Activist Track: Pirate Nibbles at CEC

I've always been impressed with Nolan Bushnell.

First he started Atari, which became the addiction of my childhood.

Then he started Chuck E. Cheese, which is my kids' addiction. If they had a choice, we'd be eating there for breakfast, lunch and dinner.

More recently he started uWink, but that's a topic for another article. For now, let's look at CEC Entertainment (CEC - commentary - Cramer's Take).

The company operates Chuck E. Cheese, the family-themed restaurant, and it is the subject of the most recent potential activist battle for Pirate Capital. I've written about Pirate in several instances over the past few years, including Monday. The fund's more recent disclosure came on April 20 when it filed a 13D saying it owns 6.1% of the shares outstanding at an average price of around $32 and change. There were no demands in this initial filing, but I am going to take you through my thinking of what may be at hand.

There are two main reasons why an activist might go after a restaurant:

Asset play: Perhaps the real estate the restaurants are sitting on is worth more than the restaurants, and the market is undervaluing the real estate.

Operations: Perhaps the restaurant has declined recently, and since everyone is an expert on food, the activist could have ideas on how to improve efficiency and market share.

CEC Entertainment's Rough Patch Shares are down at the whiskers

Source: Yahoo! Finance

A look at the one-year chart above is a clue that things have not been going so well lately for CEC. Much of that downward spiral was due to a subpar fourth quarter that saw CEC earn $9.9 million compared with $15.6 million a year earlier.

This is a substantial drop, even considering that the same quarter a year earlier had one more week. As I have written before, restaurants are hard turnaround plays. The only way to make more money from an operational standpoint is to get more customers in the door. That requires marketing efforts, and just maybe the restaurant space is getting so competitive that spending to keep your margins and customers is a losing proposition.

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At the time of publication, Altucher and/or his fund was long CEC, MCD and CKR, although positions may change at any time.

James Altucher is a managing partner at Formula Capital, an alternative asset management firm that runs several quantitative-based hedge funds as well as a fund of hedge funds. He is also the author of Trade Like a Hedge Fund and Trade Like Warren Buffett. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Altucher appreciates your feedback; click here to send him an email.

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