Revisiting GameStop · 2017-07-04 · Digitalization Management is probably onto something –...
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Revisiting GameStop June 2017
Transcript of Revisiting GameStop · 2017-07-04 · Digitalization Management is probably onto something –...
Revisiting GameStop
June 2017
Overview● Largest retailer of video game products
● New, used, physical, digital products
● Magazine (Game Informer), Kongregate.com
● Diversifying into a specialty retailer beyond games
● SimplyMac, SpringMobile, ThinkGeek
high ~ $55
base near $20
Businesses
New profitable business lines have been added and are growing
Legacy business is declining
Q: Will growth in new business, compensate for decline in legacy business?
Q: How long will the transition play out?
GamePlan
Walking the Talk
GME has over 6000 stores, but mix is changing
Retail Graveyard
● Walmart, Amazon, Internet threat to specialty retailers
– Staples, Radioshack etc.
● Increasing adoption of digital: Netflix versus Blockbuster?
– Steam, Microsoft Xbox
– Cut the middleman: direct sales from suppliers and console manufacturers
● Threat of bankruptcy
– Circuit City, Sears?
● Core business is in decline. What is its life expectancy?
● Risk of moving away from core competency
● High short ratio: Do they know something more?
PE Ratio
low multiple
● Everybody agrees that core business is in decline
● Will the decline be gradual (cheap) or swift (expensive?)
● Will it decline like Blackberry, or like Altria?
● Will cash extracted from declining businesses fund growth of new ventures?
The Opportunity
● trades near BV (~$20)
● competent capital allocation
● shares outstanding down to 103M from 158M in 2007
● EPS up to $3.37 from ~$1 in 2007
– expected EPS >$3 for 2017 and 2018
● valued at 6-7x PE
● Is too much decline baked in?
Walmart and Amazon Threat
● Market for physical video games - $20-30B– Books ~ $125B, music ~ $20B (?)
● Pre-owned games juicy margins– 2016: 25% sales, 35% GP, 45% gross margins
– 2016: $2.25B sales, $1.04B gross profit
– Important turf to protect/manage● Tiger (AMZN, WMT) hunting deer (GME)● Tiger chasing a meal (stakes not big for WMT, AMZN)● Deer fighting for survival (stakes are big for GME)
– PowerUp Rewards (46M users) to create network effects
● Partnership with AMZN for preowned games– reduce fat margins, but delay obsolescence
– buy time, which is really the key
● Margins or revenues (probably both) will go down in time
Can afford to cede new hardware and software(45% sales, 25% GP)
Moat
● The physical gaming business has no moat● GME is a middleman; and not beloved at that● Other middlemen are willing to compromise margins● Publishers and console manufacturers will gradually sell directly● We’ve seen similar templates
– Computers, movies, music
– Have to add differentiated value to consumer
● Loyalty program is a weak defense● Omnichannel is another response
The Move to Digital
Physical games likely going to linger around a little bit longer
Digitalization
● Management is probably onto something– Limited download speeds in rural America
– Filling up console memory
– Reselling physical games
– Target population may be underbanked (teens)
● On forums, it appears gamers like to download PC games (Steam etc.), but physical console games
● Also typical gamer is more tech savvy than typical music or computer buyer
● Persistence of GME business, might indicate some value proposition
Bankruptcy Threat?
● Debt ~ $800m● 2016 EBIT ~ $550m, FCF ~ $500m
– can pay off from <2 years worth of FCF
– this is also the period in which cash flows are less uncertain
● What about capitalizing leases?– Debt $800m → $1850m
– EBIT $550m → $830m
– Still need >2 years ($1850/$830)
– Monitor, but no cause for concern yet
Move from Core
“The Middleman Economy” Marina Krakovsky (Talks @ Google)
Short Ratio
Even though 25% of float is shorted, that is down significantly
2011 2012 2013 2014 2015 2016$0
$2,000
$4,000
$6,000
$8,000
$10,000
$12,000
Revenue NonDecline Decline
mill
ion
Managing The Transition
● Decline Segments– New video game hardware
– New video game software
– Preowned
● Non-Decline Segments– Accessories
– Technology
– Brands
– Digital
– Collectibles
2011 2012 2013 2014 2015 2016$0
$500
$1,000
$1,500
$2,000
$2,500
$3,000
$3,500
Gross Profit NonDecline Declinem
illio
n
Managing The Transition
2012 2013 2014 2015 20160%
10%
20%
30%
40%
50%
60%
GP MarginDeclineNonDeclineAverage
2011 2012 2013 2014 2015 20160%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
DeclineRev%
GP%
GP Margin
Declining Business
● Steady margins
● GP and revenue decreasing
New businesses
● Better margins (~45%)
● Improving overall margins
● Trading emptier calories for
richer
Catastrophe Scenario
● Margins collapse● Old business craters● Newer doesn’t ramp● Total Rev: -4% CAGR● DCF analysis
– EBIT/GP = .25
– Sales/Capital = 2.5
– 12% cost of capital
– ~10x EPS of ND alone
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
$0.0
$1,000.0
$2,000.0
$3,000.0
$4,000.0
$5,000.0
$6,000.0
$7,000.0
$8,000.0
$9,000.0RevD RevND
2010 2012 2014 2016 2018 2020 2022 2024 2026 20280.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0% GMD GMND
PT: $14.50
past
past
Base Case
● ND Margins fall slowly● Total revenue falls
– -1% CAGR
● Residual $0.5B core● Much worse than mgmt● DCF analysis
– Similar assumptions
2010 2012 2014 2016 2018 2020 2022 2024 2026 20280
0.1
0.2
0.3
0.4
0.5
0.6 GMD GMND
$0.0
$1,000.0
$2,000.0
$3,000.0
$4,000.0
$5,000.0
$6,000.0
$7,000.0
$8,000.0
$9,000.0RevD RevND
PT: $27
Optimistic Scenario● Management forcast
– Slightly more conservative
● Overall revenue increases– 2% CAGR after 10 yrs
● Successful transition– Margins stable
– Lower than today
● DCF analysis
2011
2012
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2014
2015
2016
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2018
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2020
2021
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$0.0
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$6,000.0
$7,000.0
$8,000.0
$9,000.0
$10,000.0RevD RevND
2010 2012 2014 2016 2018 2020 2022 2024 2026 20280.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0% GMD GMND
PT: $35
Summary
● Catastrophe Downside -25%● Base upside +30%● Optimistic upside: +75%● Stock volatile (25% short interest)
– CSP strategy interesting
– 6-7% dividend (wheel strategy)
● Risk are substantial– No moat business; brick and mortar
– Not particularly liked (not a Costco)
– Dependent on others (publishers, AT&T, etc.)
Base Case
● ND Margins fall slowly● Total revenue falls
– -1% CAGR
● Residual $0.5B core● Much worse than mgmt● DCF analysis
– Similar assumptions
2010 2012 2014 2016 2018 2020 2022 2024 2026 20280
0.1
0.2
0.3
0.4
0.5
0.6 GMD GMND
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
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2023
2024
2025
2026
$0.0
$1,000.0
$2,000.0
$3,000.0
$4,000.0
$5,000.0
$6,000.0
$7,000.0
$8,000.0
$9,000.0RevD RevND
PT: $27
