I haven't been to a Chuck E Cheese (CEC) location since my kids were young. But this past May, after visiting with CEC Entertainment's CFO Tiffany Kice at the company's Irving, Texas headquarters, I eagerly scarfed up 80,000 shares of its stock. CEC has risen ten percent since then, but I don't plan to sell anytime soon. I'm going to save my slice of this business for a good while. Thanks to prudent management and an unprecedented commitment to returning cash flows to its investors, CEC is a rare great investment for both growth and value.
Chuck E. Cheese's family-oriented recipe of pizza, goofy animatronic characters and coin-op entertainment hasn't changed much since Atari founder and Silicon Valley legend Nolan Bushnell opened the first location in San Jose in 1977-and there's no reason it should. Pizza is comparable to other QSR categories when it comes to low food costs and high margins, and CEC benefits from the added revenue stream of its coin-op business. This was the genius of Bushnell's vision way back in the late-70s. He sought to capture all of the profits from the games Atari was building instead of selling them for a one-time cost. Even though Bushnell originally knew nothing about the restaurant business-and wanted to name the company "Rick Rat's Pizza" until his marketing staff intervened-his model was highly profitable back then and it's still highly profitable today.
If you'll excuse one more pizza-themed pun, CEC's 567 locations in 47 states and nine foreign countries make a lot of dough, bringing in over $150 million in annual cash flow. The company's 22 percent EBITDA margin, 12 percent operating margin, and seven percent net margin are all above industry averages. And yet, even after rallying over 40 percent in the last year, its stock is still cheap by any measure. At its current $41 price, CEC trades at only 3.68x estimated 2013 EBITDA and 5.8x enterprise value. It's price-earnings ratio is 14x estimated 2013 earnings-per-share of $2.95 and 13x estimated 2014 EPS of $3.20.
Those numbers alone make CEC attractive, but what sets it apart is its management's commitment to sharing the company's significant and growing profits with the people who make them possible, its investors. Too many companies today, especially in Silicon Valley, hoard their cash. It's incredible to me that shareholders allow firms like Apple and Oracle to salt away tens and even hundreds of billions of dollars. Despite its roots in Silicon Valley, CEC takes the opposite approach. In fact, Chuck E. Cheese is one of the biggest and most effective generators of shareholder value in the market.
In the last ten years, the company has bought more than 22 million of its own shares, taking the total number outstanding from over 40 million to 17.5 million as of July of this year. This ongoing buyback program-which Kice assured me will continue even as the stock appreciates-offers everyday investors the chance to get in on a de facto leveraged buyout.
Again, this approach is almost unheard of in today's corporate world. Many companies buy their own shares, but usually just to offset options they've doled out to employees and insiders. Others go the other direction by diluting their stock with secondary offerings. CEC, by contrast, has retired more than half of its outstanding shares in just over a decade. And that's not the only way the company is giving back to its investors. In the last quarter of 2010, CEC initiated a quarterly dividend of 20 cents, which has risen every year since. It now stands at 24 cents a share, with a yield of 2.3 percent.
Of course, these measures are only possible because CEC brings in a great deal of excess cash, and it will almost certainly continue to do so. Kice told me that company management believes there is room for another 100 Chuck E Cheese locations, but that they only plan to open between 12 and 15 per year. This conservative, long-term growth strategy will keep the company from overspending on expansion. CEC is also relatively adverse to franchising. More than 500 of its 567 outlets are company-owned. This is also a good sign for the future. I've seen too many restaurant chains fall into the trap of hyper-growth through mass franchising. Whether it's Krispy Kreme Donuts or Boston Chicken, it almost always ends the same way-quality and consistency suffer as units proliferate and profitability declines, not just for franchisees but for company-owned stores, as well. Customers don't know the difference between a corporate location and one owned by a franchisee; they only see the name on the sign out front.
Finally, CEC is literally well-positioned for future growth. More than ten percent of its units are in its home state of Texas, which is experiencing a huge population boom. As I've written previously, eight of the fifteen fastest growing cities in the country were in Texas last year. One thing is fueling this explosion: a fast growing economy producing lots of good paying jobs. The state's GDP rose 13 percent from 2009-2012. I'm always on the lookout for ways to cash in on secular trends like Texas's upswing, even if it means investing in a singing rodent serving pizza. In the coming years, a lot of new kids in Texas will want to go to Chuck E Cheese, and a lot of new parents will have the money to take them there.