the Company entered into a master license agreement with a subsidiary of YUM China for the exclusive right to use and sub-license the use of intellectual property owned by YUM and its affiliates for the development and operation of KFC, Pizza Hut, and Taco Bell restaurants in China. Prior to the separation, YUM operations in mainland China were reported in their former China Division segment results. As a result of the separation, the results of operations and cash flows of the separated business are presented as discontinued operations in YUM’s Consolidated Statement of Income and Consolidated Statement of Cash Flows for periods presented prior to the separation.

YUM  CHINA (Investment Day Presentation October 29, 2017) – Highlights

As of the Investor Day Presentation, it had been one year since the YUM China spinoff from YUM. Joey Wat, the new CEO of YUMC, outlined the path forward for China’s largest restaurant chain in the years ahead.

  1. Growth Potential

YUM China has over 7,700 KFC and Pizza Hut restaurants in China; thus, being the largest chain in China. Management thinks there is no reason for there to be fewer of its restaurants in China than in the U.S.

  1. It’s Hard to Build in China

Business isn’t easy in the world’s most populous country. Building restaurants is challenging as real estate isn’t readily available. YUM has built a dining empire in spite of this headwind and is well entrenched in Chinese culture management beliefs. This gives YUM China an advantage over its competitors.

  1. Focus on the Core Portfolio

KFC and Pizza Hut have been in China over 30 years. By focusing on these core Brands rather than bringing in Taco Bell, they can better meet the changing Chinese consumer which has created the need to update the existing chains.

  1. Digital and Delivery Innovation

Another area surrounding the revamping of KFC and Pizza Hut is Digital and Delivery. YUM China has launched a new “Super App” and membership program keeps diners engaged with the respective Brands, alerting them to deals, and day part promotions and the option of ordering and digital payments.

Catering and Delivery are also a growing part of business in China. This area has grown in recent years due to the growth of dual income households.

In late 2017, over 5,100 of the 7,700 plus locations offered delivery. Delivery sales were running 14% of sales, up from 9% in 2016.

  1. A Restaurant Chain Built for the Future

YUM China planned to drive world leading  food and restaurant technology innovation, a trend that is just beginning in the U.S.

YUM China – Full-Year Highlights (2017 10-K)

  • Same store sales grew 4% with an increase of 5% at KFC and 1% at Pizza Hut.
  • Total system sales grew 8%, including growth of 9% at KFC and 7% at Pizza Hut, excluding F/X.
  • Total revenues were $7.1 billion, an increase of 6% (8%, excluding F/X).
  • Opened 691 new restaurants during the full year, bringing total store count to 7,983 across more than 1,200 cities.
  • Restaurant margin improved 1.5 percentage points to 16.8%, primarily driven by same store sales leverage and aided by the impact of retail tax structure reform.
  • Operating Profit was $785 million, an increase of 23%. Excluding Special Items, Adjusted Operating Profit was $782 million; an increase of 20% (23%, excluding F/X) driven by strong sales and margin expansion.
  • Net Income was $403 million, a decrease of 20%. Excluding Special Items, Adjusted Net Income was $564 million; an increase of 20% (24%, excluding F/X).
  • Effective tax rate was 47.0%, or 26.9% excluding Special Items.
  • Diluted EPS was $1.01, a decrease of 26%. Excluding Special Items, Adjusted Diluted EPS was $1.42, an increase of 11% (15%, excluding F/X).


Under the authority of YUM’s Board of Directors, they repurchased shares of YUM’s Common Stock from 2014 through 2017. All amounts shown below exclude applicable transaction fees.

  • Includes the effect of $45 million in share repurchases (0.7 million shares) with trade dates prior to December 31, 2016 but settlement dates subsequent to December 31, 2016.

On November 17, 2016, YUM’s Board of Directors authorized share repurchases through December 2017 of up to $2.0 billion, of which $1.9 billion was executed, an average price of $72/share. In Q1’18, $528 million was purchased, an average price of $81/share, leaving $972 million on the current authorization.

Recent Developments: Per Q1’18 Corporate Release and Q1 Conference Call

Core operating profit growth was flat, as expected. Profits from refranchising, appreciation of the GrubHub investment, a lower tax rate, and FX profits, accounted for the gain in reported earnings per share. There was also a revenue recognition change in GAAP treatment of payments to and from franchisees, including advertising fund treatment. Operating profit, ex F/X was even at KFC, up 2% at Pizza Hut, down 6% at Taco Bell. Same store sales were +2, +1, and +1, respectively. Net new units were +4, +2, and +4%, respectively.

Per the Conference Call:

Full year guidance of flat operating profit remains intact, including the headwind of 6-7 percentage points from refranchising and G&A savings, along with 2-3 points from the revenue recognition changes. At KFC: Turkey is doing especially well with SSS growth of 10%, 27% over two years, and 23 new units opened there in the last 12 months. India had Q1’18 SSS of 10%, the 8th qtr. In a row of gains, and 50 gross new units opened in the last 12 months. The US had flat SSS in Q1’18 and continues to innovate with new products. KFC in the UK changed distribution partners which disrupted sales patterns, yet to be fully corrected as of early May. At Pizza Hut: US SSS were up 4%, with net new units down 2%, though new unit development was flat sequentially which reversed a three year decline. Digital ordering, better advertising including the new NFL relationship, emphasis on delivery, are all helping. At Taco Bell: There was 4% net new unit growth, and the US successfully lapped 8% SSS last year with introduction of Nacho Fries. The GrubHub relationship has great potential, as all POS operations are being full integrated between KFC, Taco Bell & GrubHub.

In relation to the long term plan, 144 units were refranchised in Q1, 52 KFC, 43 Pizza Huts, and 49 Taco Bells, bringing the total franchise mix to 97%. All in, 500 gross new units were opened, 239 net new units, which is a sequential  acceleration. Long term debt was refinanced in April, reducing annual interest expense by about $5M and moving total debt closer to 5 times EBITDA. Overall, the long term objective is to get to 7% system sales growth, which will require both an uptick in net new units as well as same store sales.

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This morning’s release by Restaurant Brands International relating to initiatives at Tim Horton’s, its now admittedly troubled subsidiary that contributes about half of its corporate EBITDA tells us a lot about the prospects for the RBI over the next few years. The now well publicized lawsuits by the franchisees has obviously gotten the attention of their parent company. RBI management acknowledged today that “some things could have been handled better, but management has changed……in an effort to bolster that relationship….and it’s just going to be a matter of time to prove out that this is a new day, and there’s a very sincere interest in working collaboratively with all the franchisees”.

Recall that Tim Horton’s is the largest contributor to RBI’s cash flow and earnings, and the distribution margins, along with G&A efficiencies at TH have been major contributors to the overall corporate progress. To be precise, thecost of sales” at TH distribution has gone from 99.2% in 2014, on a straight line, to 83.3% in 2015 to 78.0% in 2016, 76.6% in 2017, finally up ticking modestly to 77.9% (up 160 bp YTY) in Q1’18. (Might the franchisee complaints have anything to do with the recent uptick?). At the same time, TH segment G&A went from 4.6% in ’14, to 3.2% in 2015, to 2.6% in 2016 with a modest uptick in calendar ’17 to 2.9%. In just the last two years ending 12/31/17: total corporate adjusted EBITDA, grew $480M, up 28.8%. The Tim Horton segment grew $229M, representing 47.7% of the total increase (up 11.8% in ’16, slowed to 5.9% growth in ’17, and decreased 5.0% in Q1’18). Burger King contributed $143.6M of the two-year increase (29.9% of the corporate total) and Popeye’s contributed $106.9M, all of it in ’17.  The improvement in CGS at TH contributed $122M of that. G&A efficiencies at TH contributed another $5.9M.  So the better distribution margin and G&A “efficiencies” accounted for 127.9M or 55.8% of the two year EBITDA improvement at Tim Horton’s.

The first quarter of Q1’18 showed total corporate adjusted EBITDA up by 12.2% or $54.5M. That included an increase of $27.0M at BK, or 14.4%, a contribution of $38.5M from Popeye’s versus nothing a year earlier, and a decrease of $11.0M at TH with non-recurring adjustments (to be discussed later) flowing through TH’s first quarter results.

The lawsuits will be settled at some point, there may or may not be monetary damages applied to QSR, but that will be one time in nature, easy to overlook by investors. Especially in light of the operating initiatives outlined just today, including delivery, advertising of all day breakfast and a new kids menu, roll out of a new loyalty program, profit margins and EBITDA at TH will be very difficult to improve from the current level and could even come down.

Summarizing the entire situation, RBI management is very smart, but they are not magicians. Popeye’s has a great deal of potential, but corporate efficiencies may be more difficult to employ here, especially considering the history at Tim Horton’s and Popeye’s is too small to move the corporate needle by much. Even though Burger King’s contribution could continue to grow at a 15-20% rate (not without their own set of challenges), TH will be hard pressed to grow from here. There is an increasingly aggressive competitor called Starbucks, Dunkin’ Donuts is not going away and McDonald’s does all day breakfast and all three have a head start against the latest programs at Tim Horton’s. We view QSR as an adequately leveraged (and valued) single digit growth company over the next several years.

Company Overview  

Restaurant Brands International was created in December 2014 from the merger of then Burger King Worldwide (BKW) and Tim Hortons International (THI).  Early in 2017, Popeye’s Louisiana Kitchen was added to the portfolio. Headquartered in Oakville, Ontario, the company is now the operator and franchisor of over 24,000 Burger King (BK), Tim Horton (TH), and Popeye’s (PLKI) brand restaurants generating system-wide sales of over $29B in over 100 countries.  All three brands are virtually 100% franchised and are operated as independent segments from their traditional headquarters (BK in Miami, FL, TH in Oakville, Ontario, and Popeye’s in Atlanta, GA.) to preserve their respective heritages.

BK is the second largest burger chain by locations (after McDonald’s), and third largest by sales (after Wendy’s).  The menu features its signature flame-grilled hamburgers, chicken and other specialty sandwiches, french fries, desserts and beverages.  In 2017, the system generated a little over $20B in sales from approximately 16,800 units (about 48% in the US).   The principal sources of the BK segment revenues are franchise royalties (normally 4.5% in the US) and fees, since the chain is nearly 100% franchised.  The remaining revenues derive from the 12% of BK locations leased or subleased to franchisees and from sales at 52 company units. QSR does not discuss the development costs of a new Burger King, but the largest franchisee, Carrols Restaurant Group (TAST) does. As described by TAST in their 10K, the initial cost of franchisee fee, equipment, signage & other interior costs is approximately $400,000. Additionally, their cost of land ranges from $500k to 900k and the cost of building and site improvements generally ranges from $850k to 1,025k. Using the midpoint of these numbers, the total development cost would be $2,037,000 – a fairly high total cost for a unit that averages $1.3 million. In spite of a sales/investment ratio (fully capitalized) well below the long accepted 1:1 objective, the Burger King system continues to thrive.  We attribute TAST operating success and BKs continuing unit development to the fact that many units were built years ago (with lower development costs), the long term operating success of the system that attracts build-to-suit development, and of course the very low interest rate environment of the past decade. It is also worth noting that QSR does not indicate how many units are “traditional” versus “non-traditional” such as kiosks, food courts, etc. We suggest that not too many units in the US in particular, are built from the ground up these days, and fewer still will be built if interest rates rise. Of course, in any event, BKs primary expansion will be overseas from this point forward.

Tim Hortons quick service restaurants have a menu that includes premium blend coffee, tea, espresso-based hot and cold specialty drinks, fresh baked goods, (donuts, cookies, muffins, pastries), grilled paninis, sandwiches, wraps and soups. It generates about $6.7B in system-wide sales from about 4,700 units (about 80% in Canada).  The TH segment generates revenue from sales of supplies and equipment and packaged products to retailers; from property revenues from the 80% of properties leased or subleased to franchisees; from franchise royalties and fees; and from sales at 24 company restaurants.

While BK’s supply operations are largely outsourced to approved third parties (procured in the US by a purchasing entity jointly managed with franchisees), TH operates a significant supply system to procure, store and distribute raw materials, and supplies to most of its Canadian restaurants (US units are supplied by a third-party distributors).  It operates 2 roasting facilities for blending coffee for its Canadian and US restaurants (and retail), and it operates facilities for the manufacture of icings and fills for its products, though all donuts are purchased from a third-party supplier.  TH has a variety of franchise agreements which largely reflect the extent of its ownership interest in franchised locations.  Franchisees who lease land and/or buildings from the company typically pay a royalty rate of 3%-5% plus rent of 8.5% to 10.5% of sales.  Where the premises is owned by the franchisee or is subleased from TH or leased from a third party, the royalty rate is higher; and where the franchisee essentially operates a fully outfitted company property (i.e. includes equipment, signage and trade fixtures), a rate of about 20% covers royalties and rent.

Popeyes Louisiana Kitchen, Inc. (PLKI), QSR’s most recently completed acquisition, develops, operates and franchises over 2,700 quick service restaurants with system-wide sales in 2016 of $3.4B in 48 states, D.C., and 25 foreign countries.  Popeyes specializes in strongly flavored Louisiana-style offerings, particularly chicken, but also fried shrimp, red beans and other regional specialties. PLKI is nearly entirely franchised (98% of system’s units).  The US stores averaged about 2.7k square feet with AUV’s of $1.4M in 2016.  US franchisees generated EBITDAR of $340K on average (23% margin).  From 2008 through 2016, comps averaged 3.2% (though slowing in 2016, and further in 2017), which was the major factor in the 4.9% CAGR in the AUV’s and EBITDAR margin expansion of over 500bps (along with new store performance).  In 2016 revenues were $268.9M ($108.3M company stores, $154.8M from franchise royalties & fees, $5.8M rent from franchised restaurants), EBIT at $74.5M (27.7% margin), EBITDA of $84.6 (31.5% margin) with free cash flow of $56.0M (20.8% margin).  Aside from the strong financial track record, QSR said Popeyes leadership position in the chicken QSR category (26.5% market share in 2016, up from 25.5 in 2015) fits well in its brand portfolio.  Also attractive, obviously is the “asset light” highly franchised structure, with further growth potential, especially overseas.

3G Restaurant Brands Holdings LP (3G RBH), with 43.6% voting rights, provides 3G effective control of QSR.  3G is an international activist fund specializing in consumer brands and a frequent partner with Berkshire Hathaway, which provided $3B to finance the TH acquisition in the form of 9% preferred equity, redeemed in late ‘17.  The 3G playbook is to acquire and fix up mature brands (e.g. Anheuser-Busch InBev SA/NV (Euronext Brussels: ABI) and The Kraft Heinz Co (NYSE: KHC), but unlike most activist investors, 3G is a patient investor, with an investment horizon measured in years.  In order to judge QSR’s future, including incorporation of PLKI, it’s worthwhile to understand 3G’s historical initiatives in turning around BK and TH.

Burger King – For at least a decade before 2010, management and franchisees had been in growing conflict over repeated failures to revive the brand. The conflict peaked with a franchisee lawsuit charging management with driving system sales with promotions (specifically $1 Double Cheeseburgers) that were good for royalties but costly for franchisees.  Into this poisonous atmosphere, 3G stepped up to acquire the company.  The fund, which had been instrumental in assembling global beer behemoth AB InBev, also had established a reputation as a long-term investor that achieved strong returns by turning around flagging brands, often with aggressive cost cutting and management changes.

When 3G acquired the company in October 2010, it promptly installed partners onto the board and inserted itself in operations, staffing key executive positions with partners from a deep bench of proven managers from other investments.  It instituted cost controls centered on zero-based budgeting (every budget item must be justified afresh each year).  It moved quickly to restore trust with the franchisee community by giving them a larger voice in the decision-making process and by making franchisee profitability a top priority. This included simplifying the menu and eliminating money-losing promotions.  To this end, new menu introductions and LTO’s aim more for flavor variations on legacy standards (e.g. “Angry Whopper”) than additions that are more operationally challenging. Management has, however, attempted to fill gaps in the core menu with added or improved items such as salads, chicken strips, beverages and desserts.  These additions aim to broaden brand appeal beyond its traditional young male customer to include women and seniors.  Management also attacked overhead bloat, again using the zero-based budgeting which requires justification of both historical and incremental expenses.  The payoff was a reduction in G&A from $356M in 2010 to about $160M by 2015 and 2016. The dramatic reduction in G&A, while improving profitability at the franchisor level, has not been without controversy, however. Some franchisees feel that support has been compromised along with the reduction of expenditures on behalf of the franchise system. The response of the franchisor has predictably been something like “in every large system some franchisees are happier than others, but our priority continues to be the profitability and financial health of every franchisee”.

Additionally, the company accelerated a refranchising initiative that had been under way, becoming virtually 100% franchised by 2013 (from 89% at acquisition in 2010).   Importantly, the 1,200+ refranchised units were placed with the system’s strongest hands, such as Carrol’s Restaurant Group (NASDAQ: TAST), BK’s largest franchisor and an exceptional operator.  As of year-end 2017, only 26 company stores remained, which the company has intended to retain principally for test purposes.  The new management also launched a store re-imaging initiative of the US and Canadian stores.  The company provides incentives, principally in royalty and advertising fund relief, to accelerate the pace of remodeling.  According to management, the remodels cost about $300K per unit and drive a 10%-14% sales lift.  At the end of 2017, we estimate over 70% of the stores have been remodeled.

Finally, it launched a strong international push, particularly into under-penetrated regions.  In a departure from BK’s traditional franchise agreements, the company aims to accelerate international growth through master franchise joint ventures (MFJVs) and master development agreements with experienced local partners.  The structure of these agreements varies significantly, but in general local partners are granted exclusive regional rights to develop or sub-franchise units.  The partners commit to aggressive development targets and franchisee support. They usually pay discounted upfront fees and royalty rates (vs the usual 5% rate) based on the characteristics of each market.  The partners make substantial upfront equity contributions, while the company usually obtains a meaningful minority stake in the MFJV’s with little or no capital contribution. Of course, this enhanced growth comes with financial and brand risks, principally because the company’s operational control over sub-franchisees is weaker than with direct franchisees.  QSR believes it protects against these risks by entering agreements with experienced, well-capitalized partners supported by strong management teams.

So far, results at Burger King have been impressive. The unit growth rate has more than tripled in the 8 years since the acquisition vs the preceding 6 years—from 1.5% CAGR, to 6.5% unit growth in ’17.  (In validation of the MFJV strategy, the international MFJV’s have generated most of BK’s 3,800+ unit growth since acquisition, notably: Brazil >600 in 2017, up from <150 in 2011, China >650 units in 2017, up from <90 in 2012 and Russia >400 units in 2017, up from <90 in 2012.) There has been an increase over six years in AUV’s from $1M to $1.4M and a 30% increase in profitability (according to management).

Tim Hortons  At the time of the December 2014 merger, the TH brand did have its challenges, but overall performance was strong.  In the five years before the merger system units grew at a 5% annual pace, while quarterly same store sales (20Q’s) averaged 3.1% in Canada and 4.1% in the US, turning negative only once, in Q1’13, and then only modestly (-0.3% Can & -0.5% US).  Meanwhile, operating margins were consistently around 20% and free cash flows averaged around $300M, with average FCF margins ~11.0%.   The company’s challenges were (and are) to protect the brand’s Canadian dominance (>40% traffic share), particularly from the encroachments of SBUX, to expand in the US where it has struggled to gain critical mass, and to exploit the large untapped opportunity it sees on other continents (~1% system units are located outside North America).  In Canada, management’s principal focus is on solidifying its lunch and breakfast dayparts and improving its coffee business.  In the US it closed 27 underperforming stores in New York and Maine during 2017, to concentrate instead on building density in priority markets in the Midwest.  To that end, it has signed development area agreements with partners in the Cincinnati and Columbus, Ohio DMAs and the state of Minnesota.  Internationally, it also concluded MFJV agreements with partners in Mexico, Great Britain and the Philippines.

The company has focused on G&A which, at $78.9M, was down 15.4% in 2016 over 2015, the first full year of operation under new management, then rose back to $91.0M in 2017.  (The reductions may be more significant when compared with the pre-acquisition G&A levels, > $150M USD, but it isn’t clear this is an apples-to-apples comparison.)  While TH’s capital-intensive supply chain operations seem ripe for management overhaul, nothing on that front has been reported yet.  While management disclosed that though it will be maintaining capital incentives to remodel stores, which it deems an important priority, it seems this is aimed more at the smaller franchisees.  Separately it has announced it will be reducing capital support for new stores, principally the leased and subleased locations.  This shift to a more asset-light corporate structure is consistent with its strategy for seeking out larger, well-capitalized MFJV partners to drive growth.

As of the end of 2017, with only 3 full years of TH ownership under its belt, the results were promising, but have proved to be controversial. This “progress” at the franchisor level has apparently not been shared at the franchisee level, at least as described in a number of lawsuits filed by something like half of the Canadian franchisee base, and US franchisees as well. They claim that, while their sales progress has stalled, QSR has raised the price of supplies and food, contracting franchise margins further. Additionally, the franchisee lawsuit claims that advertising contributions have been “misallocated” somehow to reduce corporate overhead. Since most of the improvement from 2015 through 2017 within the TH operating results came from “distribution” and to some lesser extent G&A efficiencies, the strained relationship with franchisees is obviously a material development. While management may claim that they went through similar “growing pains” after acquiring Burger King, there was not a similar distribution segment, and BK has built sales more successfully than TH, which takes the sting out of higher costs. As strong as MCD has been vs. BK, SBUX is an even more powerful dominant competitor in the coffee segment.

Restaurant Brands International Consolidated On a consolidated basis, QSR’s EBIT in 2016, at $1.666.7M was up about 90% over a pro-forma $875.6M USD for 2014 (i.e. assuming TH was owned the entire year), driving 1,950bps of operating margin expansion to 40.2% from 20.7%. Calendar year 2017 showed a further increase of 4.1% to $1.735M.

As a result of its acquisition strategy, QSR is leveraged at the top of the range for peer “pure play” franchisors. Total net debt at 3/31/17 of $11.4B was about 5.1X adjusted TTM EBITDA of $2.25M versus 4-5X more typically for its franchising peers. The current dividend, yielding 2.86% requires over $500M of the free cash flow and management has allocated C700M over the next four years to help TH franchisees with re-imaging stores.

QSR: Current Developments – Per Q1’18 Corporate Release and Conference Call

“Adjusted Diluted” earnings, on a “New Standard” were $0.66 vs. $0.67 a year earlier, which is the number that seems to be carried by analysts and the reporting services. GAAP earnings, reported on a “Previous Standard” were $0.66 vs $0.36. The difference in “Standards” relate (among other things) to franchise agreement amortization, amortization of deferred financing costs and debt issuance costs, reflection of advertising fund contributions and expenses, supply chain related revenues at TH, and foreign exchange impact. Forgive us for presenting these technical features of the reporting approach, but this is an unusually complex financial structure, obviously requiring these various methods of disclosure.

In any event, the “organic” EBITDA for Q1’18 was up 5.0%, including Popeye’s, driven primarily by an increase in revenues at BK and PLK, partially offset by a decrease in supply chain related revenues at TH. A breakdown of Adjusted EBITDA by Segment is roughly as follows: Tim Horton’s was down 4.3% to $250M, Burger King was up 14.4% to $215M and Popeye’s was up $80% to $40M.  We’ve “mixed and matched” these numbers between the “adjusted New and Previous Standards”, but, in spite of the reporting complexity, we have confidence that the direction and order of magnitude is indicative of the operating trends. More simplistically, comps were down 0.3% at TH, up 3.8% at BK, and up 3.2% at PLK. Systemwide sales growth was up 2.1% at TH, up 11.3% at BK and up 10.9% at PLK.

Per the conference call: Tim Horton’s reported flat sales in Canada and softness in the US. Early in the call, management addressed the tension in the TH franchise system, describing the press as mischaracterizing RBI intentions, citing inaccurate information that “usually reflect a purposely negative tone dictated by a group of dissident franchisees”. Changes have been made in communication strategy, both with the press and the franchisees, which will presumably bear fruit over time. First quarter sales at TH reflected softness in coffee sales, partially offset by breakfast foods. The results of some new lunch products are encouraging.  A new Brand President at TH, Alex Macedo, previously President of Burger King, North America, is leading the effort. A “Winning Together” plan has been put in place, based on restaurant experience, product excellence and brand communications. A new TH restaurant design, called the Welcome Image has been put in place at 10 locations, with an encouraging customer response. Management “admittedly should have done more of this in the past……we are confident that this plan will help us achieve long term sustainable comparable sales growth for TIMs.”

We won’t dwell here on the Burger King discussion. Delivery and technology applications are among the current programs. Suffice to say that results within this segment continue to be fine and the positive prospects are undiminished.

Popeye’s is focusing on delivery and technology as well, and international franchising is a major focus, Brazil being the first master agreement. With EBITDA of $40M in Q1’18 out of close to $500M for RBI in total, substantial improvement within this segment will not affect short to intermediate term overall results in a major way.

The single largest “elephant in the room”, supply chain margins at TH, was addressed when the question was asked relative to the Q1’18 decline at TH in supply chain revenues. Management responded that “we passed on some supply chain savings to our franchisees through a reduction in pricing in the second half of last year. We continued to maintain this pricing for franchisees, so margins in the first quarter of 2018 are relatively consistent sequentially with the margins from the second half of last year. Looking ahead…. we expect the organic growth profile at TIM’s to improve throughout the year.” Maybe.

Our conclusion regarding the prospects for QSR is provided at the beginning of this article.



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SEMI-MONTHLY FISCAL/MONETARY UPDATE – You Don’t Want to Know How the Sausage is Made !!

The general capital markets were fairly unchanged in June, gold bullion was down 3.4%. Interestingly, the gold mining stocks were down hardly at all. The gold mining ETFs, GDX and GDXJ, were almost exactly flat. The three major gold mining mutual funds were down an average of 0.8%.  Every indication is that substantial quantities of physical gold continues to move from West to East but the “paper” market, including options and futures, dominates the day to day price. The mining stocks acted noticeably better, when normally they could be down (or up) at least twice the price of gold. There was documented accumulation of GDX and GDXJ which is often a precursor of an upward move in bullion and an even larger move in the miners.


In just the last few days, the following articles support our long held conclusions that a great deal of turmoil in the worldwide financial/capital markets is ahead, which we believe will cause our Fed and other Central Banks to “cave” and move back to monetary accommodation, which will spark a new run in gold related securities:

(1)    First Quarter GDP latest revision shows 2.0% real growth, down from the last estimate of 2.3% and the previous estimates in the high 2s. As for Q2’18, the latest NY Fed estimate is 2.7%, a lot lower than the highly touted 4% or more the Atlanta Fed and others have been talking about.  Even if Q2 comes in north of 4%, real GDP growth over the last year or so has been no higher that the “high 2s”, not much higher than the average of 2.3% average of the last 8-9 years and that modest increase from the “low 2s” is largely due to more government spending financed by more government debt and this is not healthy or sustainable over the longer term.

(2)  The global yield curve, the spread between 1-3 year and 7-10 year government securities, has just gone “negative”, per the JP Morgan GBI index. This yield curve “inversion” most of the time presages a recession within 6-12 months.

(3)    With the Chinese stock market down 20% from its early ’18 high, a Chinese government think tank (backed by the Chinese Academy of Social Science) has warned of a “financial panic” in the world’s second largest economy, caused by leveraged purchase of shares (as in 2015), rising US interest rates, trade tensions with the US, bond defaults and liquidity shortages in China. The Chinese government should “be willing to step in with full financial support, rather than taking piecemeal steps” the study said. Just yesterday, the Financial Times reported that the China Development Bank was tightening loan approvals for its “slum development” policy, a program which has provided (a cool) $1 trillion to homebuyers since (only) 2016. The implications of the monetary manipulations by the world’s second biggest economy are huuuge!. Our take: a much higher gold price will accompany future economic “adjustments” that will have been exacerbated by governmental interventions.

(4)    Russia has cut its US Treasury holdings over 50%, from $102.2B to $48.7B in just four months from 12/17 to 4/18. While these numbers are small relative to the trillions that China and Japan hold, US Treasury securities held by all foreigners, as a percent of their reserves, has declined from 64.59% in 2014 to 62.7% in 2017, so they are steadily diversifying away from dollar related securities. Gold, as a share of foreign exchange reserves has held steady. Central Banks have continued buying hundreds of tons annually, as they have since 2009. They bought 116.5 tons in Q1’18, the most in any Q1 since 2014 and up 42% YTY.

(5)    The Wall Street Journal, several days ago, headlined “UK Central Bank Warns on Debt Risk”. The article said “it sees pockets of risk to the stability of the financial system including US corporate borrowing, risky loans in Britain, foreign-currency lending and emerging markets….as central banks step back from the easy-money policies of the past decade and trade tensions escalate.” You can google the full article, but we don’t make this stuff up.

(6)    Just under the previous article, on June 28th, the headline read: “Fed’s Ability to Fine-Tune Interest Rates is Tested”. The Fed lost “control” of the markets in ’08, salvaged the situation with trillions of financial accommodation. In some ways, the problems are larger today and the Fed, with their hundreds of PHD economists, has had a poor forecasting record.

(7)    While many observers underplay “systemic” risks in today’s financial markets, leverage in derivative securities is larger, non-financial corporate debt is at a new high (exceeding the last high in ’08), ETFs made up of cap-weighted securities will have little liquidity in a downdraft, which especially could apply to high yield fixed income ETFs. Rising default rates on student loans and subprime auto loans, sharply rising US deficits, underfunded social security and federal health care obligations are all problematic whether the market overlooks these trends for the moment or not. The momentum in capital markets can turn, literally, on a dime. If someone doesn’t think the Chinese monetary manipulation has provided at least the possibility of “systemic risk” to the worldwide economy, they are living on the wrong planet.

(8)    The equity markets are highly valued by historical standards. Interest rates are still very low which means bond prices also have substantial downside risk, especially the high yield sector where investors around the world have been “reaching for yield” for a decade.


Many of the above factors have been in play over the last four or five years, building over decades, and the timing of the unwinding of the worldwide credit bubble continues to be uncertain. It’s been said that in every crisis, you can look like a fool either before the event or after. Another advisor, when asked how a crisis develops, said “very slowly and then very quickly”. Just recently, we asked a highly regarded economist and market strategist, who agrees with us, when the turn will come. His response was as good as any: “On any given Sunday”. When it happens, a great number of people will say “how could I have not seen that?”

Roger Lipton


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Dine Brands Global, previously Dinequity, operator and franchisor (franchisor mostly) of the IHOP and Applebee’s brands, has had its share of challenges in recent years. Applebee’s has been in a “dogfight” within the competitive “bar and grill” or “neighborhood pub” segment, competing against the likes of Red Robin, Chili’s, now bankrupt Ruby Tuesday’s and the up and coming fast casual burger concepts such as Shake Shack and Five Guys. IHOP has been battling the resurgent Denny’s as well as other family dining operators.

From a long term strategic standpoint, it is an interesting question as to whether hundreds of millions of dollars should have been spent in stock buybacks and a high dividend, when the needs to invest in systems to support two franchised brands are so obvious, especially in retrospect. This situation has essentially provided a “teaching moment” to private as well as public investors relative to the need to invest part of the presumed “free cash flow” of these “asset light” franchising companies to support and protect the long term value of the brand. Franchise systems do not prosper and grow without ongoing investment to keep the brand current.

Applebee’s suffered most, as franchisees were left to their own devices to protect market share. The system got behind the curve in terms of product development, service initiatives including mobile app technology, delivery capabilities, new production systems, labor saving approaches, and more. While not “shooting the lights out”, IHOP has been the more consistent performer in recent years, mostly sustaining traffic trends while competing with the resurgent Denny’s chain and other breakfast oriented operators.

There have been many moving parts at both brands. Most of them have been typical within the industry: product development, service improvement without excessive labor, mobile app and online ordering, delivery, curbside pickup, replacement of broadcast by social media and others. Two particular unusual initiatives caught our eye in the last week or so, namely: Remote ordering at Applebee’s, to be immediately consumed at a restaurant table reserved at a particular time, and : IHOP becoming IHOB (“B” for “Burgers”), first announced as permanent, apparently now adjusted to be a temporary attention getter.

The Applebee’s innovation, ordering a meal at a particular time, to be consumed in the restaurant, on the surface seems appealing, to certain “on the go” customers as well as the restaurant operator who can make better use of the real estate by turning tables faster. However, the devil is in the details (as usual) and there seem to be a lot of elements that can go wrong,  and cost more customers than the strategy will attract. (1) If the customers don’t arrive on time the food will be waiting and deteriorating, even under warming lights (2) The food must be ready on time, and the table also, or the customer will very quickly become disenchanted with this newly offered service (3) The meal’s “staging” may vary by customer, some wanting everything on the table at once, others wanting the meal in segments, and the non-standard time between courses could confuse operations (4) Table service is still a requirement, but the customers may reduce the tip which will not encourage the wait staff for these tables (5) The whole dining “experience” will differ from normal, almost becoming a different business within the restaurant, potentially upsetting operations that are trying to serve the standard guests.  Overall, there seems to us to be lots of room for error here, and this approach will not be tolerant of mishaps. Under normal circumstances, a few minutes one way or another, or some portion of the experience that is not just right, will not upset guests. This approach, however, is supposed to be time saving and reduce stress, which too often may not be the case. Our opinion: Give it a shot, if you must, but be prepared to move on. Too many of the new ideas at Applebee’s are working well. It ain’t broke right now, so let’s not snatch defeat from the jaws of victory.

IHOB?? – It better be a darn good burger, at a darn good price. We hear that more than a few loyal IHOP customers are reacting negatively to their favorite pancake house becoming a burger joint. As we understand the developments, DIN backed off from changing the name of the chain to just using IHOB as a promotional device when customers started expressing themselves. While it seems like an obviously desirable strategy to build on the dinner daypart which it seriously underutilized, hardly any chains have ever been successful in building new dayparts that are not natural attractions. McDonald’s did it with breakfast but it took them over ten years and hundreds of millions of dollars. IHOP has more than a fifty year old identity as a breakfast destination, with pancakes as the signature item. If they happen to serve a really great burger, the customers will figure it out over time and tell their friends. To point out the obvious, flour and water provides a lower food cost than beef, so the last thing IHOP wants to do is have an existing customer order a burger rather than pancakes. Another thing that must be avoided is confusion of the customer, and the name change, if only temporary, may turn off more existing customers than attract guests to this newly self proclaimed “burger authority”. (Red Robin has already assumed that nomenclature.)

In summary: We admire the creative thought process, and there has been a lot of it lately at DIN, especially productive at Applebee’s which is apparently moving in the right direction. However, we think the new ordering (and dining) option at Applebee’s is far from a game changer and could be disruptive. IHOP’s burger gambit runs the risk of confusing (and losing) some customers, so we have our doubts here as well. That’s the problem these days in the restaurant industry. There is no easy way to differentiate your commodity. We’re fond of saying that the only hope is to create, and then build upon, a hospitality “culture’ that is strong enough to get the consumer off the couch, away from their computer or TV set, for a literal and figurative “taste” of the real world.

Roger Lipton

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Dave & Buster’s, which we have written described extensively, most recently on May 3rd, calling it a “battleground” between the bulls and bears.

PLAY ran up in price from $39 to about $47 in the two weeks prior to the earnings report on June 11th. This was based not on the widely expected soft first quarter, but expectations for better results after their new “VIrtual Reality” ride/game is introduced by mid-June. This ride/game is based on the new Jurassic Park movie coming out on June 22nd..

The uninspiring earnings, the comps, the traffic, the margins, the guidance based on the reported first quarter were basically in line with expectations. However, with 16% of the outstanding stock sold short, the absence of even worse results, and the possibility that the new virtual reality presentation will reinvigorate results propelled the stock from $47 to $55. This kind of volatility has become routine as stocks often respond in a dramatic fashion to the supply/demand relationship in the marketplace more than a reasoned response to the actual results. The price action depends more on which multi billion dollar hedge funds are long or short, than the company’s reported results and future guidance.

While the overall business continues to be highly profitable with lots of room for further growth, t is clear that both segments of the business (Amusements and F&B) need to be refreshed, especially in light of increased competition. Food and Beverage has been declining as a percentage of total sales, and Amusements have recently had negative comps as well. Turning around the “culture” on the F&B side of the business will clearly take time. The current question becomes: to what extent can the new Virtual Reality platform help the  Amusement segment?

The Jurassic Park offering is a “Game/Ride”. While I haven’t experienced it, I have seen the installation. It is a moveable platform with four seats. The ride takes about ten minutes, costing $5 .00 per person, so $20.00 for each ten minute session is generated. If we assume five minutes of downtime between sessions, to unload and load new customers, there would be four sessions per hour, generating $80.00 per hour of revenues. There will be one installation per store, the possibility of two in the high volume locations. If we assume an average of five hours per day, that would be $400.00 per day, $2,800 per week, or $145,600 or revenues per year. Obviously, two installations could provide double that. Setting aside the cost of developing this platform, or the expense of “manning” the ride/game, the potential revenues of $145,600 per year per installation, is not a “game changer” in and of itself. It can generate roughly around 1.5% of sales in a $10M facility, which is a modest positive contribution to the Amusement segment which has recently turned down by mid single digits. Assuming the platform is embraced by customers, the key question then revolves around (1) the “staying power”, the frequency, the length of time before customers lose interest (2) the need, and cost, of refreshment of the software, assuming the basic platform can be reconfigured (3) the auxiliary benefits: will new customers come in, will existing customers come more frequently, will all customers stay longer (waiting for their turn) and spend more money, etc.etc.

We indicated in our report of May 3rd that one of the potential positives here is the introduction of attractive new Amusements, including the pending Jurassic Park platform. We do not pretend to know how Jurassic Park, or follow on Virtual  Reality offerings will evolve. We suspect Jurassic Park will be popular at first, possibly very popular. How long it lasts, and management’s ability to build on its potential success is impossible to know. PLAY could well prove to be a dynamic short term investment, even after this recent 38% price appreciation, but I wouldn’t “put it away and forget it”. Stay tuned.

Roger Lipton

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Not much has changed fundamentally in the last couple of weeks. The economy is doing somewhat better, aided materially by increased government spending. Capex investment by corporations is still lagging, housing and auto activity are slowing as interest rates rise, the deficit moves predictably higher as health care costs, higher interest rates on the US debt, and much higher defense spending are long term facts of life. Though consumer sentiment and business optimism is much improved over the last year or so, consumers are still stretched financially and the possibility of a tariff “war” continues to unsettle capital markets and the business community.

Gold and gold miners have been quietly consolidating over the last few months, but had an uncharacteristically volatile day, on the downside last Friday.  That just happened to be an option expiration day, which often can generate unusually large price changes.  This type of volatility, heavy trading volume, especially at illiquid times of the day (“middle of the night”), and at inflection points for the technical chartists, used to be fairly frequent occurrences, in the gold markets in particular. It seemed like every time there was especially bullish news for gold, the price would get hit, with heavy volume in futures and options at times of the day when nobody “in their right mind” would be trying to liquidate a “real” physical position unless they were consciously trying to manipulate the short term price of “paper” gold. In any market where there are futures and options trading, aggressive traders of the “paper” who don’t have to immediately deliver the physical “underlying”, can trigger “stop loss” orders at certain predictable prices. Over time, these distortions get corrected, but the short term volatility can be unsettling. Longer term physical buyers use these distortions as buying opportunities, and it is no coincidence that China, India, Russia, and others have continued to be major buyers of physical gold, demonstrating their diversification of assets away from US Treasury issued securities. China and Russia, in particular, have clear reasons to undermine confidence in the US Dollar, improving trade and investment in the Yuan and Ruble, and a higher gold price would do just that. They understand the nature of the worldwide currency debasement and are doing what they can to cope, though our politicians lack the political will to do the same.

Friday, the fifteenth of June, was an option expiration day which, in and of itself, can increase price volatility. It cannot be coincidental that, after India and China had closed their physical trading markets, large quantities of gold futures contracts were dumped into the CME’s Globex computer trading system just before the Comex gold pit opened for the day (at 8:20 a.m. EST).  The chart below shows the price action, and note especially how the trading volume exploded higher from the typically much lower levels. IN ONE HOUR, from 8-9am EST, futures contracts representing 9.03 million oz. of gold traded, which is slightly more than the 9.01 million oz. of TOTAL GOLD STOCK in the Comex vaults, and 17.7x the number of gold oz. “available to deliver”. For the entire day, 49.5 million oz. worth of “paper” traded, the equivalent of about six months of entire worldwide production.

It does not seem farfetched to conclude that nobody in their right mind would choose this particular time of day and month to “dump” such a large quantity of “real” gold, unless the seller wanted the price lower. This has happened before, and an artificially low short term price gave way to much higher prices in the near future. No individual seller is larger than the worldwide market, over a reasonable period of time. A buyer at an artificially high price had better be prepared to buy “it all”, because they will own it. A seller, at a price lower than the true market would allow, had better have an enormous inventory because the buyers will keep coming. It will be interesting to see how this latest incident of seemingly irrational volatility gets resolved.

Roger Lipton

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