Rating Action: Moody's assigns Caa1 CFR to CEC Entertainment; outlook negative
Global Credit Research - 11 Jan 2021
New York, January 11, 2021 -- Moody's Investors Service, ("Moody's") assigned CEC Entertainment, LLC ("CEC") a Caa1 corporate family rating and B3-PD probability of default rating. In addition, Moody's assigned a B2 rating to the company's proposed $200 million 1st lien first-lien senior secured term loan. The outlook is negative.
"The Caa1 CFR reflects our view that government imposed capacity restrictions to help stem the spread of the coronavirus will remain in place at least thru the end of the first quarter of 2021 and possibly longer until health safety concerns abate." stated Bill Fahy Moody's Senior Credit Officer. For the LTM period ending September 30, 2020, leverage was extremely high at over 15 times and will deteriorate further before it begins to stabilize and gradually improve while interest coverage will remain negative for an extended period. "Overall, CEC's business model is more affected by government imposed capacity restrictions versus a standard restaurant given its high reliance on in-restaurant entertainment which accounted for the majority of earnings" stated Fahy. Moody's regards the corona-virus outbreak as a social risk under our ESG framework, given the substantial implications for public health and safety.
Proceeds from the proposed $200 million 1st lien senior secured term loan, will be used to repay about $100 million of debtor-in-possession (DIP) debt, pay bankruptcy fees and expenses and add approximately $56 million of cash to the balance sheet. The company's debt capital structure will also include a pre-petition $175 million 2nd lien senior secured term loan that is owned by pre-petition lenders and as a result does not provide any additional liquidity. CEC Entertainment, Inc. ("CEC Inc.") filed for Chapter 11 in June 2020 as a result of its high leverage driven in part by its debt financed leveraged buyout by an affiliate of Apollo Investments in February 2014 as well as the negative impact from government restrictions of on-premise dining, entertainment and arcade rooms. CEC Inc. emerged from bankruptcy on December 30, 2020. As part of its exiting bankruptcy all of CEC Inc.'s assets, non-debt liabilities and operations will be acquired by CEC with CEC also assuming all of CEC Inc.'s outstanding debt, including the $200 million 1st lien first-lien senior secured term loan and $175 million 2nd lien senior secured term loan.
..Issuer: CEC Entertainment, LLC
.... Probability of Default Rating, Assigned B3-PD
.... Corporate Family Rating, Assigned Caa1
....Senior Secured 1st Lien Term Loan, Assigned B2 (LGD3)
..Issuer: CEC Entertainment, LLC
....Outlook, Assigned Negative
The Caa1 CFR reflects Moody's view that government imposed capacity restrictions to help stem the spread of the coronavirus will remain in place at least thru the end of the first quarter of 2021 and possibly longer until health safety concerns abate. These government imposed capacity restrictions as well as consumer's health safety concerns will continue to impact CEC's ability to materially improve credit metrics over the next 12 to 18 months despite the reduction of debt as a part of the bankruptcy process. For the LTM period ending September 30, 2020, leverage was extremely high at over 15 times and will deteriorate further before it begins to stabilize and gradually improve while interest coverage will remain negative for an extended period. Overall, CEC's business model is more affected by government imposed capacity restrictions versus a standard restaurant given its high reliance on in-restaurant entertainment which accounted for the majority of earnings.
CEC's rating is also constrained by its current level of free cash flow deficits and the likelihood that the free cash flow deficits will continue until operating performance materially rebounds. While CEC will have a meaningful cash balance following its emergence from bankruptcy and will be able to pay-in-kind a portion of its interest, it will need to stem its current pace of cash flow deficits in order to preserve its liquidity as it will not have in place any external liquidity sources such as a revolving credit facility. The ratings also incorporate the company's high seasonality of earnings in the first quarter and store concentration in California, Texas and Florida. The ratings are supported by CEC's meaningful scale, good EBITDA margins driven by its entertainment focus versus peers and reasonable level of brand awareness.
Governance risk is also a key ratings factor given that CEC's will be owned by its former debt holders as well as new debt holders. Financial strategies are always a key risk of privately-owned companies with regards to the potential for higher leverage, extractions of cash flow via dividends, or more aggressive growth strategies.
The corona-virus outbreak, the government measures put in place to contain it, and the weak global economic outlook continue to disrupt economies and credit markets across sectors and regions. Moody's analysis has considered the effect on the performance of the restaurant sector from the current weak U.S. economic activity and a gradual recovery for the coming months. Although an economic recovery is underway, it is tenuous and its continuation will be closely tied to containment of the virus. As a result, the degree of uncertainty around our forecasts is unusually high.
The negative outlook reflects Moody's view that debt to EBITDA will remain extremely high and EBIT to interest coverage will stay very weak over the next 12-18 months as government restrictions on in-door dining and activities are unlikely to materially subside on a consistent and sustained basis across the US for an extended period.
The B2 rating on the first lien senior secured term loan is two notches above the assigned CFR. The B2 reflects the first lien term loan's senior position in the capital structure with respect to the company's $175 million 2nd lien senior secured term loan and other non-debt liabilities that include trade claims and lease rejection claims.
The credit facilities are expected to contain covenant flexibility for transactions that could adversely affect creditors, including: incremental facility capacity in an aggregate principal amount up to $75 million; provisions permitting the transfer of assets to excluded subsidiaries, with no additional "blocker" protections; and automatic releases of guarantees provided by subsidiary guarantors when such subsidiaries cease to constitute a subsidiary loan party or otherwise become an excluded subsidiary by virtue of becoming non-wholly-owned, subject to restrictions limiting guarantee releases unless either (x) the borrower no longer owns any equity interests of such subsidiary guarantor or (y)(1) such transaction is entered into for a bona fide business purpose (and not to evade the Collateral and Guarantee Requirement) and (2) such subsidiary becomes a bona fide joint venture with a non-affiliate. There are no leverage-based step downs to the requirement that net asset sale proceeds prepay the loans.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
Ratings could be upgraded should operations return to a level that is able to sustain debt to EBITDA below 6.5x and EBIT to interest expense above 1.1x. An upgrade would also require maintaining at least good liquidity.
Ratings could be downgraded if liquidity were to weaken for any reason, if occupancy restrictions remain in place beyond current assumptions or if earnings failed to improve following a wide spread lifting of government restrictions on restaurant occupancy.
CEC is headquartered in Irving, Texas, and owns, operates, and franchises a total of 568 Chuck E. Cheese stores and 114 Peter Piper Pizza locations that provide family-oriented dining and entertainment in 47 states and 16 foreign countries. CEC is owned by a group that includes both pre-petition debt lenders as well as new debt lenders. Revenue for the full year 2019 were about $913 million but have fallen to around $350 million for 2020.
The principal methodology used in these ratings was Restaurant Industry published in January 2018 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1108012. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.
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The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.
These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.
Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.
Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1243406.
At least one ESG consideration was material to the credit rating action(s) announced and described above.
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William V. Fahy VP - Senior Credit Officer Corporate Finance Group Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Margaret Taylor Associate Managing Director Corporate Finance Group JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Releasing Office: Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653
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