5 reasons GameStop might prove skeptics wrong
Battlefield stocks are nothing new. Sometimes public companies have passionate supporters – and detractors – who can’t help but tell anyone who disagrees how little they know about investing. The surprise this year was to find out which titles elicited this reaction.
Video game retailer GameStop (NYSE: GME) is one of them. And although the stock has risen nearly 1,000% since the start of the year, the company still has a long way to go to deliver consistent profits. This has led many – myself included – to say that the company’s current market capitalization is not justified. However, there are several reasons why a new management team could prove opponents wrong. Here are five of them.
1. He has a lot of time
One of the easiest ways for a business to go bankrupt is to have too much debt. That’s what happened to struggling physical retailers like Toys R Us and JC Penney. GameStop addressed that concern by raising capital as its stock skyrocketed earlier this year. The company’s long-term debt is down 94% from its peak and its cash flow has almost quadrupled.
2. She is reducing her physical stores
The company has closed sites at a rapid pace. At the end of 2016, GameStop had more than 7,500 stores worldwide. By the end of last year it had fallen to 4,816. It closed 693 stores in 2020 alone and has continued throughout that year. It is a similar strategy which Bed bath and beyond (NASDAQ: BBBY) job. This company has reduced its physical locations by 34% since 2017.
Management will have to continue to trim stores if it wants to turn the tide. And it will have to do it without impacting sales. Despite the cutting of sites, gross margins continue to be lower than pre-pandemic levels. Cutting costs will not help if sales go with them. That said, GameStop is making progress in controlling administrative expenses. It has led to operating margins creeping towards breakeven.
|Period||Gross margin||Operating margin|
To support this strategy, the company is opening large distribution centers in Pennsylvania and Nevada. These complete a logistics network on both coasts. Management relies on expedited shipping to meet immediate customer needs despite fewer stores. It is a bet that will have to pay off to be profitable.
3. He can keep his physical stores
You read correctly. This could turn a liability into an asset by reallocating some of the physical locations to places that more consumers want to visit. After all, he can’t close all of his stores, and neither should he.
By expanding product and service offerings, it could rely on accessories and services to change the sales trajectory. Some suggestions included game tables, game televisions, and the creation of e-sports training centers. As it stands, software – new and used video games, digital currency, and downloadable content – accounted for much less of the company’s sales in the first half of 2021.
|Period||Hardware and accessories||Software||Collectibles|
Investors might see it as the glass half full or half empty. Management is pushing for higher margin software sales to become a bigger part of the business. Of course, the fact that they accounted for a large chunk of sales when many stores close in 2020 could prove that GameStop customers will move their shopping online if that’s their only choice. The percentage of software sales in 2022 might offer a better idea of the future of this part of the business.
4. He can seek relationships with game publishers
Another idea was that GameStop could do more online for customers. Former CEO George Sherman has hinted that he may offer some type of digital exclusives or packages to customers. It’s hard to imagine because game companies such as Microsoft remove intermediaries from the customer relationship. It is the same Nike made in clothing.
With new leadership behind the wheel, it’s possible the company could persuade game makers to experiment. But they have little incentive to do so. A partnership would be more about saving GameStop than increasing overall industry sales.
Still, GameStop could forgo substantial financial consideration to try and lay the foundation for a sales channel that will help it reach the future. It may not be great for shareholders. But he could extend his business life while working on other ways to prosper.
5. He has built an impressive management team
Arguably the biggest catalyst for interest in GameStop’s turnaround is President Ryan Cohen. He is the founder of the online pet store soft and the largest shareholder of GameStop. He placed a few confidants on the board and largely built up a management team with legitimate e-commerce skills.
During the first half of the year, the company recruited an COO, a growth manager and a CTO, in addition to executive hires from Amazon, Alphabetis Google, and soft. In June, GameStop hired former Amazon executive Matt Furlong as CEO.
Why am I still skeptical
Gamestop will not be able to narrow itself down to success. Although it has made progress in containing costs, margins remain significantly lower than pre-pandemic levels despite significantly fewer stores. New leadership, especially from notable ecommerce companies like Amazon and Chewy, can’t hurt. But these executives are used to companies that sell physical products. Not digital which can be easily downloaded from the Internet. Competition is less about operational excellence and more about the simplest user experience.
That’s why I think the near future of gaming will likely be like Microsoft’s discless Xbox. In this world – where games are downloaded at home – there is no need for a company like GameStop. He probably realized this in 2016 when he tried to start his own game publishing division. Today, during a recovery attempt, management invokes secrecy as the reason to hide its plans from shareholders. The last call for results lasted less than seven minutes and no one answered questions.
Everything is possible. But to me, the share price seems to be about hope and speculation rather than future cash flow. This cash flow is how stocks are traditionally valued. Of course, the tradition left the building in January when the stock jumped 1,600%. Maybe that’s what I’m missing. Maybe this time really is different, and the traditional valuation is gone forever.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.