Investors in CEC Entertainment (CEC) are pleased with the fair offer which Apollo made for the kids entertainment business, as the investment firm offers a 25% premium compared to the closing price two weeks ago.
Yet investors are speculating on possibly an even higher offer during the solicitation period lasting till nearly the end of this month. Shares trade roughly seventy-five cents above the offer price at the moment of writing, implying that some investors might be speculating on a higher offer.
A Potential Deal
The investment firm will pay $1.3 billion, including the assumption of debt for the operator in dining and kids entertainment. The company operates some 577 Chuck E. Cheese stores and a potential deal would value each of those locations at an average of $2.25 million.
The proposed $54 per share price tag, represents a 25% premium over the closing price on January 7, the last trading day before media speculation over a transaction emerged.
Note that the board of directors previously reviewed strategic alternatives for the company in order to maximize shareholder value. The deal has been announced by the board of CEC, recommending shareholders to tender their holdings. As part of the review of strategic alternatives and the proposal by Apollo, shares of CEC have risen about 66% over the past year.
There is a minimum tender condition of 50 percent of CEC's shares as well as approval from the Federal Trade Commission, antitrust provisions and other closing conditions. The low threshold of 50% it most likely induced to increase the odds of a successful end of the potential deal. CEC is allowed to solicit superior proposals until the 29th of January.
Is The Valuation Fair For Investors?
The reported $1.3 billion deal values the equity in the firm at roughly $950 million as CEC operates with $350 million in net debt.
For the first nine months of 2013, CEC reported revenues of $643.2 million, up 2.8% on the year before. Reported earnings were up by 8.5% to $47.9 million. At this pace, annual revenues are seen around $825 million with earnings seen just above $50 million.
Therefore the $54 price tag values equity in the business at 19 times earnings. That is for a business which is not extremely highly leveraged. Note that over the past decade, shares have traded in a $20-$40 trading range. Shares have risen more than 60% over the past year on the back of this attempted takeover and the review of strategic alternatives.
In this light, the price tag seem fair to investors.
Implications For Investors
Chuck E. Cheese has terrific brand recognition and awareness yet the brand has been deteriorating. Kids love the place as they can hold parties while playing games and eating snacks.
The trouble for investors is that revenues have been flat over the past five years, while earnings are down from a peak of $61 million in 2009.
Apollo will probably be appealed to the brand awareness of the business. By upgrading and innovating the locations, and cutting costs, Apollo will most likely try to rejuvenate the business. Note that shares trade some $0.75 per share above the offer price, at a 1.4% premium, which means the market is not ruling out a higher offer emerging before the 29th of January deadline.
Investors had a good run, and the last seventy-five cents might not matter that much after the jump following the Apollo offer. You can lock in the 1.4% premium now, or make a calculated bet on a higher offer emerging. The valuation is fair, even while there is a possibility for a higher offer. The board acknowledged that management cannot improve operations sufficiently and quick enough on a stand-alone basis.
While Apollo will most likely be able to acquire the business at $54 per share, an even higher offer based on the strong brand awareness of the business cannot be ruled out.