Dave & Buster's IPO Looks Like a Bust

Editor's note: As part of our partnership with Nightly Business Report, TheStreet's Debra Borchardt will join NBR Monday (check local listings) to talk about the prospects for Dave & Buster's IPO.

NEW YORK ( TheStreet) -- Your hunger for stock appreciation may go unfilled if you put Dave & Buster's in your portfolio.

Known as "Chuck E. Cheese's" for adults, the chain plans to go public this Friday. The restaurant operator is hoping to raise $100 million in real money -- not game tokens -- through the sale of 7.69 million shares at $12-$14 each. The listing is expected to go live this Friday.

Since many restaurants that have gone public this year have actually delivered some nice returns, many investors may just assume Dave & Buster's will too. The problem is that this chain is smothered in more debt than its nachos are smothered in cheese.

Based in Dallas, Dave & Buster's actually was a public company not too long ago. It was taken private in 2006 by Wellspring Capital Management for $257 million. Wellspring in turn unloaded the chain on Oak Hill Capital for $570 million in 2010.

Now Oak Hill is looking for its own exit. The firm currently owns 95% of Dave & Buster's, but that stake will drop to 68% after the IPO, which will give the company a market capitalization of $352 million, is completed.

Oak Hill has been busy in the last two years, increasing the debt load of Dave & Buster's by nearly $100 million. As the company comes to market, it's carrying roughly $400 million in debt so the servicing of that debt will be a significant drain on the post-IPO entity that buyers of the stock will be getting a piece of.

The company plans to use $80 million worth of the IPO proceeds to pay down debt.

For its part, Dave & Buster's says it plans to spend less on labor and come up with a smaller format restaurant. The company also believes it has figured out how to make more money off game cards (I'm sure the patrons will love that) and that it intends to come up with new menu items. It's also expecting to open additional locations in order to get out of this hole.

The company is pushing its performance in the 26 weeks ended July 29 as evidence that it can turn a profit. The S-1 filing related to the IPO continually highlights these numbers, a period when Dave & Buster's posted net income of $7.25 million on revenue of $311.4 million.

But investors need to remember the chain has uneven quarters with the third calendar period being the weakest. 2012 was no exception with losses of $1.6 million and total revenues down from the second quarter, although higher than a year ago. That's why it's spinning the last six months with roughly $7 million in profits because the last three months don't look so hot.

Investors though may not look closely because other restaurant IPOs have done well. Chuy's Holdings ( CHUY) has gone up over 50% year-to-date. Steakhouse chain Del Frisco's ( DFRG) is up roughly 14%, and Bloomin Brands ( BLMN), the home of Outback Steakhouse, has gained more than 20% year-to-date.

But there are also cautionary tales out there, such as Ignite Restaurant Group ( IRG), which had a much cleaner filing than Dave & Buster's. Ignite went public in May 2012 and within months it turned out the filing wasn't so clean after all. The company improperly accounted for its leases and now has to restate its earnings. The stock has plunged and there is a class action lawsuit from the new shareholders.

Investors should enjoy Dave & Busters as a patron, not as an investment. It's a fun place and a super venue for a teen birthday party. However, if you want some exposure to the restaurant industry for your portfolio, choose a different, more established profit maker like Chuy's. If you're willing to risk a few pennies, Cosi ( COSI) could be worth a shot as a turnaround play.

IPO Desktop President Francis Gaskins believes Dave & Busters stock has a good chance for some appreciation from the IPO price, but he believes investors should look to take profits at first chance. He's skeptical of the company's ability to stay in the black. Gaskins also isn't impressed that Oak Hill wants the public to bail it out of a bad investment.

-- Written by Debra Borchardt in New York.

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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