DAVE & BUSTER’S (PLAY) REPORTS Q3 – STOCK DOWN 6% TODAY – WHAT TO DO ??

CONCLUSION

While PLAY may seem statistically cheap at 13x this year’s earnings estimate and 7.5x trailing EBITDA, there seems to be very limited visibility regarding stabilization and then improvement in sales and cost trends. Especially with a company such as Dave & Buster’s, EBITDA is far less of a measure of free cash flow than at most restaurants and retailers. Depreciation should be banked and reinvested in the concept at some point, and that is increasingly clear in this situation. Hundreds of millions of dollars were spent a decade ago to refresh the brand before it came public again, that effort paid off in positive comps for a number of years, but that effect has apparently run its course, and a great deal of maintenance capex is likely in the cards if the concept is to regain its competitive position. Ongoing unit growth has not increased absolute total earnings power over the last several years, and we doubt that this will change any time soon. Even a shrinking stock base has not been sufficient to increase earnings per share, return on invested capital is declining and we are not convinced of the appeal of PLAY at the current time.

BRIEF BACKGROUND

Dave and Buster’s Entertainment (PLAY) reported Q3, stock traded up 4-5% in aftermarket as management confirmed guidance, has given the gain back and is now trading down 5-6% from yesterday’s close.

PLAY stock came public, after being taken private several years earlier, in late 2014, moved from the teens to a high of $70/share by mid 2017, fell back to about $40 by mid 2018 as comps moderated, rallied back to $65 with a major stock buyback implemented and the promise of their new Virtual Reality platform. The stock trading now at about $38. is at a multi-year low, statistically intriguing but many fundamental trends are heading in the wrong direction. We have written, at length, many times about this situation over the last two years, and those articles can be accessed through our SEARCH function.

RECENT DEVELOPOMENTS – PER Q3 REPORT AND CONFERENCE CALL

In a nutshell, while still generating a great deal of cash flow, almost every aspect of this brand has to be reinvented: the food, the games, the physical facilities, the consumer facing technology (the mobile app and loyalty platform). This once debt free company is now levered up by $640M, today considered a “modest” 2.3x trailing EBITDA, and we can expect further borrowings to finance stock buybacks, new stores and renovation capex. Earnings per share have gone from $2.84 in calendar 2017 (ending 2/4/18) to an estimated $2.85 in the FY 1/31/20 but the fully diluted share count was 42.6M two years ago and is now 26% lower. Relative to the stock buyback, $97M was purchased in Q3 and $187M remains to be bought. We can’t resist suggesting that, knowing that sales and profits were not turning around, or even maintaining, we would have held off buying stock in the mid $40 range, with a high likelihood of paying less than $40. Oh, well, it was only 2.4M shares bought back, and perhaps (the possibility of) saving $10M or so is hardly worth the bother 😊.

Third quarter overall comp sales were down 4.1%. Within that, Amusements was down 3.9%, F&B was down 4.4%. Special Events was up 0.7%. Amusements, as a percentage of total revenues, continued to grow, to 58.4% of total revenues, so PLAY continues to be more of an indoor amusement park than a restaurant. Expense lines included Cost of F&B up 60 bp to 26.8%, Cost of Amusement flat at 10.8%, Operating Payroll with Benefits up 10 bp to 25.4%, Other Store Operating Expense up 300 bp to 37.1%. This large increase was attributed to higher rent expense with lease renewals and higher marketing expenses associated with TV and digital marketing to drive traffic and promote the new mobile app (discussed below).  Store level EBITDA was down 320 bp to 20.1%. Below the store level, G&A was up 10 bp to 5.4%, D&A was up 30 bp to 11.1%, pre-opening was down 30 bp to 1.4%. Operating Income was down 330 bp to 2.2%. Interest Expense was up 90 bp to 2.1%. Income after minimal taxes was 0.2%, down from 4.2%, $0.02 per share vs. $0.30 per share a year earlier.

The conference call provided the most candid description of the state of the business that we can recall from this management team. An increasing amount of competition was again cited as a headwind, along with cannibalization. Food & Beverage improvement is still an opportunity but previous attempts have not gained traction. A new 43-foot Wow Wall LED TV installation has been installed in a total of 48 stores by now (35 at 10/31), and the Company, optimistic about the long term effect,  declined to describe specifics about the sales lift so far. New games are being developed that encourage social interaction, and the Virtual Reality platform is being expanded. Management referenced the fact that this year’s Amusement comps are going up against the supposedly difficult comparison of the Virtual Reality introductions a year ago, but Amusements was only up 1.5% in Q3’18.

Other than the Wow Wall, perhaps the brightest specific development was the development of a new Mobile App, which signed up over 600,000 new guests in the two months ending November, purchasing $14M worth of digital power cards. For context, since there were previously less than 800,000 active guests using the mobile app, there seems to be clear opportunity in this area.

CONCLUSION: Provided above

DAVE & BUSTER’S (PLAY) TAKEN OUT AND SHOT (AGAIN) – WHAT’S GOING ON ??

This situation, as it is playing out, is no surprise to our readers. The Q2’19 release met the earnings expectations but missed on the comps, and the company lowered guidance by 5-10% for the current full year, implying a relatively weak second half. You can read all the details elsewhere, including the conference call transcript, but a summary of Q2 includes:

Operating Income was up 0.6%, Net Income  was down 4.1% but EPS was up 7.1% on fewer shares outstanding. Corporate EBITDA was up 5.3% but down 60 basis points as a percentage of sales (still an impressive 22.9%, down from 33.5%). Store Operating Income (EBITDA) was up 4.8%, but down 90 bp as a percentage of sales (still an impressive 28.9%, down from 29.8%). Food & Beverage comps were down 3.2%. Amusements & Other were down 0.8%. Amusements and Other now represents 60% of total sales, up 80 bp from ’18. It continues to be the case that Dave & Buster’s is more of an indoor amusement park than a restaurant. It  is worth noting the lackluster comps were attributed largely to the difficult comparisons with the rollout a year ago of the Virtual Reality platform.  While we can’t know how much of the Amusement comp in ’18 came from the heavily promoted Virtual Reality, the Amusement comp in Q 2’18 was down 1.2%, the Food and Beverage comp was down 4.1%.

Management adjusted guidance for all of ’19. Comp Sales will be down 2.0-3.5% (vs. -1.5 to +0.5). Net income will be $91-$100M (vs. $103-113M). The tax rate will be (unchanged from prior guidance) at 22.0-22.5%. The shares outstanding will be about 34.0M instead of 36.5M, as a result of share repurchases. EBITDA will be $272-282M ($274-284M excluding $2M in one time charges), (vs. 283-$295M previously) . Capex will be $200-210M (vs $190-200M). In summary, comps will be a point or two less than previously expected, Net Income will be about 10% less, EBITDA will be about 4% less. EPS expectations will approximately unchanged, up about 10%, protected mostly by the large stock buyback.

CONCLUSION

We have written extensively about Dave & Buster’s over the last two years, and we provide below the most recent articles. The sum and substance of this situation is that the Company is spending hundreds of millions of dollars but is barely increasing corporate EBITDA.  The chart below shows how the incremental return on the dollars spent continues to deteriorate. Management continues to do their best to get a better return from the square footage dedicated to Food & Beverage, as well as re-invigorate the Amusement offerings. The “culture” within a restaurant chain is a challenge to improve and Amusements is basically a “hit driven” business with a high level of unpredictability. Considering the above, and the information provided in our previous discussions, though PLAY is down 8% today and down about 40% from its high of 2017 and 2018, we don’t view PLAY as a bargain at $40/share.

Roger Lipton

JUNE 12, 2019

DAVE & BUSTER’S (PLAY) – TAKEN OUT AND SHOT, IS IT REALLY THIS BAD?

Dave & Buster’s reported first quarter, ending 4/30, results last evening and their stock is trading down 22% this morning. The results were only modestly disappointing, and guidance was lowered just slightly, so the stock market reaction could be considered severely overdone. However, as our readers have been informed for almost two years now, the underlying business has been deteriorating for quite some time and that is now becoming clear to almost all observers. First, the Q1 results, not so bad:

EPS was $1.13 vs $1.04 last year. EBITDA was up 3.2%, adjusted EBITDA up 2.4%. Total revenues were up 9.5%. Same store sales were up 0.3%, a point or so less than expected, which management attributed to weather and disappointment related to sales over the Easter holiday. Seven new stores were opened, and “new store performance remained strong”. Previous trends relating to increased sales at Amusements (comps up 1.8%) and decreased sales at Food & Beverage (comps down 3.3%) continued. The details were less comforting, to be sure. Operating Income was down 1.5%, down 170bp to 15.9%. Net Income $42.4M vs. $42.2M, so EPS was higher due to a lower share count. Though EBITDA was up 3.2%, it was down 150bp to a still impressive 24.4% of revenues. Adjusted EBITDA was down 290bp to 27.0%. Store Operating Income was up 3.6%, but down 180 bp to a still impressive 31.0%.

Guidance was lowered just slightly for all of fiscal 2019, ending 2/2/20: Revenues will be $1.365-1.39B, vs. $1.37-1.4B previously. Comps will be -1.5 to +0.5 instead of Flat to +1.5%. Net Income will be $103-113M instead of $105-117M. EBITDA will be $283-295M instead of $285-300M.

So: on the surface, results were affected by weather and a calendar shift, and the full year is adjusted mostly to reflect the first quarter shortfall.

However: there is no tangible reason to think that trends will improve. As discussed on the conference call: The second quarter has started off “choppy”. Virtual Reality has not provided much of a lift, extra labor is involved, volatility is to be expected in this “hit driven” area, and pricing of this attraction is still a question mark of sorts. Food & Beverage initiatives, including a Fast Casual test, haven’t paid off yet even if customer surveys are promising. Competition was called out, once again, as a negative factor, and is not expected to abate.

There is a lot more detail we could provide, but, in the interest of getting this summary out as promptly as possible, you get the picture.

Conclusion:

PLAY may now seem like an attractive turnaround speculation since it now trades near its lowest price in several years, and the valuation does not seem expensive at about 13.5x ’19 earnings and 6.5x trailing EBITDA. New store returns continue to be attractive and the Company as a whole throws off a great deal of apparent free cash flow which can be used  for new stores, dividends and stock buybacks. However, as we have described several times over the last two years, the underlying long term trends are challenging and expected to remain so. Earnings and EBITDA have been essentially flat for several years now, the Company has spent over half a billion dollars to keep it that way, and there is no predictable reason to expect improvement. Deteriorating returns on investment do not make for a premium valuation so we considered PLAY adequately valued at the current time.

REPRINTED BELOW FROM 4/15/19 – DAVE & BUSTER’S (PLAY) – REPORTS Q4 AND ’18 YEAR – IMPORTANT OVERVIEW !!

We take a long term view. This management team, led by previous CEO, Stephen King, who stepped up to Chairman in August, did a fine job of refurbishing the brand prior to bringing D&B public again in late 2014. It is important to note that hundreds of millions of dollars were spent in that effort, and it would have been disappointing indeed if operating results had not improved dramatically for at least a few years.

We have pointed out in our previous commentary that the return on the incremental investment is shrinking, just as it did when D&B was publicly held the last time. We update that discussion with the following table, which starkly shows this trend.

You can see that capex was $162M in calendar 2015, and the operating results were still ramping up, to the new “plateau” of $143M in pretax income in calendar 2016.

After that improvement demonstrated by calendar 2016 results as a result of previous spending: ($181M was spent in 2016(but we assume couldn’t have affected  the $143M of Pretax Income by much), on top of $181M in 2016, an additional 219M was spent in 2017, $216M in 2018 (a total of $616M), and pretax income is projected to be the same in 2019 ($135-150M) as 2016 ($143M).

In essence: after the ramping of results through calendar 2016, presumably as a result of the last re-invention , ($181M in 2016, 219M in 2017, and $216M, a total of $616M) will have been spent, Pretax Income will have been essentially flat, and EBITDA will be up about 30M. That’s zero current return on a pretax income basis, only about 5% on an EBITDA basis, and (we have to say again) depreciation is not free cash flow.

Management could counter that three years is not the end of the story, and there is no doubt a “tail” in terms of return on upfront investment. On the other hand, it is pretty clear that continual refurbishment of this concept is a requirement. It’s also a major feature of this story that new locations have a huge first year return. That is no doubt true, but that would mean that new stores are providing a very large part of the total results, and older stores are falling off sharply. If there is a first year return of over 50% on new stores, that would be something like $100M on the last 15-16 stores, $200M on the other 110.

In any case, if earnings at PLAY are going to continue to grow, at say 10-20% annually, more new stores have to open, materially more than the 10-12% budgeted (some of them with a smaller footprint), to offset the declining contribution from the growing base of mature stores where contribution is declining.

While most analysts may not want to talk about this strategic reality, it’s possible that PLAY’s price performance, essentially flat for the last two years, is reflecting the above discussion. At only 18x projected earnings and about 8.5x last twelve months EBITDA, the stock might seem attractive when the first year cash on cash returns for new stores  are over 50%. However, the longer term view indicates that it will be increasingly difficult to build upon the current results, especially in a retail environment that is generally unforgiving.

REPRINTED BELOW FROM 9/17/18 – DAVE & BUSTER’S (PLAY) REPORTS Q2 – STOCK UP 7% – HOW IS BIG BET ON VIRTUAL REALITY DOING?

Dave & Buster’s Entertainment reported their Q2, ending 8/5/18, last Thursday, and the stock responded positively, up 7-8% on the slight sales “beat”, the more material EPS beat, and positive company commentary regarding results of the new Virtual Reality platform.

Conclusion: The upward move in PLAY stock was mostly a function of “beating” expectations for comps and EPS, which have been coming down in the last six months, and a short position among traders who are inclined to panic. Forward guidance was raised by the Company, but the amounts were modest, and were reductions in certain negative expectations, rather than inspiring confidence that traffic and margin trends will turn positive any time soon.  On the positive side, initiation of a dividend, providing a yield of about  1%, and continued stock buybacks are positive factors. However, management has distinguished itself by its unwillingness to hold shares outright, promptly selling shares acquired by way of options. On balance, we view PLAY stock as “fairly priced”, with a still strong operating model generating impressive levels of store level EBITDA. This apparent attractiveness, however,  is offset by the risk element of the “fashion driven” Amusement segment that is the main driver of profitability and cash flow.

REPRINTED BELOW FROM 12/11/2017 – DAVE & BUSTER’S (PLAY) – THE BATTLE OF THE BULLS AND BEARS !

The Positives:

• (1) Cash on cash returns are still among the very highest in the restaurant and retail universe.
• (2) There is a very long runway for future growth, which  has been extended by virtue of the smaller format.
• (3) The balance sheet continues to be strong, relatively unleveraged, with substantial cash flow for unit expansion, stock repurchase, and dividends possible as well.
• (4) There is potential improvement in the food element, separately and/or in conjunction with the new smaller format, including a Fast Casual approach to food & beverage.
• (5) A lower corporate tax rate would improve future after tax EPS, though it obviously would not affect EBITDA.

The Negatives:

• (1) Comps have been coming down, narrowing overall, with a continuation movement toward Amusements, now 56.9% of revenues. With less than 30% of sales from food, D&B is more of an amusement park than a restaurant.
• (2) Average Unit Volumes are coming down, at least partially due to the increasing mix of smaller stores.
• 3) Margins at the store level have been coming down modestly, and may not recover due to higher marketing, higher rents, higher commodity prices, and sluggish traffic trends, especially within the food & beverage segment
• 4) Competition, and cannibalization is playing an increasing role in suppressing sales and margins.
• (5) Depreciation, that is the useful life of Amusements,  continues to be an underlying issue. EBITDA is a valid measure of “cash on cash” return at the store level, but it seems to require increasing amounts of original (undepreciated) capital as the years go on.  Noone can be sure of the useful life of Amusements. The Company declares that it is “between five and twenty years”. We discuss this issue at more length in the full Corporate Writeup on our  website (9/14/17) at : https://www.liptonfinancialservices.com/2017/09/dave-busters-entertainment/.  We have not seen this issued addressed in either company documents or analyst discussions. If our concerns are misguided,  we welcome further discussion of this issue by the company or the money management community.