Shares of Dave & Buster's Fall on Earnings

In this episode of MarketFoolery, host Mac Greer talks with analysts Andy Cross and Ron Gross about the biggest news on Wall Street. The volatile market is swinging again, this time on more news out of China and a U.S. inflation report. Tencent Music (NYSE: TME) unintentionally chose a great day to go public, as some potential changes to the Made in China 2025 plan probably helped investor sentiment.

Meanwhile, Dave & Buster's Entertainment (NASDAQ: PLAY) had slightly positive earnings and slightly negative comparable-store sales, but its expansion plan raises some big red flags. Finally, Verizon (NYSE: VZ) shows a bit of buyer's regret for the terribly named Oath. Tune in and find out more.

A full transcript follows the video.

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This video was recorded on Dec. 12, 2018.

Mac Greer: It's Wednesday, December 12th. Welcome to MarketFoolery! I'm Mac Greer. Joining me in studio, we have Motley Fool analysts Andy Cross and Ron Gross. Gentlemen, how are we feeling?

Andy Cross: Good! Good day in the market.

Ron Gross: Great, Mac! How are you?

Greer: Good day in the market!

Gross: Love good days in the market!

Greer: We haven't had a lot of good days lately.

Cross: Although, it's so volatile, so who knows?

Gross: Yeah, by the end of the day...

Cross: It could turn around.

Greer: That's true. We should timestamp this. At the time of our taping, the market is up, so it's a good day. Later on, we're going to talk about Dave & Busters, a not-so-good day for Dave & Busters. We'll get into that.

Let's kick off with a Wall Street Journal report that China is working to increase access to overseas companies. Guys, this is part of what appears to be fueling the market. This plan would replace the country's Made in China 2025 plan. Andy, we don't have a lot of specifics here yet, but the market seems to be encouraged.

Cross: We had a good inflation report here in the U.S. That's helping the stocks, as well, today. But this report coming from the Journal that China is rethinking some of the principles behind their Made in China 2025, which is the plan they set out to be a world leader in high-tech industrial manufacturing. Since China joined the WTO years ago, they've been producing mostly cheap goods that are maybe designed elsewhere, and they use their power to be able to produce these goods at very cheap costs. The plan that they put forth back in 2015 is to push more into the high-tech sector. That really set the world a little bit on watch because of what that might mean for the competitive landscape, and also from the security side, too, which the Trump Administration has pointed out. This has been a big focus of the Trump Administration. The fact that now, China may be rethinking this has investors or traders thinking, "Wow, this is going to be good news for U.S. stocks."

Gross: I, quite frankly, don't know what to believe until it's done. There's so many rumors, so much bluster, coming from both sides, quite frankly. Each side playing the other one for headlines and short-term gains, it appears. I'm in a wait-and-see mode. Trump came out and said he would even intervene in the Justice Department case against the Huawei executive. I don't know if that's real or not. Fake news all over the place. I'm in a holding pattern.

As we said at the top of the show, the market's up on this news, could easily be down by the end of the day if there's a news report that this isn't actually going to happen, or it's not actually as robust as originally reported. In the end, I couldn't even predict how this is going to shake out, but it's not going to shake out with somebody being the big winner and the big loser. It's going to be some compromise that looks similar to how things were six months ago.

Cross: Yeah, there's so much noise out in the market right now. The volatility, and the trading volumes... we're seeing the Dow Industrial Average jump almost 500 points in a day both ways. People are gravitating to any news piece. There are also talk in the trade talks that the tariffs on autos won't be nearly as high as they used to be. I mentioned the inflation report, inflation was a little bit tamer. Maybe people are thinking, "Oh, gosh, now the Fed may not raise rates as aggressively or maybe at all in December." I disagree with that. I think they will go in December.

There's just so much noise out there that long-term investors are fighting against. To Ron's point, you kind of have to just sit back and watch what happens, and act on long-term investing principles, not short-term trading ones.

Greer: Speaking of China, Ron, a good day for Tencent Music to IPO. They IPO-ed today. The stock is up. What do you think?

Gross: Yeah, interesting time for it to go public. It was supposed to go public back in October, but they postponed because of the sell-off in markets because of the U.S.-China trade war. So, interesting to go public now, not that they could have predicted that today would have been a good news day with respect to the trade wars. They were going to certainly pull the trigger at some point, so today's as good as any. They're a large company, this is a large IPO. So far, trading is going well. The stock is up around 11% in the first couple of hours of trading. Tencent Music owns the four largest music apps in China. It's owned 58% by Tencent, the parent company. Spotify owns 9% of the shares.

They priced the IPO at $13, which was at the lower end of the range, but that sometimes can create some demand in the marketplace, and the stock pops into $14, as we're seeing today. So, so far, so good. Obviously, early stage.

The company has 800 million unique monthly active users, so it's a sizable company. We'll see how it goes. It is profitable, which is nice to see.

Cross: I mean, good for them coming out in this market. That's surprising. I think maybe a year and a half ago, the stock would have been up like 20% on that kind of news, with the market moving like that. So, sticking to their guns and coming out finally, after a few delays, it took courage to go out in the market like this, to go public.

Greer: In general, in terms of IPOs, Tencent Music aside, do you have a rule that you live by? Do you not buy an IPO in the first month? The first three months? The first six months? Or does it just depend?

Cross: I don't think I've ever acted on anything inside 12 months. There are lock-up periods for executives you have to look at, because that could put some selling pressure on the stock price. We saw Facebook come out at $38, run up to north of $50, drop back down to $22 within 18 months or so. I think, just let some of the noise and short-term trading activity and corporate actions play out.

Gross: Yeah, I know some people that play games with it. If you're lucky enough to get allocated some actual IPO shares, you can flip them and make a quick buck very often. Not a game I play. Again, I'm as Foolish as it comes, I hold stocks for years. I'm not interested in making a quick 10%, 20%, even 30%. It's just not what I do. In that same vein, I typically don't even purchase IPO shares after they go public for a reasonable amount of time, until I get comfortable with the company.

Greer: Speaking of games that you don't play, Dave & Busters down almost 10% at the time of our taping. Now, earnings were up 3%. That's better than expected. But same-store sales falling 1.3%. What is going on with Dave & Busters?

Gross: You frame it up nicely. Better than expected results. Actually decent guidance going forward. But the investors -- the Street, as we call it -- seem to be focused exclusively on comp store sales. In this case, the company saw a 0.7% decrease in walk-in sales, a 6.9% decrease in special events sales. Specifically in the food and beverage area of their revenue, that's where we saw the comparable store sales come down. The amusement part of the business actually saw a slight uptick about 1.5%. That's where folks seem to be focused, even though profits on an adjusted basis when you adjust the calendar for the same amount of weeks in one period vs. another, were fine. You can't run a business if you consistently have comparable store sales that are weak.

Now, in this case, that isn't the case. Sequentially, they were fine. Year over year, they were weak. A trend, this is not, yet. But, it's certainly created some caution on the parts of investors who chose to sell off the stock.

Cross: The trend is improving on the comp store sales. A couple of quarters ago, they were down almost 5%, and they were down 2.4% last quarter. The trend is improving.

Really, what caught my eye is the cost structure. Their costs have increased. Mac, you mentioned 3% growth on the earnings side. Employee wages, they talked about their wage growth, their wage costs increasing 5%. That's hit operating margins, it's hit gross profit margins. From the cost side, they're facing some pressure that we're starting to see from more and more retailers. And I think investors are saying, "Wow, OK, the growth prospects, even though they guided for a nice growth number, it's still lower than what their store count growth is going to be guided for for next year."

So, it looks like maybe their revenue is not quite growing as fast as expected, and some of the costs are increasing. That's going to hit some of the EPS, earnings per share, growth prospects for next year, too. So, clearly, even though the trend of comp-store growth is improving, they're still facing some headwind just on the cost side as they continue to invest in all these really cool new games they have at their retail outlets.

Greer: Have you gone to Dave & Busters lately?

Gross: Not lately, but back in the day when my kids were young, quite a bit, to play the games. Not so much for the food. Just an easy place on a rainy day to go spend some money for no reason.

Greer: It seems like it should be a money-making machine. I've gone there for a few kids' birthday parties, and you spend so much money, so fast.

Cross: Well, it is. Their profit margins are north of 12%. It's a nicely profitable business --

Greer: But expensive to operate.

Cross: Getting a little bit more expensive. And now, as they grow, they're trying to grow their store footprint north of 10% per year. Next year, they think it'll be probably around 14%. But sales growth on a comp basis of only 11-12%. So, investors start seeing, "Wow, they're growing their store footprint faster than they're growing their top line sales growth," and maybe that raises some red flags.

Gross: I like what they're doing. They're buying back stock. They just put a dividend in place for the first time, which is nice to see, a shareholder-friendly action, signaling also, perhaps, that they don't need all of the cash that they generate, because they have excess cash to buy stock and pay a dividend to shareholders.

But, Andy makes a great point. The way retailers make money, whether it's a restaurant or a traditional retailer, is either by increasing comp store sales or by opening more stores. Hopefully both. But if the only reason they are growing revenue is because they are opening new stores, that's a big, big red flag to keep an eye on.

Greer: They have north of 110 U.S. locations, and they think that the capacity could be 200 in North America. But those are primarily mall-based. How does that work?

Cross: Yeah, the last store they're opening this year, Corpus Christi, Texas. If you live in Corpus Christi, folks, get ready for your Dave & Busters store opening soon.

One interesting thing they're doing is, of the new stores they're going to open, around 20% will be at the 17,000 square foot size. That's far lower than their average size of north of 40,000 square feet. They're shrinking the store footprint. But hopefully, if they can continue to innovate and get the games in there -- and they have some specific proprietary ones. Contest of Champions, is a Marvel game that's proprietary just for Dave & Busters. They're pushing more and more into these video and immersion games. I imagine they're costlier to implement, but the revenue, from a square footage perspective, is much higher than other games. So, as they shrink the store footprint, that could increase the profitability per store.

Greer: They're also doing some interesting things with the space. In the earnings call, this is a quote, they said, "We have converted one of our special event party rooms adjacent to the arcade into a highly visible area where guests can order street tacos and drink."

Cross: I like street tacos! I like drink, too!

Greer: But here's the thing: can you call them street tacos if you're not on the street? Those are actually mall tacos.

Gross: Oh, that sounds horrible! "Let's go for mall tacos, honey."

Cross: It's all about the branding, Mac.

Greer: You see that in airports now, where people have street tacos. I saw that in Austin recently. They're not street tacos if they're not on the street!

Cross: I know. It's like if you buy Chicago dog in some ballpark outside of Chicago, is not a Chicago hot dog?

Greer: Are you in Chicago? I need more information.

Cross: No, I'm not in Chicago. I'm in Houston --

Greer: No!

Cross: -- and I'm buying a Chicago hot dog.

Greer: It's a wannabe, it's a Chicago wannabe dog. I'm just saying.

Cross: Well, I think their focus, to your point, of trying to take the stores and make them more profitable and innovative around the different parts of where customers want to go and spend time, that's really interesting. As they continue to figure out, "Gosh, if the foot traffic hasn't been what it used to be, we have to make some changes, we have to get into those stores and make them better."

Greer: Do you like the stock?

Cross: I don't like the growth prospects right now. I think that space, the fact that they're facing the double whammy of OK growth, but the cost structure is getting a little bit higher... I think I would stay away from it right now.

Gross: 13X earnings, you're not paying for much growth, but it's not my cup of tea. It just doesn't excite me. I would pass.

Greer: Guys, our final story. I think, potentially, some buyer's remorse for Verizon. Verizon bought AOL in 2015. We remember AOL, right? And they bought Yahoo's core business in 2017. They combined the two under the brand name... wait for it... Oath. Oath.

Gross: Mondelez.

Greer: Ugh, woof. Well, Andy, it turns out, Verizon should have saved those receipts. Verizon is now booking a $4.5 billion accounting charge, essentially acknowledging that both the online properties haven't worked out.

Cross: Yeah, that's half of what they paid. They paid around $9 billion for both those properties, with really bold ambitions to create an online media property that can go after mobile, that can go after video. It was led by Tim Armstrong, who had great success at AOL. But back in 2015, recognized that they had to be part of a larger platform as they continued to try to grow their ambitions and play where customers found more relevance. And that was in mobile and video. So, they joined with Verizon, then Verizon went and bought Yahoo. And then Yahoo announced two huge data breaches!

This was a package that had some really uphill struggles from the get-go. And now, the new leadership at Verizon has said, "We are focusing on mobile and 5G. That's really our focus. It's not as much on these media properties," which, by the way, over the last couple of years, you saw so many investment dollars from the venture side, from the private equity side, go into these exciting online businesses -- Vice Media or Buzzfeed, some of those. And they've really struggled, as well, as the advertising market continues to be dominated by Facebook and Alphabet. It's very difficult, as Oath learned, to crack into that.

Greer: It's hard to say. It's hard for me to say.

Gross: You can't fault them for going after that digital ad space. It is growing significantly. But, as Andy said, it turns out, it's been very difficult to unseat Facebook and Google. Google owns 37%, and Facebook, about 20% of that market. And now, you have Amazon coming in as the No. 3 player, by the way. It's not like they're going to be easy to unseat. It was just too difficult.

Now, they have Project Purple, which aims to identify the strongest brands that they own, whether, again, it's Huff Post or Tumblr or Yahoo Finance, to see what the focus is going to be on in the future, acknowledging that this did not work out as planned.

Greer: Oath is a terrible name, though, can we agree? It's a terrible name!

Gross: I don't like it.

Cross: Steve Case, who engineered the AOL growth story, and then engineered the acquisition and the merger with Time Warner back in 2000, tweeted back in 2015, "Congrats to my friends at AOL. Hope the merger with Verizon will ensure a brighter future for the company that first got America Online." Obviously, hasn't quite worked out as well as expected as part of the Verizon family.

By the way, this was not a huge part of Verizon's business. They generate more than $100 billion in sales. This was a small slice of the business. With the new leadership of Verizon on board, they just thought that this was not a place where they wanted to spend too many resources, or, at least, they wanted to refocus them into, as Ron said, Project Purple.

Greer: As you look back over the past few years, do you have a purchase or an acquisition that you regret? Or, you say, if I could have that one back... ?

Cross: I bought a fountain pen. I like it, and I liked it right out of the gate. I use it to write in my journal. I was all into journaling.

Gross: Did you just use journaling as a verb?

Cross: Journaling.

Gross: It's a thing. It's not a thing for me, but it's a thing.

Greer: I know it's a thing, but...

Cross: Listen, I know you don't like --

Greer: It's just so pretentious. "When I'm summering, I'm journaling."

Cross: Summering! [laughs] Well, when I was summering, I was journaling. When I would write in my journal, Mac --

Greer: Thank you!

Cross: -- or write notes to my family or friends -- sorry, yours is still in the mail, Mac, apparently. I realized that it just didn't quite live up to the expectations I had, of me with a glass of cognac.

Greer: How much did you pay? I need an amount.

Gross: $10,000.

Cross: Oh, my gosh, no! It was an Amazon purchase!

Gross: OK.

Cross: And it's a fine pen, it just wasn't quite... it was $10 or something.

Greer: Ron?

Gross: I have a problem in that I love to purchase unneeded cooking gadgets. If it exists, I own it. And my wife hates that. I have the panini maker, I have the slow cooker for ribs, I have the zoodle maker. I have everything.

Cross: What's zoodle?

Gross: You can create noodles out of zucchini or squash. So, no carbs. By the way, zoodles don't make themselves, my friend. Somebody has to make them.

Cross: Instead of squoodles.

Gross: The zoodle elves don't bring the zoodles. I own them all.

Greer: Oh, my gosh. That may be Verizon's next purchase, Zoodle.

Gross: I own them all, and they stay in the cabinet and don't get used. They just take up space and more space. And finally, my wife gets angry, and we have to throw some out or give them away. It's a problem that I have. I acknowledge it.

Cross: We have an air popcorn maker that I think we've used once in the last four or five years.

Gross: Air popcorn is a scam.

Cross: Right? It just sits there. It sits downstairs in my basement. And I'm like, "Why do we have this?" It's right there with the pilot bed.

Gross: How about you, Mac? That shirt?

Cross: No, that's a nice shirt!

Greer: That's hurtful! This is tough!

Gross: Cheap shot.

Cross: You should have said the glasses.

Gross: Or the haircut.

Greer: Oh, my gosh! My wife cuts my hair, do you want to apologize? Do you want to apologize now?

Gross: [laughs] Sorry, Mrs. Greer!

Cross: This is going off the rails.

Greer: We were talking before the show. Both our dogs are these rescue Beagles. So, technically, you're not paying anything except a service fee when you adopt them.

Cross: Doing something nice.

Greer: You're doing something nice. But, our first dog has been rough.

Gross: So, woof? [laughs]

Greer: Yeah, it was woof. We love him, as my wife says, because he's ours. But he's got some awful habits. He barks at planes, and we have a lot of planes flying over the house because we're on the flight path to the airport. And we got a citation a week after we got him from a neighbor.

Gross: [laughs] From a neighbor? I don't think neighbors have the power to write citations.

Greer: They call the city. We had a notice, basically, "You have to control your dog," because he just barks at everything. He's pretty rough, and I don't mean that as a pun. It's not good.

Cross: So, the regret is that dog?

Greer: I still think that rescuing --

Cross: Is the way to go?

Greer: It's the way to go.

Cross: Same with us.

Greer: It's a good way to go. I think, maybe it'd be nice if you had a trial period, where you got to go on two or three dates and see how he acted. Right when we got him home, it was pretty clear that it was a misfire.

​Gross: ​ Buyer's regret immediately.

Cross: You were calling Verizon up.

Greer: He has redeeming qualities --

Gross: Do you think anyone's still listening?

Greer: No. He keeps them hidden, but he has some redeeming qualities, too.

OK, desert island poll as we wrap up. We've talked about a few stocks. If you're on a desert island for the next five years -- and you should never, ever invest this way --are you going with Tencent Music, Dave & Busters, or Verizon?

Cross: Oh, gosh! Verizon has a 4% dividend yield. That's solid. The Oath acquisition aside, with Hans Vestberg, who's the new CEO there, if you're a dividend-seeker, I think Verizon's the way to go. I think it's a recommendation of The Motley Fool.

Gross: It's a Total Income recommendation, and you took the words right out of my mouth. 4% is a nice dividend. Hopefully, the stock will appreciate, because it's all about total appreciation. You can't just focus on that dividend. But, it's certainly a solid company. Obviously, they just took a lot of costs out by offering a retirement plan for thousands of employees, which is bad for the employees but it cuts costs for the company. So, if I had to choose between the three, Verizon is the way to go.

Greer: Ron and Andy, thanks for joining me!

Cross: Thanks, Mac!

Gross: Thanks, Mac!

Greer: is our email. If you have questions, if you have comments, if you have a bad, regrettable purchase that you would like to share with us, Thanks, as always, for listening. People on the show may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's it for this edition of MarketFoolery. The show is mixed by Rick Engdahl. I'm Mac Greer. Thanks for listening! We'll see you next time!

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Andy Cross owns shares of FB and MDLZ. Mac Greer owns shares of GOOG, AMZN, and FB. Ron Gross owns shares of GOOG, AMZN, and FB. The Motley Fool owns shares of and recommends GOOGL, GOOG, AMZN, and FB. The Motley Fool recommends Dave & Buster's Entertainment and Verizon Communications. The Motley Fool has a disclosure policy.