Over the last five years, a booming economy has fueled a great deal of interest in the amusement industry, as speculators and industry veterans alike have targeted family entertainment center facilities and amusement game operating routes for acquisition. While many sizeable transactions have been completed to date, a great deal more remain in limbo, largely the result of unsubstantiated pricing. It's not a new issue, really, as the 'price vs. return' argument has existed in all walks of life, from real estate development to dot.com stocks. But in general, where there is a seller, there can typically be found a buyer... if the price is right.
Establishing 'price' is what this month's column discussion is about. Price represents, perhaps, the key ingredient in bringing a buyer and seller to the closing table. An improperly priced FEC or amusement route is likely to languish on the market for too long, during which time the current ownership has probably decided to suspend additional facility or asset upgrades. "We're selling it" becomes the general focus instead of "we're continually upgrading it". Unfortunately, over-valuation by the seller may cause the ultimate sale price to fall below the market value, as time, competition, and economic fluctuations will all begin to gnaw at the price. In an effort to help buyers and sellers arrive at a fair and realistic prices, below are some items to consider.
The Great FEC 'Build It Or Buy It' Debate
There's no question that, all things being equal, the purchase of a currently successful FEC allows the purchaser to 'hit the ground running', with instant cash flow, a complete team of employees, and an existing patron base. Conversely, the "build it" path is filled with regulatory approvals, construction delays, potential cost overruns, staff recruiting challenges, and the need for an effective market penetration plan. Does the discussion end here? Unfortunately not. If you've priced an existing FEC lately, you might find that the asking price is running seven to ten times earnings. This can be quite a premium to pay, particularly when ground-up facilities can be developed for the equivalent of about 5 times earnings. One of the primary reasons, at least in some markets, may relate to the escalation of land values. When the facility was originally developed, the land value was probably 50-60% less than the current market value. This becomes a critical issue, as the project's effective investment return can become strangled by a land value that exceeds the facility's economic value. If you're inclined to mentally separate the land investment from the FEC investment, you might be able to substantiate a seven or eight times earnings sale price, but keep in mind that the future value of the land may only achieve its maximum potential through discontinuation of the FEC, which therefore eliminates your other investment. For instance, if the current FEC is located on a prime parcel in a growing or well-established area, that parcel may be best suited for a retail/mall use in future years. Essentially, the buyer would bulldoze the structure and redevelop the site. Note, however, that the buyer's offer price would probably not include much of a premium for the FEC business that they'd have no intention of operating. On the other hand, if the FEC business is performing well but has the potential to perform substantially better (through additional investment or change of operating program), the eight times earnings sale price may not be so bad after all. A 'diamond in the rough' as many would refer to it.
The Route Well Traveled
Turning our attention to the valuation of amusement routes, today's operator can benefit greatly by incorporating some advanced planning into its future sale program. Purchasers of amusement routes tend to look for the presence of several key ingredients, some of which appear below:
- Existence of exclusive location contracts
- Diversification of assets
- Capability of current staff
- Valuation of assets ("wood")
- Quality of existing accounts (locations)
- Economic and competitive conditions within the trade region
Perhaps the thread that ties an amusement route together is the presence of binding location contracts. These contracts represent the source of future revenues for the acquired route - without them, a buyer would be speculating as to the likelihood that continued business at these locations would exist. If your existing route is not well documented by contracts, now is the time to firm up your company's position. Even a short, basic agreement adds value to a sale, particularly when compared to an undocumented route. An operator might argue that the portfolio of accounts has been maintained for years without a contract, working essentially on a handshake. The problem occurs when an acquiring firm enters the picture - suddenly those handshake deals begin to evaporate. Purchasers know this, and will discount any route that does not offer a reasonable level of business security. These documented locations also play a role in maintaining strong asset value, as a revenue-generating amusement game has inherently greater value than one collecting dust in the warehouse. Taken as a whole, the value of the "wood" will likely hover closer to true market value when the games are on location than under a bulk distress sale.
Diversification has become another big concern of most operators. Heavy concentrations in almost any specific sector of the business can be seen as detrimental. Routes comprised solely of video games will likely pose greater risks to the acquiring firm, given the issues relating to sharp depreciation curves on most equipment and violent video legislation pending in several states. Routes that contain bulk vending, billiards, and redemption may provide a bit more insulation from market changes and allow for greater future growth potential. For instance, while the video and redemption game segments have remained somewhat flat or declined, bulk vending has seen continued and notable increases in revenues in recent years. Such diversification can help to stabilize the asset portfolio in the minds of purchasers and in turn, yield a greater sale price.
Finally, there is great value contained in the quality of a company's staff, an often overlooked variable. A high quality staff, utilized effectively, can turn an average performer into a class-leading company under the proper management controls. As a seller, take a close look at your company's employee portfolio and be prepared to identify the caliber and capability of its members. While a would-be purchaser is not buying employees, they may be "investing" in their talents, which can help to sway a transaction into favorable price territory.
Before Selling, Spruce Up The Yard
As our national economy begins to slow, buyers will examine businesses more closely than ever, focusing less on future value and more on current cash flows. With this in mind, efficiency in operations will be paramount, as buyers will rely on a strong stream of future cash flows to recoup acquisition costs in as short a time possible. Buying and selling businesses in the amusement industry is a lot like buying and selling automobiles - kick the tires, take it for a spin, compare the options, and get set for the ride of your life. Done well, a single acquisition can help to leverage additional acquisitions in future years and serve as a benchmark by which to gauge your performance within the ever-changing amusement marketplace.
- The time to sweat the details is before your business is offered for sale. Some of the areas to concentrate on are:
- asset inventories - make sure they're accurate and all-inclusive
- financial statements - correct and/or reclassify earlier postings to improve statement presentation
- physical appearance - eliminate unnecessary or poor performing assets; freshen the operating facility; categorize and label books and records
- contractual and legal obligations - assemble all operating contracts, leases, and other legally binding documents together for easy reference
- human inventories - identifying composition of workforce, including experience and tenure
- description of market conditions - be prepared to provide an overview of current regional conditions including changes in population, income characteristics, business climate, government controls, and labor force.
- consult with financial advisors - a team comprised of your accountant, attorney, and amusement industry expert can accurately pinpoint the true market value of the business and establish the means by which the business can most effectively find potential suitors.
Article written by:
Jerry Merola, CFO
Amusement Entertainment Management, LLC 01/22/01