Description

This is a two-part trade that involves going long CEC Entertainment (CEC) and short Applebee’s (APPB) dollar for dollar. Chuck E. Cheese is a restaurant/entertainment destination geared for kids that has been around for over 20 years. Typical foods such as pizza, salad, sandwiches, and desserts are served. The main draw, however, is the extensive children’s entertainment options such as games, rides, and music/comic shows. There are currently 394 units (52 franchised) with the potential and plan to expand at a rate of 10% a year for the foreseeable future. CEC has had its share of problems this year and has been punished for them. They lowered F2001 earnings guidance from $2.56 to $2.50 on May 31st and reduced ’01 estimates even further to $2.22. On the first pre-announcement the stock dropped 20% and after recovering some of its losses, it dropped another 27% following the second reduction. But the earnings problem has been worked out of the stock and it trades close to its historic lows of next twelve months P/E and TEV/EBITDA. With analyst’s predictions of 20% earnings growth through unit expansion, SSS increases, cost reduction, and share buybacks; the stock has a PEG ratio of only .8. Management’s implementation of its phase 3 remodeling has been driving their SSS growth and further benefits are expected. These remodeling have included new games, rides, faster ticket counters, and menu improvements. While the results have been exciting, the costs have been fairly minimal by simply switching out different restaurants game machines rather than buying brand new ones for all units.
The second part of this trade is to be short APPB. Applebee’s has been a turnaround story this year and its shares have risen from the mid teens last summer to its current level of around $32-33. The turnaround has already occurred and the upside opportunity has virtually vanished. While the street still touts this company as a 15-20% earnings grower, the ability for earnings to be grown as this pace is questionable and the quality of those earnings are suspect. By over serving their financials a little bit closer for the past several quarters, you can see that this EPS growth is not coming from the top line. The company has been buying large blocks of their shares back, which have been accretive to EPS. While this can be a positive use of cash flow, a high multiple should not be paid for this type of growth. However, APPB biggest problems will be in its ability to grow more restaurants. There are currently close to 1400 restaurants throughout the country making it the largest casual dining chain in the world. With close to twice as many restaurants as Chili’s (EAT), APPB will be hard pressed to find new markets to enter. Once investors begin to focus on APPB future trouble in expanding EPS, the company will cease to trade at premiums to the better casual dining operators.
An opportunity like this is very appropriate for the type of environment that we are currently seeing. Without knowing the direction that the market will go in the short term due to earnings problems, layoffs, consumer confidence, or terrorism; it is much less risky to take a market neutral approach. Buying shares of CEC and shorting APPB alleviates most of this risk. A narrowing of the earnings and EBITDA multiples that these two companies trade at will result in a nice return on investment.



Symbol EAT APPB CBRL CEC

Stock Price $28.45 $32.50 $26.72 $35.00
52 week High 31.30 33.91 26.85 55.50
52 week Low 21.30 18.00 15.69 30.31
% off high -9% -4% 0% -37%
% off low 34% 81% 70% 15%

Shares Outstanding 100 37 55 28
Market Capitalization 2,831 1,197 1,470 976
Float 97 25 53 21
Short Interest 3.62 3.40 1.29 0.98
Short/Float 3.72% 13.69% 2.43% 4.61%
Avg. Daily volume (in 000s) 817 521 515 274
Avg. Daily volume $$ 23,254.7 16,944.8 13,774.1 9,598.1
SI/Avg. Daily Volume 4.4 6.5 2.5 3.6

Dividend 0.00 0.00 0.00 0.00
Yield 0% 0% 0% 0%

Book Value 9.05 8.26 15.38 11.94
Price/Book 3.1 3.9 1.7 2.9
Tangible Book Value
Price/Tangible Book

Total Restaurants 944 1286 512 390
Company Restaurants 693 285 512 336
Franchise Restaurants 251 1001 0 54
Company % of Total 73% 22% 100% 86%
Franchise % of Total 27% 78% 0% 14%

June Dec July Dec
Fiscal Year 06/2001 12/2000 07/2001 12/2000

I. P/E VALUATION
Earnings Per Share (CY)
1998 $0.69 $1.11 $1.65 $1.21
1999 0.99 1.33 1.14 1.58
2000 1.32 1.60 1.19 1.98
2001E 1.52 1.79 1.38 2.22
2002E 1.75 2.10 1.60 2.60
next 12 mos 1.67 2.01 1.57 2.51
Price/Earnings
1999 28.7 24.4 23.5 22.2
2000 21.6 20.3 22.5 17.7
2001E 18.7 18.1 19.3 15.7
2002E 16.3 15.4 16.7 13.4
next 12 mos 17.0 16.2 17.0 14.0


Cash EPS 1.75 2.10 1.66 2.60

Price/Cash EPS 2002E 16.3 15.4 16.1 13.4

Earnings Growth
1999 to 2000 33.0% 20.0% 4.4% 25.3%
2000 to 2001 15.4% 12.1% 16.4% 12.2%
2001 to 2002 15.2% 17.3% 15.8% 17.2%
1999-2002 average 20.9% 16.4% 12.1% 18.1%
2001 PE/Growth Rate 0.9 1.1 1.6 0.9
FC LT growth rate 16.25% 15.00% 13.20% 20.75%
2001 PE/IBES LT Growth Rate 1.2 1.2 1.5 0.8


Quarterly Earnings: Calendar year actual
1998a 1Q 0.16 0.26 0.39 0.42
1998a 2Q 0.23 0.29 0.56 0.26
1998a 3Q 0.13 0.30 0.42 0.31
1998a 4Q 0.17 0.26 0.28 0.22

1999a 1Q 0.20 0.29 0.25 0.52
1999a 2Q 0.31 0.34 0.21 0.34
1999a 3Q 0.27 0.35 0.25 0.44
1999a 4Q 0.25 0.35 0.20 0.29

2000a 1Q 0.29 0.37 0.25 0.68
2000a 2Q 0.36 0.41 0.42 0.44
2000a 3Q 0.35 0.40 0.30 0.55
2000a 4Q 0.32 0.42 0.26 0.33

2001E 1Q 0.34 0.45 0.26 0.88
2001E 2Q 0.42 0.47 0.48 0.43
2001E 3Q 0.39 0.44 0.35 0.57
2001E 4Q 0.35 0.44 0.31 0.35

Quarterly Earnings Growth
1999 - 2000 1Q 43.3% 25.0% 0.0% 30.8%
1999 - 2000 2Q 17.4% 21.6% 100.0% 29.4%
1999 - 2000 3Q 31.2% 13.2% 20.0% 25.0%
1999 - 2000 4Q 26.3% 21.2% 30.0% 13.8%

2000 - 2001 1Q 18.6% 22.7% 4.0% 29.4%
2000 - 2001 2Q 16.7% 13.7% 14.3% -2.3%
2000 - 2001 3Q 11.4% 10.0% 16.7% 3.6%
2000 - 2001 4Q 8.0% 3.7% 19.9% 5.4%

Change in Current Qtr Estimate (%)
One Week -0.2% 0.1% 1.2% -0.4%
One Month -2.1% -0.4% 1.2% 0.6%
Three Months -3.8% -6.8% 1.3% -4.7%
Change in FY 2001 Estimate (%)
One Week 0.1% 0.0% 0.7% -0.2%
One Month 0.7% 0.0% 0.8% -0.1%
Three Months -0.5% -2.6% 2.5% -2.2%
Change in FY 2002 Estimate (%)
One Week -0.1% -0.1% 2.4% -0.3%
One Month 0.2% -0.1% 2.4% -0.4%
Three Months 0.2% -1.3% 14.3% -3.7%

Quarterly Revenues
1998a 1Q 401 147 317 105
1998a 2Q 423 166 365 89
1998a 3Q 432 169 351 98
1998a 4Q 444 166 368 87

1999a 1Q 459 179 386 118
1999a 2Q 535 164 427 105
1999a 3Q 511 164 423 116
1999a 4Q 521 163 443 102

2000a 1Q 551 165 436 141
2000a 2Q 577 169 471 119
2000a 3Q 589 172 467 130
2000a 4Q 583 184 484 115

2001a 1Q 626 182 468 163
2001a 2Q 675 186 544 127
2001e 3Q 685 188 #N/A 128
2001e 4Q 688 197 #N/A 183
Analysts 3 3 0 2

Quarterly Revenue Growth: Year over Year
1998 - 1999 1Q 15% 22% 21% 13%
1998 - 1999 2Q 27% -1% 17% 18%
1998 - 1999 3Q 18% -3% 20% 18%
1998 - 1999 4Q 17% -2% 20% 17%
1999 - 2000 1Q 20% -8% 13% 19%
1999 - 2000 2Q 8% 3% 10% 13%
1999 - 2000 3Q 15% 5% 11% 13%
1999 - 2000 4Q 12% 13% 9% 13%
2000 - 2001 1Q 14% 10% 7% 15%
2000 - 2001 2Q 17% 10% 16% 7%

II. ENTERPRISE VALUATION
Current Current Current Current
Cash/ST Investments 13.31 14.68 11.81 13.23
ST Debt 17.64 0.82 0.20 0.12
LT Debt 231.03 79.12 125.00 44.22
Preferred/Other 0.00 0.00 0.00 0.00
Net Debt 235.4 65.3 113.4 31.1
Market Cap 2,831.0 1,197.0 1,470.3 975.8
Total Ent. Value 3,066.4 1,262.3 1,583.7 1,006.9

EBITDA(MM)
1999 260 127 194 102.2
2000E 318 130 200 127
2001E 354 144 228 139
2002E 389 163 247 156

TEV/EBITDA
1999 11.8 9.9 8.2 9.9
2000E 9.7 9.7 7.9 7.9
2001E 8.7 8.7 7.0 7.3
2002E 7.9 7.8 6.4 6.4

EBITDA multiple sensitivity to 1 pt. Multiple change
$3.55 $3.92 $4.14 $4.98
as % of stock price 12% 12% 15% 14%

Full Year 2000 EBITDA
Net Income 131.0 58.9 65.4 55.2
Taxes 70.6 34.5 39.3 35.3
Tax Rate 35.0% 36.9% 37.5% 39.0%
Interest expense (income)
16.0 8.0 24.4 3.5
D&A 100.0 29.1 71.0 33.3
EBITDA 317.6 130.4 200.2 127.3

Full Year 2001 EBITDA Estimate
Net Income 151.2 66.1 76.2 62.0
Taxes 81.4 38.8 47.3 39.6
Tax Rate 35.0% 37.0% 38.3% 39.0%
Interest expense (income)
16.0 8.1 24.1 2.5
D&A 105.0 31.5 80.1 34.7
EBITDA 353.6 144.5 227.7 138.8

Full Year 2002 EBITDA Estimate
Net Income 174.2 77.5 88.2 72.6
Taxes 93.8 45.5 54.7 46.4
Tax Rate 35.0% 37.0% 38.3% 39.0%
Interest expense (income)
16.0 8.1 24.1 2.5
D&A 105.0 31.5 80.1 34.7
EBITDA 389.0 162.6 247.2 156.2


Free Cash Flow Analysis
2001 Net Income 151.2 66.1 76.2 62.0
D&A 105.0 31.5 80.1 34.7
Cap Ex 165.4 55.0 138.0 92.2
Free Cash Flow
90.8 42.5 18.2 4.5



FCF/share $0.91 $1.15 $0.33 $0.16
Price/FCF 31.2 28.1 80.6 218.9
FCF/Market Cap 3.2% 3.6% 1.2% 0.5%



III. FINANCIAL AND OPERATING STATISTICS
Leverage:
Total Debt/Total Assets
17% 19% 10% 14%
Net Debt/Total Cap (at market value)
7.7% 5.2% 7.2% 3.1%
Net Debt/2000E EBITDA 0.7 0.5 0.6 0.2
2000 EBITDA/interest expense
19.8 16.4 8.2 36.4
Current ratio 0.57 0.55 0.79 0.86
Profitability LTM
Gross margin 69% 53% 65% 50%
SG&A % 4% 37% 43% 14%
EBITDA margin 13% 21% 8% 26%
EBIT margin 9% 16% 5% 19%
Pretax margin 9% 14% 4% 19%
Tax rate 34% 37% 42% 39%
Net Margin 6% 9% 3% 11%
ROA 11% 14% 4% 16%
ROE 18% 24% 6% 21%

Catalyst

The catalyst is simply for these two companies historic multiples is be once again reflected in their stock prices or at least for the gap to narrow. This can happen from either CEC being recognized for their problems being over or by APPB's trouble growing the topline being uncovered.