GameStop Needs An Activist – GameStop Corp. (NYSE:GME)

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GameStop (GME) is a global, multichannel video game and licensed consumer products retailer, operating over 5,800 stores across 14 countries.

The company’s success is dependent on a handful of suppliers. The company’s largest vendors are Nintendo (OTCPK:NTDOY), Sony (NYSE:SNE), Microsoft (NASDAQ:MSFT), Take-Two Interactive (NASDAQ:TTWO), and Activision Blizzard (NASDAQ:ATVI), which accounted for 23%, 22%, 10%, 6%, and 4%, respectively, of products carried by GameStop.

In the current business climate, video game hardware sales are declining and consoles are declining significantly at a rapid speed. One of the major reasons for the decline is that the Playstation 4 (PS4) and Xbox One are approaching the end of their life cycles.

Q4 Industry Results

In the Q4 fiscal year result, Microsoft reported a decline of 48% in Xbox hardware revenue primarily due to a decrease in volume of consoles sold. Earlier this year, Sony reported a decline in PS4 console-sales volume which declined by 1.2 million units in 2018 compared to 2017.

According to The NPD Group, a firm which tracks hardware sales, hardware spending in June 2019 dropped 33 percent when compared to a year ago. Moreover, year-to-date hardware spending has declined 20 percent versus a year ago.

Company Results Reflect Industry Declines

GameStop’s “New video game hardware” segment’s revenue declined by a whopping 35% in the recent 1st quarter of 2019. Moreover, given the fact that Sony’s next generation of PS and Sony’s ambitious Xbox Project Scarlett are rumored to be launched by Christmas of 2020, it is clear that the company’s new video game hardware is not going to improve in the near-term.

Pre-Owned Video Games

Pre-owned and value video is declining drastically and pre-owned video, which accounts for 28% of revenue, is the most profitable business segment which accounted for roughly 46.3% of gross profit.

This cash cow segment’s sales are rapidly declining since 2016. In the last four quarters, the segment’s sales are declining at double-digit rates. Furthermore, in the most recent quarter, the segment revenue declined by 20%. Also, the gross margin declined from 46.3% in FY 2016 to 43.4% in FY 2018.

Digital games, which are downloaded directly through the online store, are slowly replacing physical discs. Also, the lack of blockbuster games is affecting the used-video game market.

In last year earnings call, Robert Alan Lloyd, CFO told analysts that: “It does have to do with how customers can get some of those older titles, the very inexpensive titles that you can get through either subscription memberships or online in a pretty heavily discounted mode.”

The Move To Disc-less

Microsoft’s disc-less move is a long term threat for the companyRoughly four months ago, Microsoft announced a new model of its Xbox One console, a digital-only version that will not be able to play discs and costs $50 less. Moreover, Microsoft has partnered with Sony to help power PlayStation’s streaming efforts.

The company’s digital store is unlikely to become a major hubSubscription services, including services such as PlayStation Plus and Xbox Live, that offer video game downloads each month, are a long-term threat to the company.

Now, starting April 1st, 2019, Sony prevents retailers like GameStop from selling digital download codes for PlayStation 4 games.

In the most recent quarter, the company’s Digital sales declined 11% and in the last 3 out of 5 quarters, digital sales declined.

The Future Is Bleak and the Company Still Has Life

The future is bleak but business is not going away soon. After the sale of its Spring Mobile business, GameStop is currently focusing only on the video game industry. The company is now a pure-play gaming business.

Even though the long-term outlook is negative and business is shrinking, Microsoft and Sony are making new game consoles that come with games disc. This makes it clear to me that the company still has life.

The crux of the question is – what are they going to do with the cash?

The CEO Does Not Have a Credible Plan

Given the massive problem faced the company in every nook and corner of the business, the new CEO is not addressing the core problem.

First of all, the company’s newly appointed CEO outlined his goal of improving the operating profit by over $100 million. If revenue continues to decline, the cost-cutting and profit improvement plan will not matter. For example, if the pre-owned video segment (which accounted for 22% of 2018 revenue) continues to decline at 20%, it will shave off roughly $125mm to $150 million in gross profit in a year. This is significantly more than the expected improvement in operating profit.

Secondly, in July 2019, the company, under the guidance of the new CEO, hired a global design firm R/GA to develop new and streamlined physical store concepts, introducing new ways for gamers to try new titles before they buy them, and giving stores a unique layout and purpose that appeal to gamers.

This proves that the CEO has not realized the fundamental problem of the company. The core problem is not that customers are walking into competitor’s retail shop for their fancy store concept – the fundamental problem is vendors like Sony are shifting to digital and there is no reason for the gamers to visit a physical store.

Third, in the recent conference call, the CEO talked about “new revenue stream” nearly 5 times, but the fact is that he is yet to “figure out” how.

We’re evaluating new revenue streams and how we can and should participate in the digital economy, particularly given the significant number of loyal customers we bring the publishers and console makers. This will take time but is a necessity to enable us to continue maintaining our position as the leader in the video game space.

– CEO George Sherman, Q1 2019 earnings call

Overall, it is clear that the company’s new CEO is clueless and is squandering the company’s cash.

Michael Burry’s Suggestion

Michael Burry, the founder of Scion Asset Management, was among the few who predicted the 2008 subprime mortgage crisis and was featured in The Big Short, a Michael Lewis bestselling book. He is now long on GameStop.

In his recent letter to the management, he urged the company to fully execute the $237.6 million remaining on its current $300 million share-buyback authorization. He has argued that it was the right time for the company to buy back its shares and expressed his belief that both Sony and Microsoft would keep physical optical disk drives.

Given the market capitalization of GameStop at ~$400 million at the close on September 23rd, completing the authorization would retire over 80% of GameStop’s outstanding shares. Depending on the timing and quality of execution, such a repurchase would increase earnings per share dramatically – far more than any other possible action on a per-share basis. On the most recent earnings call, the CEO appeared to say that he was considering using the company’s cash on acquisitions. Shareholders that want no cash used for acquisitions and all cash used for share buybacks may have no choice but to run a proxy contest to get a new board of directors in place.

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. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Eric Schleien, the writer of this article, is not part of any shareholder group with any individual or company.

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