GameStop Still Doesn't Get It

GameStop (NYSE: GME  ) has finally found its biggest fan: itself.

The video game retailer is embarking on a $300 million share repurchase plan, promising to buy its stock at a time when everyone else seems bent on washing their hands clean of it.

Normally that would be a commendable strategy. GameStop is a cash-rich company, and in the next fiscal year it expects to generate twice as much cash from operations as it plans to spend on the buyback. The master spending plan is $300 million for repurchases, $200 million for opening 400 new stores and other capital expenses, and $100 million in reserve for potential acquisitions.

GameStop could theoretically do all this and still close out the year with roughly the same $700 million that it will start the fiscal year with.

It's a good plan, but only on paper.

Time for the rubdown
The rub, of course, is that GameStop may not be the same company it was a year ago. If folks aren't buying new or used games and consoles -- at least not from GameStop -- the entire plan craters.

Reading through the company's press release detailing its capital allocation strategy is a real treat if you enjoy arrogance and misplaced bravado.

  • "GameStop, one of the world's fastest growing retailers with a unique business model," begins one paragraph.
  • "The company intends to continue its aggressive roll-out strategy of opening new stores worldwide," begins another.
  • "The company believes its cash flow will remain at or above existing levels for the year ahead and believes the video game industry and GameStop will continue to grow in the years to come," reads yet another chunk of the release.

GameStop does such a good job of selling itself, you have to wonder how it has one of the few consumer-facing stocks trading lower today than when the general market bottomed out in March.

Behind the self-penned accolades
Unwarranted confidence is a scary thing.

Is GameStop really one of the world's fastest-growing retailers? Not anymore. Same-store sales during the holidays fell a staggering 8.6%, and that "aggressive" expansion was only good enough to generate flat total sales during the two-month holiday period. I wouldn't dare call myself "one of the world's fastest" anything in a pocket of stagnancy, especially when several fast-growing retailers -- rue21 (NYSE: RUE  ) , lululemon athletica (Nasdaq: LULU  ) , and Lumber Liquidators, for starters -- are expanding aggressively and put up strong comps in their most recent reporting periods.

Opening new stores while comps are tanking is also just plain stupid. It's a trap that snagged Gap (NYSE: GPS  ) and Hot Topic (Nasdaq: HOTT  ) several years ago. When the registers are collecting cobwebs, your focus needs to be on reviving sales instead of scouting suburban corners for future cobweb collectors.

GameStop doesn't get it. Maybe management thinks that the sales hit was temporary. Maybe it doesn't fully grasp the gravity of the situation. It can no longer get away with selling new games at retail prices when Wal-Mart Stores (NYSE: WMT  ) and Amazon.com (Nasdaq: AMZN  ) are marking them down. Price cuts elsewhere on new wares will also eat into GameStop's ransoms on used gear. This is a huge shift, because used games and gear make up the chunkiest profit margins in GameStop's model. If they take a hit, operating cash flow would also be due for a whack.

This segment used to be GameStop's "unique business model," with gamers trading in tired titles and consoles for store credit, which GameStop would then mark up significantly for resale. Its well-oiled chain comes undone when sales slow. It also doesn't help that several offline and online retailing heavies began nibbling at GameStop's resale model last year.

I won't even get into the trends of digital distribution, social gaming, and App Stores that will challenge GameStop's relevance in the future. This is not a company that should be working off of last year's results for cash flow projections or have faith in "growth over the years to come."

If it really wants to spend $600 million in a capital allocation strategy -- even if it ultimately eats well into its cash balance -- it needs to forget the buyback and the expansion. Throw it all into the acquisition pool and diversify -- instead of going old school the way it did with last year's $700 million purchase of French retailer Micromania.

Buy into social gaming companies, in-game advertisers, and gamer sites. Spend money in areas that will still be relevant, long after we've moved on from consuming games in shrink-wrapped form.

The ultimate trap
You know what's nuts? I bet that thousands of investors will buy into GameStop this week, assuming that the retailer's board wouldn't spend $300 million of shareholder money if this wasn't the bottom. Surely no one knows the company better than its own leaders. If they're drawing the line in the sand, it just has to be safe.

Unfortunately, this is also the same group that called bottom in May, August, and November -- only to be humbled a few months later. If it can't get a good read on the following quarter, how could anyone take its promise for "growth in the years to come" seriously?

Amazon.com and GameStop are Motley Fool Stock Advisor selections. Wal-Mart Stores is an Inside Value pick. Lumber Liquidators is a Rule Breakers recommendation. Try any of our Foolish newsletter services free for 30 days.

Longtime Fool contributor Rick Munarriz will admit to still playing video games, though finding time is the rub. He does not own shares in any of the companies in this story. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.


Read/Post Comments (14) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 13, 2010, at 2:54 PM, Fool wrote:

    1. What company puts a negative spin on their press releases?

    2. Companies seldom fail quicker than when they diversify into businesses they don't understand.

    3. Do you remember opportunity costs? The only way a share buy back is a bad investment is if they could have made more money by investing it somewhere else, but as you've already pointed out they're swimming in cash.

    4. Wal-mart is not going to get into the used game market.

    5. All it takes is a simple internet search to fact check your assertions.

    http://www.target.com/New-Super-Mario-Bros-Nintendo/dp/B002B...

    http://www.walmart.com/catalog/product.do?product_id=1199187...

    http://www.gamestop.com/Catalog/ProductDetails.aspx?sku=2306...

    6. Be greedy when others are fearful!

  • Report this Comment On January 13, 2010, at 3:47 PM, Fool wrote:

    I agree with Fool's points. Rick you simply hate GME and spin stories against it. Have you shopped a WMT store lately? They lock the new games and we all know how hard it is find help there. Gamers are a different breed of customers and it takes a company that specializes in that space to understand them. Most of them want instant gratification. Hence they go stand in line at midnight when a new game launches. Similarly, these kids get bored quickly with a new game and want something else. Some trade peer to peer and some go to GME to get trade currency for their game. Can you imagine these kids going to a WMT or a Toys r Us to trade games? It will hurt there image! You got at least 1 guy at GME who can chat with these gamers about whats cool about various games. Btw, that 1 guy isnt hard to find. The store is so small.

    Price war is a short term gimmick. All retailers know that only person that wins a price war is the consumer. All retailers will pick and choose a few items to lower prices to manage perception. Like WMT did with 10 books, 100 toys etc. They cant lower prices on every item. The beauty of the used business at GME is that they generate so much cash and can compete in a price war with price matching programs.

    Then comes assortment. These general merchandise stores do not have the assortment GME carries. They can get you something quickly even if they dont have a game. It takes a day to UPS a game from a nearby store.

    I am not sure about when the day will arrive where we download a large games to our consoles directly. Resale value = zero. Peer to peer trading value = zero. Chances of big game developers alienating GME = slim.

    You did a good job propagating fear amongst investors but it is very one sided. I applaud GME board approving the buyback.

    It takes them only $150K to open up a store and hence can move it pretty easily if they need to.

  • Report this Comment On January 13, 2010, at 4:14 PM, texzen123 wrote:

    Interesting article, but as one without a formal education in finance I don't fully understand? (I only have common sense at my disposal at this time, so please forgive)

    But the article say's "Gamestop doesn't get it.." Let me try to figure this out... A reporter who works for an internet website, owned by a private company that employess 200 +/- employees (Wikepedia) is professing that another company, Gamestop, (Which is publically traded) and just employeed over 15,000 temp employees for the holidays, (http://www.joystiq.com/2009/10/27/gamestop-hiring-15-000-tem... and just reported earnings for just 9 WEEKS (http://www.1up.com/do/newsStory?cId=3172181) in excess of 2.86 BILLION..... YOU are saying that THEY are missing it??? Interesting.... and perhaps my 40k a year self could tell Peyton Manning where he's missing it as quarterback as well...

  • Report this Comment On January 13, 2010, at 9:39 PM, doublecork wrote:

    texten123...you got it!

    more importantly...GameStop Gets it!

  • Report this Comment On January 14, 2010, at 9:44 AM, xtmonax wrote:

    In terms of risk; i see risk in rapid expansion when existing store performance stagnates. To the same tone, there is a great deal of risk in expanding into new (and unproven) territories, versus developing what works.

    I agree that GME has an operation that appeals to a true gamer. They have an established and validated model along with a lock on the used / buyback market. Game manufacturer relationships are proving to be strong, and they are well funded and positioned to compete with Target/Target.com or Walmart/Walmart.com for new sales.

    I adhere to the value investment principals, buy what you know and what you believe in, and from experience i think they own this space.

  • Report this Comment On January 14, 2010, at 9:59 AM, gamestopman73 wrote:

    This site is the worst anti-GameStop place I have ever seen on the web. No matter what is happening with GameStop they will find a way to put a negative spin on it. I stopped reading anything these jackasses say anymore. It's biased garbage.

  • Report this Comment On January 14, 2010, at 10:03 AM, MagicDiligence wrote:

    This holiday season was an aberration. It was smart for Wal-Mart and Amazon to discount games given awful consumer sentiment. GameStop's management dropped the ball, no question. But these are 20% margin items - not something they'll want to discount on an ongoing basis.

    Which leaves shopping experience as the primary differentiation. GameStop has knowledgeable and helpful employees that help you out through the door. At Wal-Mart you are waiting 15 minutes to find a busy sales associate to unlock the case.

    Also, the comparison with Gap and Hot Topic is way off. These are retailers with a ton of direct competition, not to mention fashion risk. GameStop is the only pure-play games retailer on the continent.

    BTW, used game sales grew 10%. This sector provides almost half of profits. It's not as easy as Wal-Mart just deciding to do it. You need a deep AND wide inventory to succeed, and you need dedicated employees to manage it. Nobody is going to bother competing in this segment.

    At the current price, GME is a real bargain, IMO.

  • Report this Comment On January 14, 2010, at 11:46 AM, feldmail wrote:

    Without increasing used game sales, GME is dead in the water. Most sophisticated gamers will tell you that these days, they will rarely buy a used game from Gamestop. Not when you can do much better buying from Amazon and then selling your old games yourself online. Gamestop was very innovative when they first introduced their trade-in strategy but that is now yesterday's news usurped by much better alternatives. Eventually, GME goes the way of Blockbuster with their brick and mortar worth just so many bricks and mortars--no different than any other electronics retailer from Crazy Eddy, 47th Street Photo, Comp USA to Circuit City!

  • Report this Comment On January 14, 2010, at 11:53 AM, feldmail wrote:

    test

  • Report this Comment On January 14, 2010, at 3:34 PM, Rehydrogenated wrote:

    I thought gamestop was a real value yesterday when i bought some. I'm surprised that the news of a stock buyback resulted in the stock losing value. If the company can't increase the value of my stock through growth right now, and they don't pay dividends, then what should they do? Leave the money in the bank?

    How the heck are they supposed to raise sales?

  • Report this Comment On January 14, 2010, at 3:50 PM, bigcat1969 wrote:

    I agree with feldmail. Gamestop still has some appeal, but they give such a small break for newer used games (often five dollars) and give so little for trades that it really isn't worth the bother. Think back on the used CD shops, remember those. Now imagine that they charged 90% of retail for used disks and gave 10% of retail when purchasing disks. How long would a trade 10 for 1 deal realistically last? That is what makes Gamestop so successful right now. It is dooming used booksellers and used CD/DVD sellers and it will doom Gamestop as well.

  • Report this Comment On January 14, 2010, at 4:56 PM, EquityBull wrote:

    How about the writer of this article compare apples to apples in terms of comps. While other retailers were down in 2008 drastically thus making the 2009 comps EASY for them GME is a victim of its own comp success. All other retailers were taking in comps last year and GME was actually UP. It was one of the lone retailers out there that pulled this trick.

    So when he writes:

    "Is GameStop really one of the world's fastest-growing retailers? Not anymore. Same-store sales during the holidays fell a staggering 8.6%, and that "aggressive" expansion was only good enough to generate flat total sales during the two-month holiday period. I wouldn't dare call myself "one of the world's fastest" anything in a pocket of stagnancy, especially when several fast-growing retailers -- rue21 (NYSE: RUE), lululemon athletica (Nasdaq: LULU), and Lumber Liquidators, for starters -- are expanding aggressively and put up strong comps in their most recent reporting periods."

    It is not fully transparent or relative since GME is its own worst enemy with YOY INCREASE

  • Report this Comment On January 15, 2010, at 8:50 AM, Commoncents75 wrote:

    The only thing Motley Fool is right about is the name of their website: FOOLS!!!

    They are so against anything GME related that it is almost hard to read anything they post and really get anything valuable out of the information being supplied which is usually very one sided.

    GME is very successful first off. Concern from investors over the 9 week holiday period reported is absolute BS. Consider this last years X-mas sales were the highest ever X-mas season by GME, so for them YOY numbers would take a miracle to obtain that success 2 years running considering price cuts on systems, economic impact, and Sony and Nintendo lack of ability to deliver enough product to suffice demand prior to X-mas. For the company to have only missed the 9 week period by a little more than 8% should be seen as a great accomplishment. What seems to be forgotten by most investors is that GME's Fiscal year doesn't end until January 31st, and by reports published in their 9 weeks earnings statement the company had almost already beat LY for entire year with 1 month left to go. The only thing keeping GME stock down is idiots like Motley Fool who constantly spew nonsense and scare folks into either a selling what they have or not buying at all. Wal Mart-Amazon-Best Buy cant touch these guys, they don't have the no how or man power to dedicate into beating them. It will take a lot more than a couple of lame duck price cuts to shake GME and there decision not to counter in my opinion was a sign of strength not weakness. Of course this is all my opinion so take it with a grain of salt, but come on people quit bad mouthing one of the few companies that has been unstoppable for several years in a row, and actually brings a smile to most faces.

  • Report this Comment On January 20, 2010, at 1:03 PM, pj19 wrote:

    Thanks so much Fool! Keep bashing MGME so I can increase my position!

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