DC Advisory
Print Friendly, PDF & Email



Leo Holdings, Inc. (LHC), soon to be CEC (or something similar), may well represent an attractive opportunity, but we can’t tell (yet). At 7.5x calendar ’19 EBITDA, with net long term debt at about 3x ’19 EBITDA, the valuation is not expensive. It is in what we term the middle ground for situations that are promising, but have material question marks. We realize that when more of the questions are answered, if in the affirmative, the valuation will be materially higher. However, this has not been a publicly held company for five years, and financials before 2018 have not been provided (to us at least), so we do not currently have a strong opinion. As we learn more about the last five years, and evaluate the current initiatives, we will keep readers posted.


What goes around comes around. CEC Entertainment, operator and franchisor of Chucky Cheese, is coming public again five years after Apollo Capital took it private, augmented by the acquisition of Peter Piper Pizza shortly after going private. CEC is being plugged into a Special Purpose Acquisition Corp (SPAC) called Leo Holdings Corp. (LHC), trading at just over the $10 IPO price, which raised $200M on 2/13/18. LHC has moved to $10.34 today from about $9.70 last month, as negotiations were finalized. . An important element of this equation is the highly qualified management team, led since 2014 by CEO, Tom Leverton, previously CEO at TopGolf.

We have listened to the recent conference call in which the deal was described and we urge interested readers to do the same, from the Investor Relations portion of CEC Entertainment’s website. We will summarize here the current state of the Company, as described in the press releases and conference call, then provide what we perceive as the pros and cons of the situation.

Chucky Cheese – As of 12/31/18 there were 515 company operated, 26 domestically and 65 internationally franchised. The locations average 12,700 sq.ft., do about $1.6M in annual sales, of which 43% is food and beverage, the balance entertainment related. Customers visit three times/year.

Peter Piper Pizza had 39 company operated, 61 domestically and 44 internationally franchised. The locations average 10,100 sq.ft, do about $1.8M annually, 73% is food and beverage, 20% is  takeout. Customers visit two times/month. There are about 82 international franchised stores signed for future openings.

It was disclosed that remodels have been increasingly successful. At Chucky, $550k spent in 2017 generated an incremental 12 points of improvements over a control group, and 2018 did even better with 17 points of incremental improvement. This increment in sales is generating over a 40% return on investment, and will be rolled out aggressively going forward. It was mentioned that buildout costs for new locations  have been lowered by 14% since 2014, but the base was not provided.

In the twelve months ending 12/31/18, company operated locations generated $896M of revenues, up from $887M. Royalty revenue were $20.7M vs. $17.9M, which may include some company stores that were franchised as well as openings. Without going line by line, store level EBITDA at company stores was an impressive 27.6% of sales, down a touch from 28.5%, but that was before 5.4% advertising expense. It is noteworthy that depreciation was 11.2% in ’18 (down from 12.4% in ’17), much higher than normal restaurant companies. Pretax Operating Income in ’18 was $50.8M after $6.9M of asset impairment. Adding back $101M of Depreciation (11.2% of Revenues), $6.9M of Asset Impairment, and other Adjustments, Adjusted EBITDA was $175M.

There are lots of operating initiatives, but the most dramatic change in trend came subsequent to July when Chucky Cheese introduced an “All you can Play” strategy. Comps went from 1.1% in Q2,  to 2.2% in Q3, to 3.3% in Q4 and 7.7% in Q1’19. I don’t know whether these quoted comps applied just to Chucky or to both concepts combined. In any event, the progress has been relatively dramatic.

Looking forward, the Company expects to generate a 4% comp in 2019 and 2020, included an unspecified price rise taken late in ’18. Corporate EBITDA is estimated at $187M, with $152M of discretionary cash flow in 2019, $172M in 2020. Total net long term debt, post merger, will be about $588M, or 3x ’19 EBITDA. The total current Enterprise Value of about $1.4M is about 7.5x ’19 EBITDA.

Summary of Positive Investment Features of LHC (Leo Holdings, Inc.) – CEC Entertainment

  • (1) The Chucky venue is uniquely appealing to families. (2) The price value relationship is attractive, recession resistant  important in a slowing economy. (3) There are lots of opportunities to further monetize the brands (4) There is a long runway for growth, domestically and abroad, especially if recent sales gains can be maintained (5) Remodeling results are encouraging, providing a lever for higher sales and better ROI. (6) The sales improvement, if sustained, can be broadly transformative (7) The international franchised deals will add to royalties (8) With only 3 family visits per year, opportunity exists to build frequency (9) Substantial discretionary cash flow provides opportunity for debt reduction, stock buybacks, dividends, or acquisition.

Summary of Question Marks

  • Though store level EBITDA margins, as a percent of sales, are impressive, very few new stores are being built, indicating that the ROI on 10-12k square foot new facilities is less than compelling. Therefore new locations, at least domestically, will not be a large part of this equation, though higher sales would be magical (2) While same store sales progress the last several quarters are impressive, it remains to be seen whether this is a base that can be built upon (3) There are lots of pertinent unknowns. What has been the history from 2015 until early 2018? (3) Depreciation is unusually high, at 11-12% of sales. What has been capitalized, rather than expensed, and why? (4) Why has Apollo Capital chosen this (less than commonplace) IPO approach. What has precluded the sale to other private equity firms, or discouraged a qualified underwriter. What portion of the history, or the opportunity, have they seen that we haven’t?

Conclusion: Provided at the beginning of this article

The following additional information was posted twenty four hours after the above article.


We appreciate that CEC Entertainment’s investor relations firm, ICR,  brought to our attention the fact that historical performance is publicly available from 2015 through 2018, when CEC was owned by Apollo Global Mgt. (We previously called it “Apollo Capital”). We made reference in our initial summary report that there were many unknowns in terms of the operating history from 2014 until 2017, and said we would comment further when more facts are known and as the situation develops from here.

With further operating facts available, our conclusion remains the same, but we understand more completely why CEC chose to go public in this manner.

Elaborating on our previously stated question as to why other private equity firms or an established underwriter has not stepped up, so that CEC chose to use a SPAC to become publicly held. The answer is: (1) Same store sales have been flat from 2014 through 2018 (including the pickup in late 2018) (2) Corporate Adjusted EBITDA has been flat at $170-175M annually (3) Adjusted Corporate EBITDA margin has gone down steadily from 23.9% in calendar 2015 to 19.5% in calendar 2018 (4) The number of company operated stores has been “flat” over the five years (5) The franchised units has been up from 172 to 196 over the four years, we suspect most of it international, since that is promising at the moment. It’s easier to understand now why potential financial sponsors of this situation, looking at five years of flat to down results, would hesitate to make a big bet based on six months of improving same store sales.

We were wrong in our suspicion that a number of company stores had been refranchised in 2018, accounting for the 16% growth in franchise fees and royalties. That was primarily the result in a change in accounting treatment, new revenue recognition  treatment shat included $3.5M of advertising contribution from franchisees in 2018, which apparently included a YTY  increase, resulting in the increase from $4.152M to $4.815M.

Our summary report emphasized the introduction of the All You Can Play approach, in July 2018, at Chucky, since the improvement of same store sales started at that point. In fairness,  we encourage readers to read the company’s full annual 10k report which details many other marketing and operating initiatives which management no doubt has high hopes will contribute to ongoing sales progress.

A couple of other material issues are described in the ’18K:

(1) Capex has been, and will be, substantial. using up most of the “free cash flow” from operations. There are three classifications: Growth capital spend (includes the Pay Pass initiative, remodels, expansions, major attraction and new venue development, relocations, franchise acquisitions; Maintenance Capital Spend (game enhancement, general venue capital expansion, corporate expenditures: It Capital spend. Growth capital spend has been $55M, 51M and 31M from calendar 2016 through calendar 2018.  Maintenance capital spend has been 34M, 36M and 45M from ’16 through ’18. IT capital spend has been $10M, 7M, and 4M from’16 to ’18. The totals were $99M in calendar 16,  $94M in’17, $80M in ’18, Estimated capital expenditures will total $95-105M in ’19, a new high. This high level of capex explains why depreciation is so high, at 11-12% of sales. CEC is basically reinvesting their depreciation in capex, which over the long term is the correct strategy. This situation demonstrates why we have said many times that depreciation is not “free cash flow”, and EBITDA as a measure of operating performance doesn’t tell the full story.

(2)  There was a class action lawsuit instituted subsequent to the going private transaction in 2014, against Goldman Sachs and CEC, criticizing the treatment of the public shareholders. This lawsuit was dismissed in the fall of ’18, but the plaintiffs have indicated they plan to appeal. We can’t argue the facts of this case, and it’s been dismissed, but the outcome of ongoing litigation can never be assured.

We will continue to provide relevant material analysis is we learn more. Again, neither ourselves or our affiliates are long or short this situation, though that can always change. We have no reason to be negative, just realistic and as accurate as possible. We try to provide summary information here, as a timely service to our readers.




Roger Lipton.