GameStop: The Outlook Is Bleak

| About: GameStop Corp. (GME)

Summary

GME's holiday sales report provides evidence that it is being squeezed out of the gaming market.

GME's business model is faltering and its diversification efforts will not prove sufficient to counter the decline in its core business.

GME presents a value trap that prudent investors should avoid.

Newest Holiday Sales Update

This morning GameStop (NYSE:GME) reported that global sales for the holiday period fell 16.4% to $2.50 billion. Additionally, total comparable store sales declined 18.7%. However, management noted that comp trends improved from November (-26.6%) to December (-13%) and expects them to improve in January.

Management believed that sales were "impacted by weak Call of Duty: Infinite Warfare and Titanfall 2 sales", coupled with "aggressive promotions on Thanksgiving Day and Black Friday." CEO Paul Raines went on to say that the sales in the video game segment were impacted by "industry weakness, promotional pricing pressure and lower in-store traffic..."

Further, management reported that new hardware sales decreased 30.3% with strong sales or recently release new hardware, such as the Nintendo NES Classic not being able to offset the significant drop in PlayStation 4 and Xbox One hardware sales.

Non-Cyclical Negative Datapoints

Although GME's business is quite cyclical, based on product releases, management said that in November and December, it lost market share. Additionally, its pre-owned sales declined 7.9% compared to the holiday period in 2015. Those two data points, which are not affected by product releases indicate that GME is being squeezed out of its market.

The simple fact about the industry is that Brick-and-Mortar video game stores are no longer necessary, as consoles are shifting from a physical disk to downloadable content. As physical games become obsolete, this will not only lead to lower sales for GME's new gaming business, but also its pre-owned business. With the pre-owned segment accounting for a much higher profit margin than its new segment (46.4% vs. 24.3% for pre-owned and new software, respectively) this presents a cognizable problem for GME.

Positives From The Release

On a positive note, GME reported that its collectible business saw an increase in sales of 27.1% to $176.9 million. It also saw its Technology Brands revenues expand 44% to $192.4 million. However, those segments only represent a drop in the bucket of GME's total $2.50 billion in sales and it is unlikely that GME will be able to scale these segments enough to offset its decline in its gaming business.

On another positive note, GME reported that it repurchased 755,400 shares of common stock at an average price of $22.63 or $17.1 million worth of stock. Management also reported that it has approximately $192.2 million remaining on its current share repurchase authorization and intends to repurchase $75 million in fiscal 2016. The share repurchases, coupled with its $.37 dividend (which yields around 6% right now), has been a factor to keep the stock from falling in the short term.

However, I believe that GME is a value trap and, as its business continues to decline, it will not be able to maintain these programs. It has been issuing debt at higher rates of late and will likely need to end these programs to service that debt in the future.

Quick Update On GME's Debt

In September 2014, GME issued $350 million in unsecured senior notes at a rate of 5.50%, due on October 1, 2019. Additionally, in March 2016, GME issued $475 million of unsecured senior notes at a rate of 6.75%, due March 15, 2021. The most obvious implication of these issuances is that GME will have to come up with $350 million in a little over two years to repay the first senior notes. In all likelihood, GME should be able to do that since it can presumably borrow new notes. However, with GME's business deteriorating, and interest rates set to rise, GME's cost of borrowing will likely increase and the interest expense it will have to pay will rise, further causing a deterioration of its margins.

Conclusion

GME is being squeezed out of its market and its attempt to diversify into other segments is unlikely to counter the decline in its core business revenue. With the holiday report showing it is losing total market share and seeing a decline in pre-owned sales, I believe that GME's days are numbered.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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