CHUCKY CHEESE – (LHC) PUBLIC AGAIN – MORE INFORMATION !!
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 that 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., There have been a total of 32 new franchised locations opened in the last three years, 16 in 2016, 8 in ’17, 8 in ’18., mostly international we assume, and a total of 10 closed, for a net addition of 8 over three years.
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. Also, the company made the point on the conference call that acquisitions could also be part of the capital allocation process, to build upon the existing synergies of managing multiple brands.
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