GameStop Still Not A Value Play

Summary

• Here I review recent developments at GameStop and why the company still is not a value stock.
• The sale of the company's wireless business may offer a reprieve, but only if management uses the proceeds wisely.
• GameStop still has far too many red flags to make it worth considering, including severe management turmoil.
• The company is circling the drain, albeit slowly.
• The case for GameStop is more speculation about a potential buyout than investing for the future.

Ten months ago, I reviewed why GameStop (NYSE:GME) was not a “value” stock. A low P/E ratio and a high dividend yield do not automatically qualify a company as being good value. One of the main arguments for buying shares – that the company would inevitably be taken out by private equity – was recently dashed by an announcement by GameStop’s board that it would cease looking for a buyer. Shares are down 24 percent since I wrote about the company in March 2018.

The many negative aspects of the company remain unchanged, and if anything, they have only gotten worse. Benchmark analyst Mike Hickey said it best last December:

[GameStop] has become irrelevant in the videogame market, as consumers accelerate the migration towards digital purchases, and as games adopt live service models that greatly extend the average play experience and where platform/publishers work towards future subscription/streaming models.

Although the $735 million sale of the company’s wireless store chain bought more time, I maintain that the company is circling the drain - slowly but painfully.

A Boss Level Challenge

GameStop's stock briefly surged last June when the board announced that it was reviewing "strategic alternatives," including a sale of the company. By the fall, many observers were convinced that a deal was imminent. The speculative frenzy ended almost as soon as it began, however, when GameStop revealed that a sale was off the table due to lack of available financing.

The fact that no deal was consummated is in itself a red flag for anyone considering buying shares now. Do stockholders really think they know something that private equity does not?

In any event, the sale of GameStop's wireless business offers something of a reprieve - if management allocates the cash injection wisely. The company has been vague on its plans for the asset sale proceeds, although debt repayment is one of the stated options.

Indeed, vagueness about future plans is one of GameStop's hallmarks these days, seeing as it has lacked a permanent CEO since its previous leader abruptly resigned last May after just three months on the job. In fact, most of the top brass, including the executive vice president, COO, CIO, human resources chief, and the marketing head, were also pushed out last year.

The turmoil at the top could not come at a worse time for the company. Although holiday sales were stronger than expected due to sales of new hardware, GameStop's signature used games segment was down 16 percent from the previous year. This is especially worrisome because the company now derives 40 percent of its gross profit from selling pre-owned products.

Balance Sheet Blues

GameStop carries over $800 million in debt, with a $350 million payment due this year. Still, the $730 million asset sale ostensibly provides some relief. Could this be the catalyst that GameStop needs?

Well, as long as management does not blow the cash injection. We still have no idea as to their plans, which may include efforts in "reducing the company’s outstanding debt, funding share repurchases, reinvesting in core video game and collectibles businesses to drive growth, or a combination of these options."

At least some of those options would likely further destroy value, so investors will have to pay careful attention to what the future CEO says on the matter.

Meanwhile, GameStop just wrote off $557 million of its intangible asset value due to the "sustained decline" in the company's stock price. Even though this is not a cash charge, it still represents a major concession to the seriousness of the company's predicament.

Circling The Drain

Although GameStop has often been compared to Blockbuster, I see the situation as being similar to that of Bed Bath & Beyond (BBBY) and other specialty retailers. These chains were powerhouses before the likes of Amazon (AMZN), Target (TGT), and Walmart (WMT) started eating their lunch. The problem with GameStop and its ilk is that they do not sell a differentiated product. There is simply no moat around the company's business.

New initiatives like collectibles (Beanie Babies, anyone?) seem more like desperate grasping than part of a credible plan to turn around the business. Blowing through hundreds of millions on stock buybacks at high prices also only served to destroy tremendous value for shareholders.

Yet, despite clinging to a doomed business model, GameStop is throwing off a lot of cash, as dying companies often do. Indeed, the company generated $325 million in free cash flow in FY 2017. To its credit, management allocated a lot of capital toward new business lines outside the core video game retailer, but it has not been enough. Operating margins have deteriorated 27 percent over the last three years. The cost to service the company's ballooning debt now comes to some $50 million a year.

GameStop does not own substantial fixed assets, so this is hardly a value stock under the traditional definition. At least a case could be made for Macy's (M) as a real estate play, but GameStop's options are running out. All of the company's value is derived from future cash flows, which are dubious at best. It looks like the company could continue its slow, painful slide into total irrelevance for a long time, hurting stockholders along the way.

The one card the company has yet to play is an outright sale of the firm. That idea has already been bandied about for at least five years, though, with no deal coming to fruition. At this point, the case for GameStop looks less like an investment and more like rank speculation.

Analyst’s 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.