PLAY - Dave & Busters

[johnny]

Interesting movement in these shares. Disclosure, I once was short, and now I'm long. Was blind but now I see.

 

Quick Description for the Boomers

 

Dave and Busters is adult Chuck E. Cheese's. They build giant arcades that are attached to, basically, an Applebees kind of thing. Their revenue is about half games and half restaurant. The margin on the games is very high. Basically 100% for classic "video games", and then very high 80s for "redemption style games" (which are really the lion's share of business). The margins on the food and beverage side are in-line with the industry. The facilities are huge. Like 20-60k square feet. You are probably familiar with D&B because half of you are Seritage bagholders. So you already know one good aspect of the business--they are one of the few big-box takers for a lot of space coming online, and their leases tend to reflect the desperate situation emerging. They come into a town, negotiate $1/sqft rent in prime areas, and then proceed to just demolish every mom and pop outfit paying $2/sqft in a strip mall.

 

Okay, here's the deal. Shares are around $20 each right now. Let's call the market cap around $630M.

 

Bad Thing One

 

They did something very stupid and started doing massive buybacks in the last year (not at $20/share). They financed this with a facility that I believe is up in Summer of '22. They were buying at about twice today's prices. Woops. Oh well, they have 9 quarters to get ready. EBITDA for the 17 18 and 19 years has been pretty consistent at around $275m. They are growing stores, so yes, their same-store traffic hasn't been good, but nothing catastrophic.

 

By the way, don't value this company on EBITDA.

 

So anyway, EV

 

So, now they have something like $700m of net debt, if you treat the card balance deferred revenue as money good, which you should since amusement margins are like 90%.

 

So EV is ~$1.3B--Under 5x EBITDA, if you insist on ignoring me when I tell you that's not a good metric for this fucking business.

 

Here's the crux of how I think about this: They have something like 140 locations right now. So you're paying a little under $10m per location. This is pretty much right in line with what their net development costs are. So you're buying the company sort-of-like at duplication cost. Their claimed ROIC has averaged low-to-mid 20s for the past five years, and they claim to have beaten their 35% "year one cash-on-cash returns" target on new stores pretty much every year since 2011. The average, according to whatever their blackbox formula is, is in the low 40s% (though there is a clear downtrend for the last few years towards the mid-30s). I should mention at this point that one reason I was short before was that I think they're a little loose and aggressive with their accounting; I specifically think they grossly under-depreciate their arcade machines. So let's put an overlay of skepticism over any proprietary metrics they come up with. But still, these numbers are good enough that we can put in a decent bullshit margin and still end up okay. Check slide 21 of their January 2020 presentation. I think my entire thesis for investing is basically "we are buying at roughly their build cost" plus slide 21 of this deck. Everything else is just spot checking.

 

Bad Thing Two

 

Like I said, I was short partly because I thought they were full of shit on depreciation. I still think that's likely true, but I can't be 100% sure (they definitely under-depreciate in percentage terms, but it's plausible that their basis understates the true value of the equipment because of bargaining power, blah blah blah). But even if you decide they are in fact under-reporting that expense, you could double it and you're still only taking a few percentage points of margin and the business is still fine.

 

So What About Recession??

 

They have an okay story to tell here--their worst performing vintage from a "first year cash on cash return" perspective was the 2008-2010 openings, but they still report those as coming in around 30%. A few caveats, though:

 

1. They probably got these built quite a bit cheaper given what was happening, so it doesn't mean we should expect the new fully-priced developments to post similar numbers in the bad scenario

 

2. Those were likely much more prime, low-hanging-fruit type locations. They have clearly taken up most of the obvious markets and are now stretching to reach areas that are more marginal. So those could turn much harder.

 

3. This business has the honeymoon-period phenomenon, where Y2 is worse than Y1, and they aren't exactly too fucking clear on how bad that drop off is over time. So a 30% cash return in year 1 may actually end up to be a somewhat mediocre story, once you account for the subsequent drop off and the True Maintenance Capex required to keep the stores well-trafficked. And did I mention I don't trust their accounting?

 

The Qualitative Stuff

 

I recently met somebody who is a small operator in this space that was looking for growth investment. As I've noodled that deal, I've become more appreciative of D&B's scale advantages. While I don't respect their accounting, it does seem like they think about product (on the amusement side at least) in a very serious way, and they're not at all complacent about it. Some of this takes the form of really dopey ideas like their "VR experiences", which I think are incredibly stupid boomer-brained bullshit. But the way they push forward on other aspects of the customer experience do impress me.

 

Just as a quick example, and in fact one that is really out-of-date, D&B has basically helped totally normalize the concept of playcards instead of tokens. Even the brain-dead among you can probably appreciate why this is preferable for the operator, but it's actually much more well-liked by the customer as well. It might seem to you that this is a fairly simple concept (and it is), but if you want a plug-and-play solution for something like this, you are going to be absolutely sodomized by the vendors as a non-scale player. You're talking like $40-50k for a location if you are willing to take all the integration/upkeep risk. Closer to six figures if you get roped into a service contract. Maybe that doesn't sound like a lot to you 1%er motherfuckers, but that can end up being something like 30+% of your Total Amusements Cost for the small operator trying to get things done on a budget. As things like aggressive smartphone app-integration get pushed forward, I think this story gets even worse for everybody else.

 

Not that I think small arcades are even really D&B's competition at this point. Those guys are mostly dead, and D&B isn't primarily marketing as a substitute for Street Fighter nerds to hold tournaments. It's competing in the "date night" and "group outing" and "team building" business against movie theaters, bowling alleys, etc.

 

And that's what makes it qualitatively attractive. If you really put D&B against its other "amusement" comps, I think it has the capacity to endure bad times much better because I believe its costs are much better. Unlike AMC, they're not rendering 50% of their topline amusement revenues to Big Buck Hunting or whatever, nor are they especially sensitive to production slates. (Nobody says "let's see AMC" but they do say "let's go to Dave and Busters").

 

You might imagine something like bowling is relatively fat-margined. You'd be wrong! Bowling COGS are like 35-40% according to the latest Bowl America 10-K I spent exactly five seconds looking at. So basically Dave and Busters is like Saudi Arabia if they were drilling for millennials.

 

Thus concludes the pitch. If you think I'm wrong, fight me.

 

[NBL0303]

This is an utterly excellent write-up. I need to consider it to know which points to push back on, but in any event, it is one of the best write-ups I've read on this site. Thank you.

[Foreign Tuffett]

Thanks for the write up. Several years ago I hosted/organized an annual employee event at a Dave & Buster's. PLAY stores are great for family friendly events because the kids can play video games, the adults can play pool or bowl, Tom from accounting can drink beer until he gets 86'd....basically there is something for everyone to do.

 

I think you are right to look very, very closely at depreciation here. Actual maintenance capex is probably quite high. There is nothing more depressing than an old, run down video game arcade, so they have to keep buying new arcade machines and refurbishing old ones to keep the stores fresh. The most recent 10-K says each box has ~150 "redemption and simulation games"....lots of money and effort to keep them presentable and in working order as the store base ages, particularly given how much valuable real estate they occupy.

 

You are right that PLAY undoubtedly has scale advantages over mom and pops, but (as you mention) mom and pop businesses of this type are such terrible businesses that I don't think that means much. The two types near me (mid size US city) either (1) exist only because the guy who owns them knows how to fix up old arcade and pinball machines or (2) new/unproven glorified hipster bars

 

Also, looks like nearly 10% of revenue comes from events, which I would imagine is relatively pro cyclical.

 

All that + the leverage means this is a pass for me.

 

Last but not least

Johnny, if you want to duke it out I will be at the 3rd floor Las Vegas Wynn ice machine tonight at midnight wearing a red velour jumpsuit, feather boa, and sunglasses.

 

[peridotcapital]

I was long this until recently (sold at $46 on the activist pop) and got quite lucky given how the virus has now crushed entertainment stocks. I guess the thing that worries me most are the new entrants in this sector. You've got chains like Pinstripes gobbling up former Sears boxes and upstarts like Punch Bowl Social getting huge growth investments from Cracker Barrel. While I agree the business is good and D&B has scale, they are not the only player anymore like they used to be. If other chains are expanding, it does not bode well for D&B's new unit potential or existing unit same store sales. So then you get traffic declines and margins tank due to high fixed costs and negative operating leverage. Isn't that why their metrics have been poor the last 1-2 years? What will make that turn around? Or is that all priced in now at $20...

[johnny]

One reason I've softened up on the depreciation/maint capex stuff is the fact that D&B should be approaching monopsony-like buyer status. It's not that they're the only buyer, but it's really hard to make a game pencil out if you know that they -won't- be buying. Arcade games have always been a high-fixed-cost, largeish gross-margin type business. What this says to me is that the future of this space is probably going to look a lot like D&B either vertically integrating or, at the very least, enjoying some vertically-integrated economics in lieu. I don't think they're going to be paying $70,000 for Halo Cabinets in 2030. It just doesn't make sense for them to be paying 500% markups on physical assets in order to help amortize the development costs of software that their competitors can only afford because of their purchase.

 

I think they can start guiding their vendors more towards concepts that are in fact more durable assets. See, for example, the new game genre that I can only pitch as "we licensed that iPhone game and now you get tickets". A big vertical LCD, maybe a single big button for flapping your bird, or two big buttons for crossing your road, and a ticket dispenser. These cabinets have a lot of aesthetic sizzle and novelty, but I could accept the claim that they're only depreciating 10% a year. One of the best performing games in the arcade I've checked out was the basketball and ski-balls. Those have mechanical components that wear/need replacement, but I can believe 10% depreciation on those as well.

 

In conclusion, sure they're bullshitting about their depreciation. But I guess I'm open to the possibility that they have the economic leverage to bend the reality of the industry to fit the shape of their fabricated curve. How's that for a bagholder quote?

 

That said, the limited examples that exist of D&B getting more "involved" in the amusements side has not made me think this will be a smooth process. I think they've had some terrible proprietary garbage. Their VR experiences are similarly stupid, but at least it shows they understand that is the string to be pulling on.

 

All-in-all, this remains the area of most serious concern for me. The debt gets stupider and stupider the more I think about it--the CFO should be taken out back and shot. CEO left alive, but forced to watch, and maybe we try to make him think we're going to do them both. Not sure about this part of the pitch, may leave that slide out.

[johnny]

I was long this until recently (sold at $46 on the activist pop) and got quite lucky given how the virus has now crushed entertainment stocks. I guess the thing that worries me most are the new entrants in this sector. You've got chains like Pinstripes gobbling up former Sears boxes and upstarts like Punch Bowl Social getting huge growth investments from Cracker Barrel. While I agree the business is good and D&B has scale, they are not the only player anymore like they used to be. If other chains are expanding, it does not bode well for D&B's new unit potential or existing unit same store sales. So then you get traffic declines and margins tank due to high fixed costs and negative operating leverage. Isn't that why their metrics have been poor the last 1-2 years? What will make that turn around? Or is that all priced in now at $20...

 

I'm not familiar with those concepts, but I am quite familiar with Round 1, who has been aggressively expanding for at least half a decade. Round 1 target similar sizes (sometimes even larger IIRC) and is a US beachhead for a Japanese company, which means their investment mandate is to target a four-wall EBITDA margin of -1%.

 

I will say that D&B seemed to handle the R1 challenge reasonably well, and when I look at other concepts, it really seems to me that they're making a lot of decisions that D&B has purposefully avoided. Bowling, for example, is not sufficiently productive per square foot, so D&B doesn't builds alleys (though they maintain a few from acquisitions). Pinball requires a lot of specialty labor that isn't justified by the revenues, etc. There's a lot of hipster shit going on in these competing firms (foosball tables?) that makes me skeptical they're actually going to be able to scale well, as envisioned. That's absolutely a gut-draw though I've never been to either chain you mentioned and will have to do some meditating on the topic.

 

Same store weakness was, to me, fully explainable by the fact that a lot of their "new" locations are just twenty miles away from existing locations. Maybe I have been a bit to flip about those statistics though.

[5xEBITDA]

Is replacement cost the correct yardstick for valuation given the current & potential impacts of retail / entertainment sector deterioration? It doesn't matter if historical cost is $10 million when the NPV might be below that.

[Guest roark33]

The problem with PLAY is the operating leverage, the fixed cost leases and overall cost to operate these places is just going to work terribly against them in a time like this.

[johnny]

Given what is going on with the market I'd agree there are better opportunities elsewhere. The long-term prospects for these boxes are, in my opinion, pretty good. But the next 12 months may well be a disaster, and given the leverage situation, possibly fatal.

 

If they hadn't totally walked themselves up to a cliff's edge on this buyback I'd say they were perfectly able to deal with the Coronavirus thing. Oh well.

 

I do expect if COVID-19 ends up having a truly catastrophic effect on the business (-20% is survivable, -50% probably isn't), this will be a generalized experience that will push the government towards unprecedented intervention that companies like D&B seem pretty well situated to exploit (scale, important economic input to giant REITs, "economic soundness" absent the current crisis). Here it is, in the flesh folks: my thesis has now shifted to "Wouldn't some of that Moral Hazard stuff be great?".

[Guest roark33]

DB is definitely TBTF

[johnny]

Well I owe the board major thanks for shaking me out of this position quickly. The day I was buying I got really stubborn at $20 and it ran away up to $21 or $22.

 

So I flagged it for review at half that price and....here we are. Company is down another 30% today, we're at a market cap of $250m. I still think it's almost mandatory that the feds are going to have to come up with some liquidity/debt extension/relief package for retail that Dave is in a prime position to benefit from. But there will be a -very- strong argument that while coronavirus isn't their fault, their totally dipshit capital structure decision deserves to be massively punished, so given that moral argument and the compelling opportunities with companies that don't owe 2x their market cap in a lump sum payment in two years, I still wouldn't say this is an obvious winner. But I can't help shake the sense that there's just no way they're going to be able to design/calibrate a response that actually -does- punish imprudence like that exhibited by D&B.

 

But I find myself more and more sidetracked by trying to imagine what the appropriate relief package would look like. Does anybody have any wild guesses here? Either they fail to contain this thing and we get a huge rush of failures, or they're going to come up with some totally unprecedented package, in which case the first people to accurately model the impacts are probably going to be able to pick up some very good low-risk bargains. This and MAC both seem like they're basically priced at a 50% risk of BK.

[Guest roark33]

Wow, check out the movement in this stock...amazingly entertaining these days...

[estoybien]

Yea, absurd. Short now?

[Guest roark33]

PLAY doing 75m stock sale and hoping to tap Main Street Lending Facility from Fed for up to 150m.  I bet they survive here, but earnings are going to be significantly whacked this year.  Tough to tell how much value destruction has occurred. Any growth put on hold for the near future. 

[Guest roark33]

https://www.sec.gov/Archives/edgar/data/1525769/000119312520131748/d925494d424b4.htm

 

Doing another stock sale, this time $100m.  They opened up their first store on April 30. 

 

I wonder if they saw the attendance numbers and thought....wow, we are going to need a lot more cash.