GameStop's Awful First Quarter And The Joy Of Gambling

Summary

• GameStop has pre-announced fiscal 1Q20 results, and the numbers do not look very encouraging.
• Comps ex-closed stores suggest that the collapse in revenues cannot be fully blamed on the COVID-19 crisis.
• Fun fact: GameStop has burned far less cash while being partially shutdown than as a fully-functioning retailer.
• Why bother buying GME, other than for the pure joy of gambling, with so many more compelling alternatives to it in the market?
• Looking for a helping hand in the market? Members of Storm-Resistant Growth get exclusive ideas and guidance to navigate any climate. Get started today »

GameStop (NYSE:GME) shareholders: brace for impact. The retailer has pre-announced fiscal 1Q20 results, and the numbers do not look all that good.

Global sales and comps are estimated to come in about one-third below year-ago levels. As a result, adjusted EBITDA will turn from a positive last year to a negative this time. Net loss of roughly $167 million suggests a sizable, negative EPS of $2.50 - although about 75 cents of it should be associated with a one-time charge for inventory obsolescence.

Credit: Bisnow

Worse than expected

Although the numbers above look awful on the surface, identifying the short-term impact of the COVID-19 crisis on GameStop's first-quarter results is important. In the retail space, Dollar General (DG) comes to mind: maybe 22% in positive comps will not be the new normal going forward, and neither will TJX Companies' (TJX) evaporating revenues.

During the quarter, several GameStop stores were closed, even though the company declared itself an "essential business" in order to remain open for a few extra days. But the following quote provides a clue as to how bad the period has been for GameStop, even after accounting for COVID-19 headwinds:

Excluding stores that were closed during the first quarter as a result of the COVID-19 pandemic, comparable store sales are expected to decline in the range of approximately 16% to 17%.

The sharp decline in comps ex-closed stores during a period when at-home entertainment should have thrived is worrisome. At the same time, I think the numbers also speak to the well-known challenges faced by the company prior to the pandemic. GameStop continues to suffer from the final few months of the console cycle and a secular shift towards streaming and mobile gaming.

Source: DM Martins Research, using data from company report

It was also interesting to note that cash flow from operations, while still negative, is expected to improve substantially this year. This is due to the company's "focus on optimizing the cash conversion cycle and carrying more efficient levels of inventory, which resulted in accounts payable at the beginning of fiscal 1Q20 being lower".

Yes, GameStop has burned far less cash while being partially shutdown than as a fully-functioning retailer.

Why play this game?

Since I wrote my most recent, bearish article on GameStop, the stock has climbed 14% from $3.60/share (granted, against a 22% gain in the S&P 500). But between then and now, shares (1) lost a third of their value in the last week of March, (2) doubled in the first few days of April, and then (3) fell by nearly 30% in the first half of May. Time the entry right, and an investor would have looked like a genius. Time it wrong, and a portfolio's returns would have been embarrassing for the rest of the year at least.

I certainly have fundamental reasons for not liking GameStop and its stock. However, what drives me further from it is not a "hot take" on the future of the company. Rather, it is the stock's erratic price behavior and all the distraction that comes with share ownership.

Data by YCharts

The graph above shows how hard it has been for an investor to deal with GME in the past year. Shares have consistently failed to reclaim 12-month highs, while bouncing all over the place. More important than the business prospects, the stock has been influenced by speculations on the gaming console cycle, drama at the Board of Directors, sky-high short interest, and the buying and selling of shares by a celebrity investor.

There are currently 2,800 names trading at the New York Stock Exchange. Why would I ever consider buying GME, other than for the pure joy of gambling, with so many more compelling alternatives to it in the market?

Analyst’s Disclosure: I am/we are long DG, TJX. 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.

Comments

[Free Solo]

Wouldn’t you have loved to gamble this?

[lotsofquestions]

@DM Martins Research Why not buy warner gaming to further support loyalty program. I feel like the partnership makes sense even thought Gamestop did not have those partnerships before. The time is now if they want to keep their customers, no?

[John Miller]

@lotsofquestions how would you pay for WB Gaming? (Warner Gaming is the gambling service right?) What are the bond covenants against raising more second-tier debt?

How many paying members did the loyalty program lose in 2018 and 2019?

[lotsofquestions]

@John Miller Sorry I was under the impression it is a video game company like ATVI and EA? Not sure where your seeing its gambling.
This also seems to support that it is video game. en.wikipedia.org/... company. ractive_Entertainment.

They should go to market and raise equity (not more debt) and redeem 400K of debt (may be too late, but what a time to do that with the debt trading 70 cents on the dollars). You call it WB Gamestop (keep a relationship with WB-- still have great IP). You keep retail and run it to break even, the focus is now to support a beefed up loyalty program and online sales program. Have a couple of tiers, where the higher tiers gives you access to games. Bonus: Sign up the e-gamers (go for the top talent and try to develop your own), and start your own twitch like platform (who says it too late). Sign in real social media talent from silicon valley (open up your organization properly). Get leadership from twitch and/or Huya (they can expand into Asia much faster than through Retail or retail alone). There is a plan there, but they have to be opened to open up their organization and innovate, not milk the shareholders to the last possible moment (they won't feel good about it if the company goes bankrupt, their shares will be worthless and they will be rich but unhappy).

[Voltrdr]

Telsey Advisory Group Upgrades $GME to Buy after the close.... $6 PT

[DM Martins Research]

I interned there for a bit! :-D

[EricInPDX]

Maybe one buy side analyst might be right for the first time in four years? Nahhhh .. probably not.

[Voltrdr]

Kool....Dana is really good, I worked with her at BSC back in the late 90s early 2000s

[ding dong]

"with so many more compelling alternatives to it in the market?"

Which ones?

[DM Martins Research]

Hi, Ding Dong. I think there is a spectrum, both within retail and outside it (but still in cyclical sectors).

In retail, there are plenty of safe bets that I will ignore here -- I don't consider companies like Dollar General and Costco to be peers of GameStop. In specialty retail, ULTA and EL have been mentioned by Barron's recently (www.barrons.com/...), although I haven't done homework on them lately. In department stores, I don't particularly like KSS (seekingalpha.com/...), but I think its chances of full recovery are better than those of GME -- and the stock price is still pretty depressed. Again, it's about the spectrum: "less worse" is more desirable.

Outside retail but in high-risk sectors, I like LUV in airlines. If only one single plane is flying in the sky this time next year, I bet it will be a Southwest one (seekingalpha.com/...).

I'll stop here, but I'm sure that there are many more. Happy investing!

[gmdl]

@DM Martins Research ULTA, if bought it 140 close to end of March is fine, it is now at forward PE of 36.9, i doubt this is good time to get into that... Morningstar rating is like 2** star, fair value 200$, so 10% gain at best.
And Q3 2020 revenue compare to Q3 2019 -10%, wait and see Q4

[DM Martins Research]

Thanks for the note, gmdl. I have been hearing wonders about ULTA from other analysts/investors, but I haven't done any homework there. PE of nearly 40x does sound aggressive, unless the growth story is very compelling.

Take care!

[Cash Flow Seeker]

@ DM Martins Research

What’s the play on GME

Has Burry sand bagged the shorts?

[Jocubus]

This was an incredibly short article and barely provides any information that can't be found in the press release from the Company.

[davidcheung]

when it comes to advertisement, i prefer short to long.

[DM Martins Research]

Jocubus, my SA colleague wrote a pretty long, very good (in my opinion), much more extensive article on GME recently. Check it out: seekingalpha.com/...

Now, if there is a chance that you didn't like this article because it goes against your bullish bias on GME (just speculating, since it happens often), you will not like the long one either.

Happy investing!

[Mathieu Malecot]

@DM Martins Research as far as i can tell @Jocubus is short.

[DM Martins Research]

Great engagement here, thanks! I’ll go through the comments in more detail soon. Enjoy your weekend!

[myflag51]

Juatin I read on one of the SA articles comments section that the only reason that GME management is reluctantly conducting the bond exchange offer is mainly due to the pressure from one or more activist /major shareholders.
If this is true the GME did not initiate the exhange offer on their own strategic decisions to enhance shareholder value, rather due to external pressure exerted by some major shareholder.

In the past I read the same thing about GME doing the dutch auction last year was to appease
the shareholder just a few days before the general annual meeting to get a win for their proposals.
Wouldn't good management/board be initiating any/all actions on their own volition for the main purpose of enhancing shareholder value?
TIA

[User 49198486]

All I know is... Fall 2005: Xbox360/ps3 release. GME rises from teens to 50s in subsequent year. Fall 2012: Xbone/ps4 release. GME rises from low 20s to 40s starting August through subsequent year. Fall 2020: new next gens. All considered, I'm willing to "gamble" GME makes big moves in 2021. Maybe not to 50s or 40s, but it won't be single digits.

[John Miller]

@onidraug the price did run-up last time, but when there was no actual earnings growth from the gaming categories the price quickly tanked. I think it is a big gamble to say the market will make the same mistake again.

[Justin Dopierala]

@John Miller - Why would they have growth in other categories in 2012 when they were selling less consoles then they had sold in 2011, 2010, 2009, 2008....

[John Miller]

@Justin Dopierala the expected earnings growth was in 2013 and 2014. When he says "Fall 2012: Xbone/ps4 release." I think he meant 2013 and the run up did not begin until early 2013 anyway right?

In any case, no gaming earnings growth ever materialized. Of course I know you think it is because there were less units sold by GME in 2013 than 2012 but you know my position on that.

I told you i am not willing to relitigate it further until you can use my definition of "directly and specifically."

[gmdl]

name pls few beaten up names, such as?

[Justin Dopierala]

Agree with other posters... the reported comps you are citing were for stores open for curb side delivery, not simply open. The Australia comps are the only comps for stores that were completely open and they were up 35%... which shows the exact opposite of what the entire premise of your article is about.

By the way - you are comparing GameStop's volatility against the S&P 500 - an index of the 500 largest companies in America which is mostly made up of large tech companies like Amazon, Alphabet, etc? Does that make any sense? Why not the Russell 2000 Value index or simply the Russell 2000 index?

[EricInPDX]

Justin, it doesn't really matter what you want to compare GME too .. pick your index, and any significant time period. Rather than investing in GME, you would have been far better just taking your clients money and investing in the SPY etf. Sure, you are gonna argue that GME could go to $6 or something, but the risks (to me) outweigh the gains. Of course you know I'm short, so we'll see what happens.

Regardless, I still can't find any compelling reason whatsoever why someone would not have taken the opportunity cost of instead being long GME (for any time period) to just go and invest somewhere else. Especially after the market meltdown in March …. there we so many beaten up names you could get for a song instead of staying in this POS bricks and mortar retailer that is going to go BK in 3 years or less.

And who cares about volatility against the Russell or the S&P or anything else? Are you really going to argue that GME is a good investment because it is less volatile than "something"? Compare the returns against anything. I'm sure it will be in the basement for anything, including retail.

[Mathieu Malecot]

GME is a good trade because it is volatile.

[myflag51]

Justin: I read each and everyone of your posts with great faith and trust that you are honest,objective and very knowledgeable about goings in GME
stock.
My question is that GME has always been crowing about their great liquidity
position. If that is true,then why are they refinancing the bonds maturing in
March 2021 with almost a 34% increase in interest paid when they could
just buy the current bonds at a discount of atleast 20-25% of the par value?
TIA

[Y_P_K]

I see no reference to the debt refinancing initiative, you find that insignificant in terms of announcement along with preliminary Q1 numbers?

[John Miller]

@karaolid sometimes it is hard to work all major angles into an article. Justin posted some info in a another thread showing who can purchase and trade the new notes will be similar to the riteaid deal and that it has good liquidity. The info also highlighted the difference in how the covenants will be handled (a substantial negative in the GME swap). There is also a lot less time to maturity on the old GME bonds. I think the last trade on the old GME bonds yesterday was 86.

[Mathieu Malecot]

the swap is a good deal for participants because they get both the higher yield of the bond and the discount when purchasing bonds to swap. that said, we should be looking at how many of the swap-able bonds are available to purchase and comparing that with the new 10% bonds on offer. someone that never sold bonds is unlikely to participate in a swap but any institutional investors looking to lock in more than 10% might still be interested if they can buy enough of the old bonds to swap at a discount to par.

[John Miller]

@Mathieu Malecot what makes no sense is a speculator can capture half the return you describe just by buying at a discount now and hold till March. This removes the majority of the time risk.

[User 12756481]

Not sure author understands Gamestop's release. They did not have "several stores closed." 100% of stores closed except those in Australia which had over 30% growth.

The -16% comps were not for "open" stores, they were for stores open for curbside delivery and even those were shut down for an entire week during the quarter.

[John Miller]

@Do Research i got the impression the “open” stores that were down -16 were mostly in Europe. Sometimes we know transparency is being reduced (no slide deck, mixing new/Preowned) and sometimes they make it vague. Like they quote cash and revolver used for q1 versus total liquidity for Q2 with no indication how the revolver availability has changed in either quarter.

[Justin Dopierala]

@John Miller - Europe's stores were closed first and the longest. Not sure if they even had curbside delivery in Europe; therefore, there is probably not a single European store included in that number.

[John Miller]

@Justin Dopierala

...the Company temporarily closed all 3,526 of its U.S. locations...

Excluding stores that were closed during the first quarter as a result of the COVID-19 pandemic, comparable store sales are expected to decline in the range of approximately 16% to 17%.

During the final six-weeks of the fiscal first quarter, approximately 10% of the global fleet remained fully open...

There are only 340 Australia New Zealand.

Anyway, when he says the -16% percent is for the curbside stores I* think he is a misunderstanding but as I said, everything is all very vague. ....when it could be made clear with a slide deck and when unlike categories are mixed or the method of reporting changes from quarter to quarter.