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GameStop: More Bad News

About: GameStop Corp. (GME)
by: Michael Wiggins De Oliveira

Holiday results update come in weaker than expected.

Free cash flow is now likely to point towards negative $300 million for the year (unadjusted).

This stock remains too speculative, with a poor risk reward balance.

Investment Thesis

At the start of September 2019 I noted in an article titled Stay On The Side:

[...] having a long position, despite its allure of investing in a fallen angel is just too speculative and not worthwhile investing in.

Subsequently, last month I noted:

[...] Just because something has fallen in price, and is facing a grim outlook, this does not immediately imply the stock is a bargain opportunity.

Thus, it is on this theme that I expand today's discussion: why ''fallen in price'' is not the only necessary ingredient towards a satisfactory investment. Ultimately, why GameStop is too speculative and not worthwhile investing in.


2019 Holiday Results: No Good News

Gamestop (GME) reported results that were challenging to stomach for the all-important holiday period.

Indeed, fiscal 2019 guidance now points towards comparable sales being down at the midpoint of 20% compared with being down in the high teens as previously expected going into the holiday season.

Furthermore, whereas previously, prior to the holiday season, fiscal 2019 adjusted EPS had been pointing towards $0.10 to $0.20, the figures for adjusted net income are now expected to come in negative. Hence, even though EPS figures are not disclosed in the update, it's safe to assume that management does not quite have a full handle on the business.

Capital Allocation Strategy?

During December's earnings call, management's guidance was pointing towards ending the year with total cash and liquidity in excess of $1 billion. Whereas yesterday's holiday sales update now points towards cash and liquidity of approximately $900 million - $100 million drop over the course of the one month.

To be fair, we were not informed about how much the change is being driven by creditors pulling some of GameStop's revolver. Having said that, to err on the side of caution, we should expect most of the shortfall being driven by a reduction in cash flow from operation.

Consequently, GameStop's December's guidance adjusted free cash flow for fiscal 2019 had been pointing towards $200 million to $220 million. Although, the difference between adjusted and unadjusted comes down to ''more than $400 million'' drag, which was due to overhanging accounts payables from the previous year paid off early in 2019.

Moreover, if previously GameStop's actual free cash flow was expected to come in at negative $200 million, realistically, we can expect GameStop's fiscal 2019 free cash flow to now come in at negative $300 million for the year.

Further, if the strategy from GameStop's management had been to aggressively repurchase its total outstanding shares, having bought back close to 35% of its total outstanding share during its trailing nine months, the question on investors' mind today will be whether management is likely to continue to repurchase shares in the face of recently reported dismal quarter?

Realistically, I fail to see management having any maneuverability left, as operations continue to face such challenging existential questions.

If GameStop did not carry any debt whatsoever, it could possibly have had a one-off special dividend or similar return of capital; but as it stands now, with more than $400 million of debt on its balance sheet, and having partially drawn down some of its revolver, and such negative free cash flow, this will restrict many avenues for a return of capital.

Valuation - Too Speculative

GameStop's valuation is highly controversial: if GameStop is able to survive into next year's next generation console lineup later this year, today's valuation may provide a strong return for shareholders.

The problem is, that over time, GameStop's value proposition gets withered away. The need for customers to use its stores for frequent and recurring purchases becomes close to nonexistent.

Moreover, as is well known, downloading video games totally does away with the need for GameStop altogether. So even if GameStop survives the next twelve months, the multiple investors will be happy to pay for GameStop is likely to continue compressing.


In this author's opinion, investing is less about potential moonshot investments, which have high-risk high-reward potential, and more to do with low-risk high-reward profile.


Warren Buffett's immortal rule should be closely adhered to. In the event that GameStop's shares were to fall a further 35%, investors would need more than 50% in their next investment simply to be back at breakeven. Not to mention the poor time return from their portfolio.

This investment remains too speculative and capital is best deployed elsewhere.

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.