Last week, we got more color via a Barron's interview about Michael Burry, portfolio manager at Scion Asset Management and prominent player in Michael Lewis's The Big Short, and why he has taken a 3% stake in video game retailer GameStop (GME).
Burry believes the business deterioration at GME, caused largely by the shift of gamers to online, digital gameplay, and away from consoles, is overstated by the market. He clearly believes GME will be around for a long time and reports of its imminent demise are overblown. I will not opine as to how long GME can generate free cash flow from its store base, or whether it should be paying down debt or buying back stock, as Burry does, but one thing jumped out at me when I read about his thinking; his reference to the fact that "90% of GameStop's roughly 5,700 stores are free-cash-flow positive."
In a world where bricks and mortar retailers are intensely focused on managing their fleet of physical locations, we hear managements talk about this metric a lot. Also called "four-wall" cash flow or "four-wall" margins, it reflects the sales of each store relative to the direct costs required to operate the store, such as rent, utilities, wages, inventory, etc. Many times retailers will keep locations open as long as they are generating a profit "on a four-wall basis."
This metric seems to be quite short-sighted. Sears (SHLDQ) famously kept hundreds of locations open due to "positive four-wall EBITDA" even as the company was losing plenty of money and eventually went into bankruptcy. J.C. Penney (JCP) is trying to avoid the same fate and also prefers the "four-wall" metric and, as a result, continues to operate roughly 850 stores, way more than customers really can support longer term.
The problem with "four-wall" profitability metrics
