The Covid-19 pandemic has been devastating for the location-based entertainment (LBE) industry, which includes a broad variety of venues commonly referred to as family entertainment centers (FECs). The lockdown of LBEs/FECs resulted in zero revenue for months and continues in many parts of the country. Meanwhile expenses for rents, debt payments, utilities, property maintenance and at least keeping top management on board continued. Few FECs, especially the independents and small chains, had the capital to pay those expenses while they waited to reopen. Some obtained Payroll Protection Program (PPP) loans, but they were rarely sufficient to compensate for all the ongoing expenses for such a long time period. Where FECs were permitted to open, they had the added expenses of making improvements to meet safety, sanitation and distancing requirements, plus there is new ongoing labor expense to continually sanitize and clean, screen guests before entering, etc. Worst of all, revenues come nowhere close to pre-Covid levels, so in most cases revenues were below breakeven, further feeding the cash drain. Dave & Buster’s reported in early June that their reopened stores had average same-store sales at 37% compared to the same time last year. Even their best performing units were at 55% of 2019 levels. An analysis I did in early June found that D&B needed 70% of 2019 same store sales to breakeven cash flow wise.
On June 24th, the pandemic brought down a 43-year-old FEC institution when CEC Entertainment, Inc. (CEC), the parent company for Chuck E. Cheese’s children’s entertainment centers and Peter Piper Pizza eatertainment restaurants, filed for Chapter XI Bankruptcy reorganization. CEC owned and operated 515 Chuck E. Cheese’s and 40 Peter Piper Pizzas. Additionally, they had 97 franchised Chuck E. Cheese’s and 89 franchised Peter Piper Pizzas that are not included in the bankruptcy.
CEC was operating on thin ice before the coronavirus hit. They had an excessive debt burden of almost $1.0 billion ($948M or $1,708K per owned unit), caused when Apollo Global Management took them private in 2014. In addition to debt, the Chuck E. Cheese’s were seeing declining same store sales. During the good 2019 economy, they reported a $28.9 million net loss on $912.9 million in revenue. They were paying nearly 10% of their revenues on interest payments ($87.2 million).
In my June 2 blog, I calculated CEC’s cash flow breakeven revenues. They needed 97% of comparable same-store revenues to just pay the bills. During the lockdown, they only had revenues of 10% of previous, primarily from a delivery-only virtual kitchen brand they created, Pasqually’s Pizza & Wings,that they operated out of their kitchens undercover through third-party restaurant delivery apps such as Door Dash and PostMates.
At the time of their bankruptcy filing, CEC owed nearly all their landlords several months of past-due rents and more than 50 landlords had filed lawsuits to evict them. The bankruptcy filing stopped those lawsuits, which CEC says was one of the reasons for filing, as they didn’t want to lose the stores.
Under Chapter XI bankruptcy, companies can reject real estate and other leases (basically cancel them), and landlords are entitled to three possible remedies. For the first 60 days of the tenant’s occupancy following filing (if they stay), the landlord has an administrative claim for rent ahead of general unsecured creditors. However, any claim for unpaid rent past due prior to bankruptcy filing is an unsecured claim with the same priority as all unsecured creditors. Finally, the landlord may be entitled to future rent that would be due under a lease following rejection. However, the Bankruptcy Code caps a landlord’s damages to the greater of one year’s rent or 15% of the rent due for the balance of the lease, which becomes a non-priority unsecured claim paid only after all other claims (so much for the value of long-term leases for landlords).
CEC has filed to reject the leases for 45 closed or underperforming locations. The company said it plans to reopen some of the restaurants that were still closed and continue operations at 266 Chuck E. Cheese’s and Peter Piper Pizzas throughout the bankruptcy proceedings. That leaves the future of 44 unaccounted stores of the total of 555 previously operated ones in doubt.
What’s the likely outcome? CEC will probably get sold, probably for less than their debt, meaning Apollo will lose its ownership position and the debt holders will take a haircut (get less than they’re owed or have to unfavorably restructure the debt.) CEC’s adjusted 2019 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 also see the value of company’s name recognition. Rumors are that Dave & Buster’s is a potential buyer.
Dave & Buster’s, the next largest North American FEC chain (excluding bowling chains) with 137 units is fairing much better during the pandemic. They had $157 million of cash on hand May 3 at the end of their first fiscal quarter. Then later in early May they raised an additional $110.6 million through a private placement of stock. As of mid-June, they have cash on hand of $255 million, or nearly $2.0 million per store to weather the pandemic crisis.
The third largest American FEC chain is Main Event with 44 centers owned by Ardent Leisure Group out of Australia. They had to sell a 24.2% share of the entertainment chain for $80 million with a future option for the buyer to take a majority stake in July 2024 to hopefully have adequate liquidity to survive to the other side of the pandemic (again nearly $2.0 million per unit).
A smaller FEC chain, Apex Parks Group, with 10 family entertainment centers and two water parks, was not so lucky back when they filed for bankruptcy in April. They had been struggling for years due to the increased competition and the lockdown was the nail in the coffin for them. Parts of the chain, including five Boomers FECs, Speedzone Los Angeles, Sahara Sam’s Oasis and Big Kahuna’s Water & Adventure Park, were sold to APX Operating Company, a privately held company with six FECs and two water parks in California, Florida and New Jersey. Apex’s two other Boomers in California were permanently closed.
I was originally going to title this blog “Is the Chuck E. Cheese’s bankruptcy a bellwether of a FEC mass extinction event.” However, I then realized that extinction means all of a particular species of FEC will disappear. I don’t think that will be the case in the near future, but there are a few business models that may become extinct after the pandemic (more on that in a future blog). Then I thought about describing the dire road ahead for FECs as an apocalypse. But that term seems overused for retail stores and malls and is defined as “the complete and final destruction or an event involving destruction or damage on an awesome or catastrophic scale,” which may be just a little too severe to describe what I see as the road ahead for the LBE/FEC industry. So, I settled on “decimation,” defined as “destruction of a large proportion of a group or species,” which I think is the future for the industry. Large numbers of LBEs and FECs will likely not make it to the post-pandemic new normal, and even then, with things not being the same as the pre-pandemic normal, more will fail. I predict that at least 30% of FECs will go out of business and be permanently closed by the end of 2021, perhaps even sooner. I may need to increase this percentage depending on how long it takes the country to once again get the coronavirus under control.
Here’s some of my reasoning, some of which I discussed in an April blog, The inconvenient truth – almost all location-based entertainment business models are now obsolete.
Changed attitude of the outside world – People are learning to view the outside world and contact with other people as dangerous, as a threat to their and their loved ones’ health and lives. Many have become OCD virus-phobic. Fear of touching communal surfaces, fear of close contact with other people, fear of crowded places, especially indoor ones, and many other fears of the outside world have become behavioral norms. FOMO (fear of missing out) has morphed into FOGO (fear of going out). These fears and the new behaviors they’ve created will last for many people long after the crisis passes and will keep them from returning to LBEs and FECs. For some people, FOGO will never vanish.
Waiting for a vaccine – Polls I’ve reviewed consistently show that at least one-third of people have no intentions of returning to FECs and other type LBEs until there is a vaccine or no new infections in their state. This will seriously depress attendance when FECs do reopen during the pandemic.
Habitualization of at-home socialization & entertainment – During lockdown and subsequent self-isolating at home for many, we’ve seen an acceleration of the trend that was already underway – both time and money spent on at-home digital entertainment and socialization displacing out-of-home options. People have been introduced to new improved virtual and digital social and entertainment options and are taking up new or returning to old hobbies. These new routines and habits are likely to be sticky and permanently replace some of the visits we previously made to out-of-home social and entertainment experiences. Research on habit formation has found that it takes a minimum of 21 days to form a new habit and a little over two months (66 days) for a new behavior to become automatic. We’re now more than 110 days into the closure of most FECs. Many people are unlikely to return to their pre-pandemic out-of-home entertainment behaviors, or at least to a lesser degree. Many FEC experiences that were attractive in the past will be less relevant and compelling compared to the at-home ones we have gotten comfortable with and are enjoying. The at-home options are far more convenient, less costly, and now considered safer. This loss of appeal will be especially true for FECs that offer mediocre experiences, which will be among the first to seriously fall out of favor post-lockdown.
Reduced discretionary spending – The recession will last for a number of years. People are also saving more. There will be less discretionary spending on out-of-home entertainment and dining.
Reduced venue capacity – During the length of the pandemic, social distancing requirements and reduced capacities will restrict attendance, especially at peak times, when the majority of attendance occurs. Even if all government restrictions are lifted, many people will still not venture to FECs during the pandemic if there isn’t social distancing or they are too crowded.
Lack of sports – Many FECs, such as Dave & Buster’s, have sports bars as a draw. Sports have been on hold and are trying to startup. The current surge in infections is make some of those efforts doubtful. Also, crowds drinking at bars (when you can’t wear a mask) and talking loudly is considered about the highest transmission risk there is for catching the virus.
Incurred payables or debt when locked down – With no revenues during lockdown, FECs incurred payables for rent, debt and other on-going costs. Few, if any, had the operating capital to pay these. Even the PPP loan program didn’t cover them all, especially for the extended time most were or are still closed. For those FECs that could borrow money or work out extended payment terms with landlords and others, this increases ongoing expenses when open.
Excessive debt – Many FECs have high debt, similar to CEC’s situation, often as high as 90% of cost through the use of SBA guaranteed loans.
Operating at a loss when open – Even when they open, most FECs will continue to operate with negative cash flows since so many people are avoiding public places, especially the more dangerous ones – the ones indoors with an extended stay and crowds.
Increased operating costs – The need to implement new safety standards in FECs will increase labor costs. This includes daily deep cleaning, frequent cleaning and disinfecting while open, and such things as a door person to check guests’ temperatures and possibly get their contact information. There will also be increased cost for cleaning supplies, staff masks, one-time use menus and other items to make the facility not only safe, but even more importantly, perceived as safe by customers.
New capital costs– FECs will need to spend money for needed safety improvements, including renovations such as breath shields, technology for contactless transactions and reservations, maybe additional outdoor furniture, etc.
Group events – FECs typically generated 25% to 35% of their revenues from corporate and other group events. Those events with large numbers of people are now either restricted or considered unsafe to attend by the majority of people. Even if they are held, their operational model is disrupted as people are no longer willing to go to buffets.
Over saturated markets – Even before Covid-19 there was over expansion and excessive competition in many markets. Many FECs were already financially suffering.
When FECs do reopen, attendance will be very slow to return and will be seriously depressed for the duration of the pandemic, in most situations below cash flow breakeven. Even when the pandemic is over, attendance will probably not return to pre-pandemic levels, even with less competition, as the size of the potential market for customers, attendance and spending will have also shrunk. And for sure during the pandemic, the reduced FEC demand will probably be redistributed based on how safe from catching the coronavirus a visit is perceived to be. Outdoor FEC experiences will probably fare better than indoor ones.
Few FECs have a business model that works under all the attendance and economic disruptions I’ve described. That is why I predict the decimation, the failure and permanent closing of at least 30% of FECs, mostly the independents and small chains. It’s the larger chains that will most likely have the greatest survival prospects, as they can better access the cash needed to weather the storm or to restructure their economics through bankruptcy to make it to the post-pandemic out-of-home entertainment world.However, for FECs that do make it to the other side, if they think that they will prosper going forward with their current business models (less all the social distancing, limited capacity, sanitation and other changes operating in the pandemic required) since there will be less competition, they may be in for an unpleasant surprise. I will discuss that in my blog next week.