Vol. XII, No. 8, December 2012
Is the FEC truly profitable?
When it comes to projecting or examining the profitability of an FEC, there are many concepts of profit. There is pure accounting profit, which shows revenues and expenses (including amortization and depreciation) and typically is on an accrual basis, meaning revenues and expenses are recognized even if not collected or paid. Then there is EBITDA (earnings before interest, income taxes, depreciation & amortization). EBITDA comes close to cash flow before debt, but doesn’t account for replacements and new capital expenditures. And then there is pure cash flow, the difference between all cash collected and cash paid out, in other words, what was the net change to cash over a period of time. In terms of feasibility, pure cash flow projections are perhaps the most important as they tell whether the FEC can pay all its bills and debt.
Investors are typically interested in the profit concept of cash return on their invested capital, expressed as a percentage. 15% would mean for a $1.0 million investment, the investor would expect to receive the equivalent of $150,000 per year plus get their original $1.0 back at some point in time.
The problem with most FECs and their original financial projections is that they are not really realistic on what cash flows and the return on invested capital will be. A simple example [to avoid the complexity of an IRR (internal rate of return) calculation] is an original investment of $1.0 million and receipt of $150,000 a year for seven years. At the end of the seven years the investor would have received payments of $1.05 million. So the investment has been paid back and there is a profit (return on investment) of $50,000. In fact, the $1.05 million in payments is really worth less than the original $1.0 million investment if you consider the decreasing value of money due to inflation. If the investor had invested the $1.0 million in CDs, at today’s top rate of 1.8%, the CDs would have cashed out as $1,133,000 after 7 years, $133,000 greater than the original investment and would have been risk free ($250,000 could have been invested in four CDs in four different banks to be fully insured by the FDIC).
So for the investor to receive a return on the FEC investment, either the FEC would have to be sold at the end of the seven years so the investor got back the $1.0 million or the FEC would have to continue to generate a $150,000 payment beyond seven years.
Here’s the problem with either of the above scenarios. Most FEC concepts require considerable reinvestment every five or so years as their main attractions need to be replaced or their concepts get old and out of date in terms of their ability to generate attendance. That reinvestment is in addition the additional investment required due to wear and tear that requires replacement or remodeling of a lot of furniture, equipment and interior finishes. Also, most computers and electronics don’t have much more than a three-year life. Most financial projections fail to account for all that reinvestment. So if a buyer can be found at the end of 7 years, they most likely will heavily discount the purchase price due to the needed reinvestment. Furthermore, if the major attractions or the concept is loosing appeal, revenues and profits will be down, further depressing the sale price. So at the end of the seven years, the investor might only recoup $500,000. That would mean only an overall 10% return on capital invested.
And if not sold and assuming a best case scenario that revenues and profit did stay constant from day one, the FEC would have to generate $150,000 a year for a very long time for the investor to have received a 15% return (after 20 years the return is 14%).
That is still better than the FEC going bankrupt or closing, which unfortunately many poorly conceived ones do. Decreasing attendance, revenues and profits prevent FECs from raising the reinvestment capital required to renew the business. Assuming the FEC had to close at the end of seven years since it could not be sold and it lacked the ability to raise the capital to remodel, the $1.0 million capital investment would have only yielded a 1.2% return, worse than the CD.
The bottom line is the numbers just don’t work for FECs that have to replace or significantly upgrade most of the revenue generators, the attractions, or change the concept after 5 or so years. Their original projections amount to what we call seducing yourself with the pro forma.
To be truly profitable under any definition, FECs need to have a long-term life. They need to be built on time-tested proven formulas. Much of the FEC road kill is attributable to concepts built on the next new thing, attractions and concepts that prove to be fads rather than have long-term staying power.
When we examine those evergreen FEC concepts that have stood the test of time, we find some commonalities. First, food and beverage is at least 40% of total sales when the F&B portion of group sales is included. Second, party and group sales are a substantial portion of the business. And when it comes to family and adult-oriented concepts, the attractions are multi-player and multi-participant that facilitate highly interactive social encounters between the members of the group. The human beings are what make the attractions and social experiences change from one visit to the next, what we call repeat appeal. The attractions help facilitate the social experience. They also change the dynamics of large group events. Instead of participants just socializing with one or two people they know, after playing the attractions as a group, the participants become a much more integrated group as they discuss and even poke fun at what happened while playing. That accounts for why bowling, laser tag and miniature golf have stood the test of time. It’s different for fixed iron rides. There is little social interaction and after awhile, it’s Been there; Done that. That’s why theme parks have to make regular, around every three years, major investments in new attractions to maintain their appeal. With individual rides such as go-karts and bumper boats, there is an element of social interaction within a group, so they do have repeat appeal. They don’t get old like fixed rides.
So the bottom line is that to be truly profitable, FECs need to be developed with concepts that have long-term repeat appeal and don’t require major capital investments in new attractions. Don’t seduce you and your investors with the pro forma. Help the industry prevent road kill.
