GameStop: Playing for a Turnaround

04/23/2019 5:00 am EST

Focus: CONSUMER

George Putnam

Editor, The Turnaround Letter

GameStop (GME) is a global retailer of video games, collectibles and consumer electronics, with over 5,800 stores in the United States, Canada, Europe and Australia and nearly $9 billion in revenues, notes George Putnam, editor of The Turnaround Letter.

GameStop thrived in the era when gamers bought the latest video game consoles, cartridges and discs at its stores. Customers frequently would re-sell these backs to the company as pre-owned, as well as buy other pre-owned items at sizable discounts to new ones.

Not only were the pre-owned products a high-margin business, but they drove a tremendous amount of traffic to the stores, which provided plenty of opportunities to sell other high-margin accessories.

Today, however, physical game cartridges and discs are being replaced by direct downloading. And, more-powerful PCs and mobile devices, along with the trend toward cloud-based games, are reducing the need for dedicated game consoles.

Leadership churn, having just announced its fifthCEO change in two years, has left the company in strategic and operational disarray. Despite all of these negatives, GameStop's demise is greatly exaggerated. Its revenues have been surprisingly stable, falling only about 4% over the past four years.

While online games continue to improve, sales of physical consoles remain strong and provide a highly sought-after gaming experience. Even with the lack of leadership, GameStop continues to attract customers to its stores and highly developed online platform.

Further indicators of GameStop’s relevance: its PowerUp Rewards program has 55 million members worldwide, while its Game Informer magazine is the largest digital publication in the world and the 4th largest consumer print publication in the United States.

The company should continue to generate plenty of free cash flow even after funding its capital spending and a generous dividend (15% yield). The simple accumulation of cash in a better-managed GameStop would provide strong value to shareholders.

Despite these financial traits, GameStop shares trade at a 1.7x EV/EBITDA multiple, perhaps the lowest multiple of any credible and sizeable company listed on the NYSE or Nasdaq. This outlier valuation appears to also obscure the potential value of its Game Informer media franchise.

Change may be coming to GameStop. Two activist investors are pushing for more shareholder-friendly actions by the board and are threatening a proxy fight to replace the entire board at the upcoming annual meeting (likely in June).

We are encouraged (reluctantly, given the high CEO churn) that the company has just appointed a new and respected outsider as CEO, George Sherman. He could prove to be a positive surprise for shareholders.

Despite the obvious secular challenges, the company’s demise is not set in stone. For patient, risk-tolerant investors, the shares’ extreme discount, with potential value unlocked by several catalysts, offers the opportunity for outsized returns.

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