KKR puts Dave & Buster's into PLAY ▶️
The grass always appears to be greener on the other side.
If you know someone who’d love to get Lever Up in their inbox (or has been involved with the subject of discussion), I encourage you to forward this to them!
Admittedly KKR’s activist stake in Dave & Buster’s is not news and only tangentially related to the subject matter of this letter, but the story has some things going for it that warranted it being discussed here:
It was tempting to write a headline with D&B’s stock symbol pun
We discussed earlier a historically activist fund investing in private equity, so it’s only fair we look at a historically private equity fund getting into the activist game
Nothing is precluding me from writing this (unlike another story which I hope to share after the dust settles)
PLAY is public, which presents an opportunity to note that nothing discussed here is investment advice
While KKR clarified that they are not turning full-Ackman just yet, the move incited other PE execs to start calling their lawyers and evaluating how activism can augment their current approach. Earlier this year, TPG was reported to be raising an activist-ish fund of their own
Target 🎯
Dave & Buster’s operates entertainment and dining venues across the U.S. Less formally, it operates 134 arcades, akin to Chuck E. Cheese’s for a slightly older crowd. The company has struggled in recent years, in part due to increasing competition from in-home entertainment alternatives (think streaming apps, the rise of mobile video games). As a result, same-store sales have been increasingly negative.
The revenue split for D&B is roughly 58% from Amusement and 42% from Food and Beverage, with growth in the Amusement segment outpacing that in Food and Beverage. Which is good for the bottom line, because Amusement gross margins are near 90%. The growth has been driven by new store openings (with same-store sales declining), and new smaller store formats.
D&B has a rich history of putting bankers’ kids through college: 💸
2005: Wellspring Capital took D&B private for a total value of approximately $375M
2008: Unsuccessfully tried to IPO
2010: Oak Hill Capital Partners bought D&B from Wellspring for $570M
2011: Unsuccessfully tried to IPO
2014: D&B goes public at an approximately $625M valuation
Buyer 💰
Kohlberg Kravis Roberts & Co., founded in 1976 by Kohlberg, Kravis, and Roberts, needs no introduction. Aside from their emergence in the activist sandbox, KKR has been busy building a capital markets arm, raising a $15B Asia-focused fund, rivaling TPG’s Rise (see also) with its own $1B Global Impact Fund, engaging in a PR campaign, and sitting on a ton of unrealized gains. Carry is typically paid out after LPs receive their capital back plus a preferred return, so an increase in unrealized carry indicates slower exits. I struggled to find a KKR buyout fund younger than a decade which has a DPI greater than 1x. Typical private equity hold periods are fabled (or, at least, modeled) to be 3-7 years, though this assumption is increasingly being challenged. 🐢 (Counterpoint. Countercounterpoint.) Given KKR’s (and others) recent raises of longer-term funds, I am curious how these groups are managing carry payments. While 15 years may be an attractive hold horizon for some LPs, 15 years is also nearly half of an investor’s career and I am certain some creativity went into structuring compensation.
Concerning Dave and Buster’s, KKR’s 13D disclosure made no mention of immediate plans for a take-private transaction, or anything else of note, really. It did mention that KKR members “have and intend to continue to engage in discussions with management or the board of directors of the Issuer about its business, operations, strategy, plans, and prospects.” However, the highlight of the filing was this line:
Dragon has entered
Which is only made better by context:
Dragon has entered into derivative agreements
It’s too early to tell whether any other bidders may emerge (or if a deal would even happen), but given the ongoing dialogue KKR has with management, I would assume they are in the leading role if a transaction were to occur.
Market 📊
I am going to share some data points and disclaim responsibility for taking a position. Admittedly the trends are mixed.
Experiential dining/retail seems redundant, but it’s the best term the media has come up with to describe “experience as a service”. Selling experiences is at the core of D&B’s business model so the company appears to be in a good place from this perspective.
App Annie reports $86B was spent globally in mobile gaming in 2019, 25 more than all other [at home] gaming combined. While the report compares only at-home gaming, the trend underscores the rise of mobile gaming as an indirect competitor to venues like D&B.
Apollo-backed Chuck E. Cheese’s parent company (CEC) has pulled its IPO plans in 2019. CEC was previously put up for sale but the process did not go far as comp sales took a hit. Apollo took CEC private in 2014 and has been pushing an effort to reimagine Chuck E. Cheese’s as a place millennials would want to go. (They serve booze now?) You may recall, the $1.3B buyout in 2014 was financed with a $760M loan and $250M unsecured notes. The secured loan was recently refinanced with a maturity date of 2025, so Apollo isn’t feeling particularly pressured to sell. Based on its filings, CEC has been reinvesting its earnings into opening new venues so the debt hasn’t budged much. Assuming an exit at $1.4B (targeted valuation at 2019 IPO) the returns don’t look particularly promising for Apollo. (FN:1)
Potential Deal? 😕
Analysts (notably SunTrust) have been calling D&B a compelling buyout target for over a year. Both, SunTrust and Stifel estimate if a deal is struck it would be done at approximately $50 per share, or approximately $3.4B TEV (including capital leases).
Equity Value: $1.5B
Enterprise Value: $3.4B (12.1x TTM Jan 2020E EBITDA)
Acquisition Debt: based on CEC, the sponsor can likely get 4.0-4.5x debt to finance the acquisition, or about $1.2B. Imprudently using CEC as the single comp, that means an interest expense in excess of $100M.
D&B guides to new store openings of ~10% in the foreseeable future, which would demand further investment. Current CapEx runs $80M-90M per year, including new stores and renovations, and is financed from operating cash flows. Cash flow from operations has been roughly ~$100M, so I don’t see enough free cash flow conversion to support a particularly heavy debt load. At best, the company levers up and can maintain slow but stable growth. At worst, this will be another case of a company unable to invest in growth as its resources are hampered by interest payments.
More likely, cash interest expense would be meaningfully lower (via OID) and the company would be able to sufficiently fund both, its interest payments and CapEx. To generate an IRR in the high teens, the sponsor would have to grow the EBITDA at a 10% CAGR and pay down a good chunk of debt. You read that right: high teens. Which is likely what a large buyout fund like KKR is targeting these days.
Given these seemingly aggressive assumptions (I would envision the board would demand more than $50/share), I don’t particularly see how a sub-20% IRR would compensate investors for the types of risks present in this business.
Footnotes:
You have to admire that it’s positive in the first place. But also, I am nearly certain Apollo extracted some value here, I just haven’t done enough digging to figure out how.
Photo by Mikechie Esparagoza from Pexels