Few restaurant chains have generated as much speculation during the pandemic as Chuck E. Cheese.
The chain generated some controversy after it was discovered that it created a secondary brand called Pasqually’s that sold its pizzas for delivery. More recently, however, its potential bankruptcy has some suggesting that it could close all of its stores.
Chuck E. Cheese is going nowhere, of course. Its parent company, CEC Entertainment, may not even file for bankruptcy. But it appears destined for a sale of some sort coming out of the pandemic. And the fact that multiple buyers are interested in the company demonstrates that many investors see its pre-pandemic profitability as too attractive to ignore.
CEC, which also owns Peter Piper Pizza, has been on the market in some form for some time. The company, which is owned by the private equity firm Apollo Capital Management, explored an initial public offering in 2017. Last year, it agreed to a merger with the shell company Leo Holdings in a deal that would have taken CEC public through the back door. That deal collapsed last year.
Its sales plunged during the pandemic, and the company in May hired advisors to analyze strategic alternatives. Earlier this month, reports emerged that it was considering a bankruptcy filing as part of this process.
The company’s primary problem is having $1 billion in debt, a legacy of Apollo’s 2014 buyout of the chain. The merger last year was intended to write off some of that debt.
Leveraged buyouts have killed a lot of restaurant companies. CEC had $87.2 million in interest payments last year on $912.9 million in revenues. Spending nearly 10% of your revenues on interest payments make it that much harder to make a profit, and CEC did not do that, losing $29 million.
But eliminate that debt and CEC has a lot of things going for it. As the attention paid to Chuck E. Cheese in recent months demonstrates, the company has plenty of name recognition. Also, its games tend to be highly profitable, and certainly more profitable than the business of selling food to consumers in a dine-in format.
The company’s adjusted EBITDA margin, or earnings before interest, taxes, depreciation and amortization, was 20.2% last year. That kind of margin is bound to attract buyers who see the company’s name recognition and decide to take a go of it.
And, indeed, some buyers appear to be considering it. One of them, according to the Wall Street Journal, is grocery magnate John Catsimatidis, who has apparently bought some of CEC’s bonds on the open market.
Another group of bondholders are apparently willing to invest up to $100 million and keep the chain out of bankruptcy.
These potential buyers are apparently taking a “loan-to-own” strategy, in which potential buyers scoop up debt on secondary markets, where it is traded at a discount by previous loan holders fearful of a company’s future. Those bond holders then leverage that debt to acquire equity in the company.
That appears to be a good way to buy a restaurant chain these days. Fortress Investment Group used such a strategy to scoop up Krystal and the former Craftworks chains. It should be a popular merger and acquisition strategy in the coming months as more chains appear to be headed for Chapter 11.
To be sure, there is usually a reason why companies’ debt trades at a discount. CEC’s credit rating has been downgraded since the pandemic, and it’s important to note that the company’s EBITDA margin was earned in a world before the coronavirus.
The pandemic appears likely to change the way consumers use restaurants for a long time. And it will hurt most chains rely heaviest on dine-in customers. Chuck E. Cheese certainly fits that bill.
Still, for these potential buyers it might be worth a shot. After all, kids will always want birthday parties. It may only be a matter of when their parents will be comfortable having them.