Dave & Buster's (NASDAQ:PLAY) has been one of the more puzzling stories in the restaurant industry in recent years.

Following its 2014 IPO, the stock surged as D&B turned in impressive comparable sales and earnings growth. Same-store sales grew 7.3% in fiscal 2014 and jumped another 8.9% in fiscal 2015, and the company was consistently blowing past earnings estimates. 

However, the eat-and-play chain's performance began to plateau in 2017 when the stock peaked at $72. Since then, comparable sales have consistently fallen, declining 0.9% in fiscal 2017 and 1.6% in fiscal 2018, and are on track for a decline of 2.5%-3% in fiscal 2019. The stock is now down about a third from its 2017 peak.

It's not clear what's caused the decline in performance, though a number of factors could have contributed to it, including rising competition in the form of food delivery apps and home entertainment options like Fortnite and video streaming, customer fatigue with the brand, menu and game assortment, oversaturation from growing too quickly, a lack of perceived value, or something else.

The disconnect between the potential Dave & Buster's showed a few years ago and its more recent weak performance seems to be why private-equity firm KKR just revealed a 6.3% stake in the company, saying it has held meetings with management. The activist investors may agitate for changes in the board of directors, a change in its capital return policy or asset sales, among other possible moves, though it's unclear what KKR's specific plans are.

The entrance to Dave & Buster's

Image source: Dave & Buster's.

A prime turnaround target

If D&B can return to growth, the stock would appear to have a lot of upside potential as it currently trades at a P/E of just 16.8, and has a number of appealing attributes, as the company laid out at the recent presentation consumer goods-focused ICR Investor Conference.

Dave & Buster's unique model of offering food, bar beverages, and arcade games has given it a number of advantages over traditional restaurants.

First, the company has industry-leading average unit volumes at $11 million, showing the ability of its locations to draw in customers and spending. By comparison, that AUV is more than double that of The Olive Garden, at $4.8 million.

For the current year, the company is targeting an EBITDA margin of 20.5%, showing the business is still highly profitable before indirect costs like depreciation. The model has also offered good economies of scale and is attractive to landlords as a traffic driver, helping the company secure some of the best real estate in its chosen markets. Dave & Buster's cash flow is strong. It has high cash-on-cash returns from new stores, and a return on invested capital near 305.

While those factors may all be enticing to an investor like KKR, they haven't been enough to make up for the company's weak performance.

The turnaround strategy

Dave & Buster's management hasn't been sitting still amid the comparable sales decline, and in the recent investor presentation, the company outlined a multi-pronged strategy for revitalizing its stores.

First, the company is adding "WOW Walls," or 43-foot walls of connected TVs that should enhance the sports-watching experience at the eat-and-play chain. So far, the company has added that feature to 48 of its 135 locations. 

In amusements, it's focusing on bigger games with marquee titles to draw interest, while also adding social/multiplayer games to build on the social aspect of its business, including physical games like giant jenga and cornhole.

In food, it's working to meet guest expectations with new and novel menu items, and is working with a consulting firm to do so.

It's unclear if any of those improvements have paid off so far, as comparable sales still seem to be heading lower in the current quarter based on management's reaffirming its full-year guidance.

What's next

Investors can't be faulted for getting impatient at this point, as the stock has slumped for nearly three years while the broad market has been roaring. The activist stake from KKR is clearly a step in the right direction. Between that and some of the ideas laid out above, D&B could be taking the first steps in its turnaround. If performance hasn't improved over the next few quarters, I'd expect some changes in the management team as the company and KKR clearly believe it has unrealized potential. The company still plans to nearly double its store count, seeing room in the market for 235-250 locations, an indicator that there is still plenty of future growth left for the chain.

Keep your eye out for further updates from KKR and Dave & Buster's, as the activist investor hasn't revealed any specific plans yet. KKR's coming on board looks like the best opportunity to turn the business around in years.