Dave & Buster’s: Had to buy it at this price (NASDAQ: PLAY )

Shares of Dave & Buster’s (NASDAQ: PLAY) have been hit, falling 23% over the past year and down more than 50% from their April highs following disappointing 1Q24 results, along with concerns about weak consumer spending and high leverage caused investors to exit the stock. While I don’t like Dave & Buster’s balance sheet, and there’s a strong likelihood of further earnings weakness next year if consumers continue to pull back, I think the stock is too cheap to ignore at current levels. Moreover, while just four months ago investors were excited about the prospects of management’s profit-improving plan, at less than $32 a share, investors are not giving any credit to profit-improving initiatives.

While the stock is not without risk, I view the risk/reward as favorable for contrarian investors. It should management is only doing a few of its initiatives well, I think Dave & Buster’s stock could double or better. Even assuming a weakened economy with little compensation from management’s plans, I see little downside in the stock. Given what I see as an asymmetric situation, I took a position in Dave & Buster’s stock.

Recent results

As noted above, 1Q24 results continued to see slight same-store sales growth (same-store sales down 6.2% in 2023), likely driven by negative traffic/transactions (Dave & Buster’s not highlights traffic/transaction compensation), given that the company has begun implementing some of its pricing initiatives (discussed below). Declining same-store sales, along with some incremental expenses (related to a new menu launch, which management does not expect to recur) led to a 12.6% year-over-year decline in 1Q24 EBITDA.

While management mentioned improving trends early in 2Q24, we saw some evidence of a consumer spending environment in 2Q24 that could persist into 2024/2025 and lead to continued weakness in like-for-like sales store and EBITDA. While I expect macroeconomic headwinds, management is not sitting still and has several initiatives to improve revenue and EBITDA (see below).

Management profit improvement initiatives

As I noted above, in 2023, current management proposed what we considered to be a bold target of $1 billion in adjusted EBITDA by 2025. I think it’s probably fair to say that this will not be achieved.

That said, I believe many of the initiatives (outlined above) can produce significant EBITDA gains over the next 2-3 years. I think we can reasonably expect $200-300 million in improvements. New domestic store openings, international franchising and store remodeling should conservatively produce a minimum of $150 million in incremental EBITDA over the next 3 years. Additionally, I think there is merit to the expected EBITDA gains from gaming and grocery pricing initiatives, where Dave & Buster’s has been slow to gain price despite inflationary pressure over the past few years. Similarly, I believe the company’s digital marketing initiatives (membership/loyalty program) should contribute to same-store sales/EBITDA growth.

ASSESSMENT

Today at $32 per share, Dave & Buster’s trades at just under 5x TTM adjusted EBITDA of $535 million based on 220 stores. That doesn’t give any credit for management’s bottom line improvement program, but also doesn’t take into account the likelihood of a future decline in same-store EBITDA due to a weakened consumer spending environment.

Over the past decade (excluding COVID), EBITDA per location has ranged from $2.1 million to $2.7 million for Dave & Buster’s (adjusted for Main Event; 2022 and 2023 were $2.7 million and $2.6 million, respectively ). Assuming that Dave & Buster’s opens 50 new locations by the end of 2026 and assuming only $2 million of EBITDA per store (-23% vs. 2023) takes me to $540 million in EBITDA in 2026/27 (essentially equal with TTM). This seems like a reasonable disadvantage case. If D&B continues to trade at a draconian 5x EV/EBITDA multiple on what I would consider depressed results, investors should get out.

Assuming $2.4M in EBITDA per location (midpoint of historical range) comes to $650M in 2026/27 EBITDA (using 270 stores). Applying a 7x EV/EBITDA multiple (it has historically traded at 7-8x over the last decade) and subtracting net debt, I get a value of $80 per share (+150% upside).

Finally, what if management’s profit-improving initiatives are successful? Assuming $3M per store, this takes me to $810M in 2026/27 (still ~20% below management’s $1B target). At an EV/EBITDA multiple of 9x (Dave & Buster’s traded north of 10x in 2016-17), this puts me at $150 per share (after deducting net debt), which works out to 368% upside.

Risk factors

– Dave & Buster’s has more debt than I’d like. While current leverage levels (2.4x net debt to TTM EBITDA) aren’t too concerning, Dave & Buster’s has operating leverage (heavy fixed cost burden means EBITDA may decline at a faster rate faster than same-store sales) and that ratio could quickly head north of 3x. I say “may decline at a faster pace” rather than “will decline at a faster pace” because it’s entirely possible that management initiatives will offset a significant portion of any same-store sales weakness.

– In addition to debt on the balance sheet, Dave & Buster’s has lease commitments of over $200 million annually. We estimate a fixed load coverage ratio of 2.2x. Again, this isn’t too concerning, but declining same-store sales could push this higher.

– Instead of paying down debt, Dave & Buster’s is using discretionary cash flow to open new locations (50-60 new locations by the end of 2026), remodel existing locations, and buy back inventory (Dave & Buster’s a repurchased over ~20% of outstanding shares in the last two years). While the new locations and remodels will almost certainly increase cash flow, I was less enthusiastic about share buybacks and would have preferred paying down debt. Of course, if management’s profit-enhancing initiatives are successful, buybacks might seem predictable in hindsight.

– Dave & Buster’s is sensitive to consumer spending trends, especially the spending trends of lower income consumers (37% of Dave & Buster’s customers have incomes below $50,000 per year and another ~39% earn $50-100,000 per year). Lower-income consumers, who benefited disproportionately from COVID-related stimulus in 2021-2022, have been hardest hit by inflationary pressures over the past two years.

Conclusion

While investors have fled Dave & Buster’s given a weakening consumer outlook, along with operating and financial leverage, they see the stock as offering an asymmetric return at $32 and have taken a long position in the stock.