Photo by Wance Paleri on Unsplash
 

I wrote recently about some "post-pandemic" stocks and whether they can sustain their current momentum going forward. In this review, we will look at another Green Screen stock that falls into that same post-pandemic category: Dave & Buster's (PLAY).

The question as always: is Dave & Buster's a great business? Does it have growing and recurring revenue streams? Can it withstand competitive and macroeconomic challenges to be a market-beating long-term (3-5 year) investment? Let's take a look at these points, and also, the valuation to see if it passes muster as a stock worth considering.
 

Eat, Drink... Meh

Dave & Buster's 3-word marketing catchphrase is: Eat. Drink. Play.

Remember that, because it is a perfect encapsulation of this business!

I'm sure most of you know what Dave & Buster's is. They operate large entertainment locations (30,000-45,000 square feet) that combine a restaurant, numerous bars, a large gaming/arcade area, and often auxiliary gaming areas for activities like bowling or billiards. Currently, the company owns about 150 locations, almost all of them in the U.S.

23% of revenues come from food and non-alcoholic drink sales ("Eat"). 11% are from alcoholic beverage sales ("Drink"). 67% of revenues are from the gaming business ("Play").

Food and drink sales are pretty standard and uninteresting, in my view. This portion of D&B is basically a casual dining restaurant business, with margins similar to chains like Brinker (EAT) or Darden (DRI). If it were just a restaurant, D&B would have a pretty hard time getting into the Green Screen, as restaurants do not generate particularly high returns on capital.
 

But Play - YES!

The interesting part is the Gaming segment. It is really the key to this business.

The ticker isn't "PLAY" for nothing!

Gaming makes up 67% of total company revenues. Most of the sales in this segment (72%) come from "redemption games". Players buy what is essentially a debit card, paying to load it up with points. Then those points can be used to play a variety of games: arcade-style video games, skeeball, air hockey, basketball shooting games, etc. Players can win tickets redeemable for various prizes.

Non-redemption games are things like bowling, billiards, VR experiences, shuffleboard, etc.

Gaming makes D&B locations unique. It is what sets them apart from Brinker's Chili's or Darden's Olive Garden. It also gives customers a reason to stay longer, which in turn leads to more food and drink sales.

Then there is the financial aspect. The gaming segment has excellent 91% gross margins, and far lower operating and labor costs than the food/drink side. As a result, D&B generates operating margins in the 12-14% range, compared to 8-10% for a typical restaurant chain.
 

Growth Potential Is Modest At Best - And Revenues Are Not Recurring

Let's now dig into the key points of a business model examination: growth potential, recurring revenue, and moat.

Starting with growth. One good thing about restaurants is that their growth potential is straightforward to gauge. Management estimates a store potential of about 250 locations, vs. 150 currently. The company has been targeting 8-10 net new openings a year, about a 5% rate. That is modest growth, at best.

The second growth lever is comparable store sales growth ("comps"). This has been extremely volatile over the past 3 years due to COVID. Pre-COVID, comps were pretty tame, 1-2% on average. With 2022 clearly a "reset" year, I expect D&B to return to more historical comp trends going forward. This isn't too inspiring either.

Finally, there is the acquisition route. While this is my least favorite way for a company to grow, Dave & Buster's has gone all in on it with an $835 million acquisition of Main Event earlier this year. Main Event was D&B's #1 competitor, although it was more focused on non-redemption gaming.

While Main Event will certainly spice up revenue growth for 2022 and 2023, it also really leverages the balance sheet. The company now carries over $1.2 billion in debt, with a scary 345% debt-to-equity ratio. Worse, operating income looks to only cover forward interest payments by 2-3 times, at most.

This brings us to a final point: this is not a recurring revenue business. This is discretionary, transactional spending in its most basic form. Customers may visit a D&B location once and then never come back again. This is a business that could be very hard hit by an economic recession, which adds significant risk to the debt concerns outlined above.
 

Looking For A Moat And Not Finding One

The third key thing I look for in a business model is an economic moat - a structural protection against competition. Since we plan to hold stocks for 3 or more years, this is key to an investment's success.

With Dave & Buster's... there just isn't one. There are zero switching costs for customers. The brand is not a major factor. There is nothing particularly unique about the business that prevents new competition. Bowling alleys, billiard halls, restaurants, and small arcades open (and close) all the time.
 

Valuation

Finally, we get to a category where Dave & Buster's looks pretty good: valuation.

I put together a discounted free cash flow model with the following assumptions:

1. Revenue growth of 48% for 2022 and 20.5% for 2023, owing to the COVID rebound and Main Event acquisition. After that, about 10% annual growth, tapering down to 7% by the end of the 10-year forecast period.
2. Free cash flow margin of 13.5%. The company was averaging this rate before 2020, and it is roughly in line with its pre-tax operating margin.
3. Share dilution between 2-5% annually, in line with historical norms.
4. A discount rate of 12%. Given the unattractive revenue model and lack of a moat, my confidence in the model is low, and so the discount rate is quite high.

Plugging in these numbers, and subtracting out almost $25/share in net debt, I get a fair value of $52.50. That represents a 39% margin of safety from the current $37 stock price. For folks who like the company, the market is currently giving you a decent price on the stock, if you want it.
 

Conclusion

It shouldn't be hard to tell that I'm not a huge fan of Dave & Buster's as an investment. The full-service restaurant business is just so difficult. It is highly exposed to competition, economic cycles, food and labor costs, and consumer preferences. It requires a lot of capital to build and maintain locations. Growth is extremely expensive.

If you really like Dave & Buster's and want to own a piece of it, the stock price is reasonable at present. That's about the only good thing I'm seeing here. Dave & Buster's (ticker PLAY) gets a RED (unattractive) rating.

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