Description

Company Description and Investment Catalysts

Dave & Buster’s operates in the family entertainment center space. Its large (15K -55K SQF) locations feature arcade-style gaming, food and beverage offerings (including alcohol), and lots of TVs for watching sports. The arcades feature both traditional games as well as virtual reality type offerings. The food is typical bar food – burgers, fries, pizza, wings, fried apps, salads, etc. There’s a full bar with a large variety of specialty cocktails.

In 2022, Dave and Buster’s acquired privately held competitor Main Event, which operates similar facilities, although Main Event locations also feature bowling. There are 165 Dave and Buster’s and 59 Main Events, with plans to open more.

Dave & Buster’s is well-diversified regionally however Main Event has large swaths of territory across the U.S. where it does not yet have a presence. Dave & Buster’s brand growth will be centered on moving into smaller MSAs as it is currently concentrated in the largest MSAs.

Unsurprisingly, a large percentage of the business is done on weekends, with families dominating during the day and adult friend groups in the evenings. The company tries to entice visitors on weekday nights with a variety of promotions, most of which focus on food and beverage. Dave & Buster’s also has a special events business, offering kids birthday parties, corporate outings, and outings for organizations like churches, sports leagues, etc.

Competition in the family entertainment center space is fragmented, with two prominent competitors that are publicly traded: Bowlero (BOWL) which operates bowling alleys that also have arcades, laser tag, and food and beverage offerings, and Topgolf (MODG), which operates upscale driving ranges with food and beverage offerings. Formerly public Chuck E Cheese operates arcades with F&B offerings that are targeted at families with young children.  There are also a variety of regional operators that compete with Dave & Buster’s, but there are no competitors other than the three just mentioned that approach having national scale.

The company does 65% of its revenues in entertainment/games, which carry the very high gross margin of 91%. The other 35% of the business is done in Food & Beverage, which has a high gross margin for a restaurant operation of 74%, presumably because of the higher mix of beverage revenue (both alcoholic and non-alcoholic).

Subsequent to the closing of the Main Event deal, most of the C-Suite of Dave & Buster’s turned over, with Main Event CEO Chris Morris assuming the role of Dave & Buster’s CEO. In June of 2024, the former Main Event CFO Darin Harper rejoined the company as its CFO. There are a number of other senior executives at Dave & Buster’s who came from Main Event, including the COO and CTO.

This change of management is an important piece of the Dave & Buster’s story, because the company has historically been undermanaged. Under prior leadership, Dave & Buster’s simply had not been following many of the best practices of retail and restaurant management. As an example, they only recently began building a customer list that they can directly market to. Another example – also regarding marketing best practices – until recently, almost all their advertising was being done on linear TV, and they spent almost nothing on digital.

Another example of undermanagement – there hadn’t been any price increases on the games side in 20 years. Given inflation, especially recently, this is a total headscratcher… but it gets much worse when you consider the opacity around game pricing. There are no hard prices listed on the games. Instead, a customer buys a card with tokens to play. With a price increase, the tokens will run out after slightly fewer minutes of play. Given price increases can be so subtle, it’s crazy they never took any.

Simply put, the Dave and Buster’s organization has been a sleepy one, and there is a new management team now in place with a track record of being much more aggressive and modern in its approach to growth.

At its June 2023 investor day, the new management team outlined a series of six operational initiatives that they believe have the potential to grow EBITDA by $430 million to $600+ million. Given the company did $556 million in EBITDA last year, executing against only a fraction of the opportunity defined last year would be a gamechanger to EBITDA.

Beyond the operational improvements being pursued, there are other opportunities for EBITDA growth, including new store openings, cost cutting, and entering international licensing agreements.

Simply put, not everything has to work here. There are nine major levers for growth, and even if only two or three of them come to fruition, EBITDA could rise 20%-50+%. The stock is not discounting any of these initiatives working, currently trading at only 5.25x EBITDA and a P/E of 14.

The current valuation entirely discounts management’s comprehensive EBITDA enhancement plan. An EBITDA multiple in the 5s suggests that the market does not believe that accretively opening new stores will be a possibility either. Investor skepticism in the plan is reflected in this multiple and was at least temporarily justified by very weak 1Q24 results, which the company reported in mid-June, prompting the stock to drop 11% after the report and bleed another 10% in the two weeks following earnings.

For 1Q24, Dave & Buster’s reported -5.6% same store sales and higher than expected deleveraging on the negative comp, with EBITDA down 13% year over year on a 2% sales drop. Management explained that the cost of testing and training for the new operational practices caused a one-time expense drag affecting Q1 results. Management added that sales, comps, and profitability all improved in the beginning of Q2, but the market simply didn’t believe them or didn’t care.

Assessing the Turnaround Opportunity

This graphic from the 2023 investor day lays out and quantifies the six levers for EBITDA growth:

There are two levers here that I see as having a very high probability of working out: strategic game pricing and special events. As mentioned above, the gaming price increases will be very opaque to customers, and Dave & Buster’s is only planning to raise prices 10% over three years. This seems conservative but leaves room perhaps for more increases in the future. The $80-$120 million EBTIDA opportunity here seems very attainable.

The other possible low hanging fruit is fixing the special events business. During the pandemic when the stores were shut down, the company laid off its in-store special events workforce and adopted a centralized call center model upon pandemic re-opening. This was simply a bad choice, as having someone in-store present in the community who knows the local businesses and organizations in the area is a much more effective way to sell events.

I’m cautiously optimistic about food & beverage improvements, where a redesigned menu should cut down on complexity and in turn help quality and throughput. The risk here is that past visitors who had a subpar F&B experience may be hesitant to give Dave & Buster’s a second chance on F&B. If they build it, will they come?

Getting people to try Dave and Buster’s for food while they are there to play games or watch sports will be an exercise in marketing execution, which happens to be the biggest opportunity dollar-wise to grow this business. To me, this is the initiative where it is hardest to get confidence. It’s still early days, and this is an exercise in messaging as well as medium, and messaging working is something that is always hard to handicap. I also view the remodel opportunity with some skepticism as well, as I do with all retailers or restaurants embarking on a major renovation effort.

The company also has a $60 to $80 million cost-cutting initiative underway.

As for store growth, the company has plans to open about 16 units per year, part of a larger plan to grow from the current 224 store locations to 550+.  They are currently looking outside of major metros into smaller markets. They are building smaller, somewhat less expensive stores for the smaller markets, but are bullish about the ROIs they are seeing from them.

If just games pricing and special events work out and everything else is a bust, yet the company continues to open around 15 units per year, I think EBITDA in 2027 could come in close to $700 million, versus $556 million last year.

Risks

The number one risk and the only thing that keeps me up at night regarding this stock is the existential question of whether you can turn around a consumer cyclical company in a recession. This is obviously a highly discretionary experience and destination, and the average cost per person for a visit was $36 as of last year.

The low-income consumer is really hurting right now. On the first quarter call, Dave & Buster’s mentioned that spending was strong from higher income patrons, but the bottom was falling out on the low end (an observation echoed on countless 1Q retailer/restaurant conference calls).

In the post pandemic period, it seems the customer base growth on the low end may have outpaced that on the high end, due to the increases to minimum wage and broader inflation in hourly wages plus the effect of the stimulus checks. Also, older Dave & Buster’s are often attached to malls, and many malls that used to be A malls have migrated to B malls over the last few years, which would also affect the clientele that come to them.

The current management clearly has a very private company mentality towards their growth initiatives and plans to plow ahead with every initiative that testing indicates is a good idea, regardless of the macro backdrop, the stock price, or the election cycle (which also tends to be a drag on consumer spending).

If the plans are indeed good, plowing ahead is exactly the right thing to do. Dave & Buster’s should be building the systems, infrastructure, and marketing that will allow the company to reap the rewards when the cycle turns back in their favor. But management spent most of their time on the 1Q24 call expressing their excitement over their testing and early results, and didn’t spend as much time as perhaps they should have explaining why weak 1Q results aren’t a good indicator on the prospects for their turnaround program, which probably frustrated many investors who were more focused on the substantial earnings miss.  

While this management team has lots of experience in the family entertainment center industry, it doesn’t have a lot of experience running public companies, which may explain the conference call flub of not explaining better why the quarter was weak and also why investors should look past the weakness.

It’s worth noting the board presence of activist investor Hill Path Capital, which has also been involved in SeaWorld. Scott Ross, the founder and managing partner of Hill Path, previously worked at Apollo and has sat on boards of companies in related businesses such as Great Wolf Resorts (indoor water parks) and CEC Entertainment (parent of Chuck E Cheese). Hill Path has a board seat and owns 18% of the shares.

I do think the plan is solid, and I like that there is some outside oversight from a large investor with a board seat who knows this industry – as well as the broader entertainment, lodging, and hospitality industries. It is quite possible that even with effective execution on many of these initiatives, Dave & Buster's might find itself running to stand still in the short term, because any EBITDA enhancing improvements may be offset by deterioration in the core business due to the economy.

That said, on the other side of the theoretical upcoming recession, this company could be spring loaded for growth. The multiple is very depressed currently when you consider where it traded pre-pandemic, which was generally between 7x and 10x multiple of EBITDA. The company has also been a steady grower in revenue and EBITDA over the years, which theoretically should support a higher multiple.

In fact, the multiple is so depressed now that the stock is essentially flat versus its price five years ago – despite EBITDA nearly doubling over the same time period (one-third of which was the Main Event acquisition – but the rest was organic).

Short interest is high here at 20%. More proof of skepticism regarding this management team and its plan. But that short interest could also turn into a tailwind if the company returns to positive same store sales.

One final thought on the economic backdrop…. Dave & Buster’s doesn’t just compete with Bowlero, Topgolf, and other family entertainment centers. It competes with other forms of out of home entertainment ranging from casual dining concepts and movie theaters on the inexpensive end of the scale to theme parks, concerts, sporting events, and vacations on the expensive end of the scale. While there is no doubt that a down economy will be a major headwind, there may be some offset from more people staycationing or looking for cheaper alternatives for entertaining their families close to home (e.g., taking your kids to Dave & Buster’s in lieu of Six Flags or an NBA game).

Valuation and Other Financial Considerations

At the current EV of $2.9 billion, the company is trading at just 5.25x its FY24 (Jan year-end) EBITDA of $556 million.

In my base case, I hold this depressed multiple, assume the company can tack on $150 million of extra EBITDA in the next three years via game price increases, a special events rebound, and new store openings. This would get me to a base case valuation in the mid $60s for approximately 65% upside.

If more things go right – e.g., food and beverage utilization increases, cost cuts are successful and not reinvested, or marketing optimization indeed leads to better conversation, visitation, and frequency and in turn better same store sales, I could see the stock going over $100.

As for the downside, it feels like a falling knife right now, but the stock’s valuation probably reflects the expectation for a double-digit decline in EBITDA in 2024. Outside of the pandemic shut down period, the stock has bottomed many times in the low $30s, so there is probably 15%-20% downside here if everything goes wrong.

The company has $1.3 billion in debt and approximately 2.3x leverage. It is self-funding for the store openings and remodels.

Management remains unshaken by recent operational and trading volatility and is buying back stock. In 2023, the company bought back 8.5 million shares totaling $300 million (average price $35) and representing 17.5% of shares outstanding. It bought another 1 million shares for $50 million in 1Q24 (obviously not at as good of a price).

Management believes in the opportunity. I do too, but in the spirit of full disclosure, the macro backdrop makes me think it might take a couple of years for this to play out. In better times, I would have thought a couple of quarters would be enough time for proof of concept, but in the current macro environment, this investment will require a little patience.

Retail turnarounds are notoriously difficult, even in the best of economic times. It’s a big lift ahead for Dave & Buster’s, but the plan is solid, management appears to be greatly improved, and a lot of the bad news is already out and in the stock. The risk/reward appears to be very asymmetric here, and there are many ways to win. The opportunity is large enough to merit buckling up and committing to having some patience.

Catalyst

• Operational improvement translating into higher EBITDA, accelerated EBITDA growth, and positive same store sales
• Productive new store openings yielding credibility for ambitious long-term store opening targets
• Improved free cash flow as some one-time IT and other investments roll off