Dave & Buster’s Stock: Cheap But I’m Not Buying (NASDAQ:PLAY)

Dave & Buster’s (NASDAQ:PLAY) shares have been a relatively strong performer thus far in 2022 with shares off less than 10% which compares favorably to the Russell 2000 Index/ETF (IWM) which has declined over 20%. Dave & Buster’s has produced record results as consumers flock to its restaurants following the pandemic. In addition, Dave & Buster’s significantly increased its footprint when it acquired Main Event, a similar entertainment/restaurant concept earlier this year.

In acquiring Main Event, Dave & Buster’s took on $835 million in debt. While results are strong and the valuation is inexpensive at less than 6x current EBITDA, I have decided not to buy shares as I do not believe current profitability levels (which are far above pre-pandemic levels) are sustainable. In addition, Dave & Buster’s has more financial leverage than I’m comfortable with, particularly as we approach an economic downturn.

Current Results

As you can see, Dave & Buster’s (standalone) has been on fire for the past 18-24 months as results have far exceeded pre-pandemic levels.

2Q saw a continuation of strong trends with comparable store sales up 5.7% (and nearly 10% versus 2019). On the 2Q earnings call, management noted that strong trends continued into the first 5 weeks of Q3.

Main Event Transaction

In June, Dave & Buster’s purchased Main Event, an entertainment/dining concept with 52 locations throughout the US, for $835 million. The transaction price equates to ~8x current EBITDA and was funded entirely with debt. Similar to Dave & Buster’s, Main Event has enjoyed record results – as shown below, adjusted EBITDA has doubled from pre-pandemic levels.

While the logic of bringing these two businesses together makes sense, I question the sustainability of Main Event’s profitability – similar to Dave & Buster’s the business appears to be running well above trend due to pent-up post-pandemic demand. If I apply historical profitability levels (2018-2019 EBITDA/location) to the current base of locations, Main Event would be earning $66 million in EBITDA which means that the acquisition multiple would be 12.6x EBITDA.

Balance Sheet

Dave & Buster’s funded the acquisition of Main Event with a variable rate term loan (2029 maturity).

Prior to the transaction, Dave & Buster’s had a very clean balance sheet (<1x net debt to EBITDA). After acquiring Main Event, the balance sheet still looks decent on current results with net debt/EBITDA of ~2.1x. However, I am not convinced that current results are sustainable. If the combined business produces results more akin to 2019 (using EBITDA per store), total EBITDA would be ~$420 million (-19% from current levels) and net debt to EBITDA would be 2.7x.

While 2.7x alone is not concerning, I would highlight that:

1/ Beyond debt service commitments, Dave & Buster’s does not own its real estate and has material lease obligations. In total Dave & Buster’s has annual fixed lease obligations of $192 million per year.

2/ 2019 results still reflect a strong economy. In a recession, results could be worse than 2019. Dave & Buster’s has significant operating leverage with a large component of fixed costs. This means that a hit to revenue will have a magnified impact on operating profit. I suspect EBITDA could come in 30% below 2019 levels should we have a harsh recession – in this case, Net Debt to EBITDA would approach 4x.

Valuation

Below I lay out the valuation looking at a few different scenarios:

Price	36.5	A
Shares o/s	49	B
Market Cap	1788.5	C=A*B
Net Debt	1125	D
Enterprise Value	2913.5	E=C+D
2022e EBITDA	522	F
2019a Pro forma EBITDA	420	G*
Estimated ‘Stress’ Case	300	H
*Pro-Forma for Main Event Adjusted for # of locations
EV/2022e EBITDA	5.6
EV/2019a Pro forma EBITDA	6.9
EV/Stress Case	9.7

Click to enlarge

There is no denying that Dave & Buster’s shares are cheap on current results. If this level of profitability proves to be sustainable, shares should do quite well over the next few years. Using an 8x EV/EBITDA multiple, the stock would have over 70% upside.

Should profitability revert back to historical norms (2019 levels), the same 8x EV/EBITDA multiple suggests 20-25% upside.

In the event that a recession leads to per store EBITDA falling 30% below 2019 levels, and using the same 8x EV/EBITDA multiple, shares would have 30% downside.

Conclusion

Given that I believe current results reflect pent-up post-pandemic demand and are not sustainable, my expectation is that 2019 (adjusted for store numbers) is a normalized level of profitability. While shares still appear to have modest upside, I’ve decided to pass given my concerns about operational and financial leverage as the economy weakens.