Did GameStop Just Finally Admit Total Endgame Defeat?

June 4, 2019 by Jon C. Ogg

Source: Dwight Burdette / Wikimedia Commons
It’s been a tough period of years to be a video game retailer, even for the largest of them all. Even trying to offset slower video game disc sales by selling wireless phone coverage didn’t help GameStop Inc. (NYSE: GME) avoid the migration that was unavoidable from online sales to what became a downloading world — and now more into an instant on setting that may not even require downloads. After numerous quarters of disappointing earnings turned into numerous years of disappointing earnings, it looks as though GameStop has signaled the first official round of defeat.

While there is some basic earnings and sales data, the list of long-term obstacles and of future obstacles just cannot be ignored. There may have been some hope in years past that GameStop could survive and maybe even thrive, but that looks ever more like blind hope rather than reality.

GameStop announced with its quarterly results that its total global sales decreased 13.3% to $1.5 billion. Its comparable store sales decreased by 10.3%. It was almost a universal negative in sales trends. New hardware sales decreased 35.0% and new software sales decreased 4.3%. GameStop’s pre-owned sales declined by 20.3%, with declines in both hardware and software, and its digital receipts decreased 6.7% to $255.4 million. Accessories sales increased by just 0.6%, while sales of collectibles rose by 10.5% to $157.3 million. Net income from continuing operations for the first quarter was $7.5 million ($0.07 per share), versus $20.4 million (or $0.20 per share) in the same quarter last year.

Things are getting bad enough that GameStop has decided to eliminate its dividend payments completely, noting an effort to strengthen the balance sheet and to preserve approximately $157 million in cash annually. As of June 3, 2019, the company has reduced the total amount outstanding on its 2021 unsecured notes by approximately $39 million, leaving $436 million outstanding.

For all of 2019, the declines in the business are expected to continue. GameStop announced in April that it was implementing a cost-savings and operating profit improvement initiative that would include supply chain efficiencies, operational improvements, expense savings and pricing and promotion optimization. While the company says it’s on track to achieve annualized operating profit improvements of approximately $100 million, the reality is that fiscal year 2019 total sales from continuing operations (and comparable stores sales) are now projected to be in a range of −5% to −10%.

GameStop ended the quarter with $543.2 million in cash and cash equivalents, and the company is down to $436 million in long-term debt. The problem is that GameStop’s sales keep trending lower, and even with being able to say “things are still better than in 2017,” the reality is that the long-term trajectory puts people who are going to go to GameStop to buy video games in the same relative class of people who are buying packs of cigarettes and actual newspapers.

There was a time when there were rumors that private equity firms had an interest in acquiring the largest independent retailer of video games. That didn’t happen, and the earnings opportunities and ability to take enough money out of the business likely will prevent that from ever happening. Private equity firms might now not even want the negative press from shutting the business down and taking what’s left out of it (if there is even enough to take).

New management may not matter. GameStop was dealt a huge embarrassment when, in 2018, CEO Michael Mauler resigned after just three months on the job leading the company.

GameStop remains a battleground stock for investors. On last look, some 40.1% of the float (about 39.8 million shares) was listed in the short interest. And the four top holders are mutual fund and exchange-traded fund managers (Fidelity, BlackRock, Vanguard and Dimensional) with a 46% stake — money that could disappear in an instant if GameStop gets put on any blacklist after cutting its dividend. Insiders own only about 2.5%, according to the most recent data, although that may be a different number depending on other interests.

Shares of GameStop closed up 4.7% at $7.82 ahead of earnings, but they were down over 26% at $5.75 late in Tuesday’s after-hours trading session. UPDATE: Its shares were indicated to open down almost 30% on Wednesday morning. The 52-week trading range was $7.32 to $17.27 ahead of the drop after earnings, and its shares appear to be at roughly a 15-year low after a 2002 initial public offering.

GameStop has paid a dividend since 2012, and the attractiveness of a 19% dividend yield coming into earnings should have been more than a red flag that things have gone from bad to worse to dire.

George Sherman, GameStop’s chief executive officer, said:

Since joining GameStop in April, I have been undertaking a thorough review of the business and working closely with the team to improve our operational and financial performance, address the challenges that have impacted our results, and execute both deliberately and with urgency. We believe we will transform the business and shape the strategy for the GameStop of the future. This will be driven by our go-forward leadership team that is now in place, a multi-year transformation effort underway, a commitment to focusing on the core elements of our business that are meaningful to our future, and a disciplined approach to capital allocation.

GameStop can talk about its multiyear transformational effort all it wants. Again, the company’s long-term business trends appear to be on the same trajectory as selling newspapers and packs of cigarettes. Dare we ask if it can avoid the trap of Blockbuster and many other failed retailers before it? Unless the company can figure out a way to get buyers into its stores and keep them there long enough to buy things, there doesn’t seem to be much of a future here. The next expected Xbox and PlayStation next-generation console refresh just might not get here in time for the company.

There was a long time when GameStop screened out as the ultimate value stock. The problem is that the earnings trajectory over the long haul was so bad that it was merely a value trap. Things are even worse than that now, and even the last few holdout fans of brick-and-mortar retailers have to be wondering how GameStop can get back on its feet and survive another ever-changing business cycle in the video game industry.

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