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Bram de Haas
Bram de Haas
Articles (387)  | Author's Website |

Burry Goes After GameStop

Review of Burry's letter to the board of GameStop

August 22, 2019 | About:

Michael Burry of Scion Asset Management and Big Short fame is long GameStop (NYSE:GME). He sent a letter to the board of directors urging them to engage in buybacks now. It is not Burry's typical modus operandi to go activist, which is both a pro and a con. It signifies this should be a pretty unique situation and at the same time, he doesn't have the experience of an Icahn or Ackman engaging boards. Which may detract from his success rate in getting the board to go along. Read the full letter here. I'll discuss some key paragraphs (emphasis mine):

"As mentioned in our previous letter to the board, we have concerns regarding capital management at GameStop. Given recent GameStop common stock prices under $4 per share, we must re-state that GameStop complete the remaining $237,600,000 share repurchase at once and with urgency."

Gamestop has a buyback authorization with $237 million left. Given it authorized such a large program, it is a bit of a mystery why it is not executing more aggressively, but it is a reasonable request especially in light of GameStop's financial situation and outlook.

"Given the market capitalization of GameStop at $290 million at the close on August 15th, 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."

I think this is a little bit of hyperbole because if the company actually tried to execute the full buyback, it would quickly end up pushing up the share price. Consequently, it would have to continue buying at higher and higher prices, and it wouldn't exactly result in the retirement of 80% of the shares. But even a substantially lower amount (and a higher share price) would be amazing results for shareholders, obviously. Add to that this result is fairly easy to achieve. GameStop has cash far in excess of its market cap and could take advantage in a big way. It has $540 million in cash and $460 million in debt and is cash-flow positive.

"Through August 15th, a total of 11 trading days, 50,399,534 shares have traded. At this rate, for the month of August and for the third month in a row, the number of shares traded will exceed the total number of shares outstanding. Because of such high volume, we maintain that GameStop could pull off perhaps the most consequential and shareholder-friendly buyback in stock market history with elegance and stealth."

Burry is correct that the volume is there but as I've described in the paragraph above, actually initiating an aggressive buyback would have consequences.

"Shareholders staring at all-time lows in GameStop stock see little evidence that GameStop has effectively leveraged its elite position in the gaming universe as the new paradigm came into clear view over the last five years.

The unfortunate reality is that Amazon, not GameStop, bought Twitch in 2014. Instead, in 2014, GameStop started buying wireless store assets. And in 2017, Amazon, not GameStop, bought GameSparks - while less than a year ago GameStop reversed course and sold its wireless store assets. Shareholders are right to worry."

Here Burry criticizes GameStop's strategic management. I'm not sure if that's a wise move. If his intent is to have them engage in a buyback, why anger them this way? He isn't looking to change the board or change management. Therefore this seems a bit over the top and unnecessary to me. Perhaps Burry wants to show the board management has made a lot of mistakes and they are wrong to oppose a buyback. It could also be the beginning of a campaign to later try to get management removed.

"We expect GameStop’s business will perk up a bit during 2020 and 2021 as the new console cycle, with associated software updates and introductions, finally gets underway. But what is happening now in the stock is about more than late cycle doldrums or even the streaming paradigm – shareholders do not have faith in current management, and have not been inspired by new leadership policies."

Here Burry again points out managements inadequacy, and he follows it up in the next paragraph by discrediting their capital allocation skills.

"We submit that when share prices are at or near all-time lows and more than 60% of the shares are shorted despite cash levels much higher than the current market capitalization, lack of faith in management’s capital allocation is the default conclusion."

It is an important skill, but it not absolutely necessary for a CEO. if they are backed up by a respected chairman of the board who is a really good capital allocator. But the reason Burry likely criticized management so much is that they oppose a buyback. That's somewhat unfortunate because that means it is less likely to happen or to happen in size.

"The Board deemed up to $6.00 per share a good price for a buyback less than two months ago, and the price of the stock today is nearly half that amount.

We again advise the Board to represent shareholders well, and to ensure the execution of the remaining repurchase authorization in full."

At the end Burry urges the board to act. It is a simple request to have the company execute on sizeable buybacks, and the argument the board accorded the program at a lower share price will hold weight. Board members will want to act in a way that reconciles their actions with earlier acts and should be susceptible to this kind of reasoning. With Gamestop trading at 0.27x book and 1.6x free cash flow, Burry once again uncovered an interesting opportunity here.

Disclosure: no position. 

About the author:

Bram de Haas
Bram de Haas is managing editor of The Special Situations Report and Founder of Starshot Capital B.V.

Visit Bram de Haas's Website

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