With the stock down 44% in the last year, trading at six times earnings, and Jim Simons (Trades, Portfolio)’ Renaissance Technologies upping its the position in GameStop (GME, Financial) by 4,194%, I want to like GameStop, but I think it might be a value trap.
GameStop is a specialty retailer of video game products with 1,393 stores in 49 states. In the last 10 years, GameStop has bounced back and forth between $20 to $50 per share and trades at $25. Long term, I don’t see GameStop breaking out of this cycle, and the stock is more likely to come crashing down as big box and online retailers continue to adjust to changes across the industry.
There’s almost nothing that GameStop can do about it. Here’s a company that has tripled its revenue and doubled its earnings in the last decade yet hasn’t been able to build book value without reducing the total number of shares. Don’t get me wrong; it’s great to see a company buy back stock, and GameStop has bought back a lot – more than 54 million shares. This has pushed EPS up to $3.74 per share and from that alone, investors may think “Oooh, it’s trading at 7x earnings. That’s cheap!” I remember thinking the same thing with Movie Gallery and Hollywood Video just 10 years ago. Short term, the stock went up 200%, but long term, the business went bankrupt.
I hope I’m wrong, but I think this is the same fate I see with GameStop. One side of me looks at the numbers the company is posting and if I was blind to the business model, I might be led to believe that the value is much higher than the $2.6 billion market capitalization would suggest.
Analysts are speculating that GameStop is looking to virtual reality (VR) for growth and survival, but VR becoming mainstream is still further off than many pundits are promising. More importantly, it’s not really a sure thing that VR will catch on or just be leapfrogged by something else. And, don’t forget the coming market recession that will surely rock stocks sometime in the next five years – sooner rather than later by my estimates.
Here’s what we know. In the last 15 years, GameStop has grown its revenue from $1.1 billion to $9.1 billion, yet since 2010, both sales and earnings figures have been flat. If you were looking at this from a purely private equity perspective, capital payback would take less than seven years.
That seems very appealing and if you are in the camp that believes GameStop is a quality retailer, by all means buy the stock. I could be 100% wrong on this one, and if so will chalk it up to an error of commission – poor analysis.
I have to admit, the company is more than just a single store video game retailer with the following brands “making the most popular technologies affordable and simple:”
- Kongregate, a browser-based game website.
- Spring Mobile, a retailer of AT&T and Cricket products/services.
- Simply Mac, a retailer of Apple products and solutions.
- Game Informer, the world's most circulated video game magazine.
- ThinkGeek, a retailer of video game and other "geek" related clothing, gadgets, toys, etc.
I really want this “too good to be true” valuation to be accurate. With $9.1 billion in revenue, $800 million EBITA and $397 million NET on a market price of $2.6 billion and paying out 5.8% in dividends, the stock is super enticing.
Most value traps are, but if consumers start withholding their spending, I do not believe that GameStop’s brand is strong enough to divert dollars away from Walmart (WMT, Financial), Best Buy (BBY, Financial) or Amazon (AMZN, Financial). While GameStop’s management has done an admirable job of using cash flow to boost EPS, when earnings fall below $200 million in the next few years, a $2 EPS with 0% growth forecast, the stock will get cut in half again.
That being said, I don’t think the video game industry is going anywhere! It’s just that gamers have more options and the delivery of games will continue to be more digital in nature. I don’t need to leave my house to get the latest version of FIFA. I just download it on my PS4.
Putting on my business consultant hat, the only way GameStop will survive in the future is by making its stores destinations rather than transactional environments. If this was 2008, I might be more apt to write a positive analysis on the company, putting price estimates as high as $50, but after barely surviving one retail implosion, I don’t want to speculate on another one.
Disclosure: I do not have a position in GameStop.
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