The question is whether the original item must be "expunged" as-is, or whether simply the value has to be paid back. So the thief isn't gaining either way!
As you suggested -- yes, if you modified the item, you keep the item, but instead have to pay back more. The dialogue in the TV show is saying that it still doesn't seem fair that this item per se can stick around -- effectively the thief bought it at 100% markup, without asking the owner.
If I steal a block of wood worth $100 and the block is still sitting in my house, I'm obligated to return the said block, plus $100. Whereas if I stole that block and then turned it into a chair, I pay back $200. It's a more fair way, when you think about it -- otherwise we'd have to start figuring out the value of the chair now ... did your work mean you now have to pay less than $200 ... effectively ... but the critical point is that the verse reads veheshiv es hagzela asher gazal -- he shall return the stolen thing he stole, which the Talmud (Bava Kamma 94a) interprets as "ka'asher gazal" -- as it was stolen, i.e. the obligation to expunge the item itself, as-is, is only if it's in the original condition.
This is pretty clear in Maimonides' Robbery & Lost Property 1:5. And for lots more, it's the opening subject of the Talmud's Bava Kama Chapter 9. (The chapter is literally known as one who robs wood because it opens with one who robs wood but then carves it into implements should simply return the original value)
(Footnote: okay if you robbed it in broad daylight by force, you'd just pay back the original or its value. The penalty of an added 100% is if you snuck into their house or pickpocketed them. The main points are the same.)
(Double footnote: the question of literal expungement after modification, vs. restitution, came up with Swiss banks that received blocks of dental gold from Nazi Germany. For bonus points, check out Naska DeRav Papa -- items made of precious metals are considered "changed" if molten down, but blocks of precious metals are not considered "changed" if molded into something, as it's easily molten back to a plain old block.)