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3 Reasons GameStop Failed to Attract Buyers

By Leo Sun - Updated Apr 25, 2019 at 8:35PM

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A dated business model, unclear turnaround plans, and higher interest rates kept buyers away from the video game retailer.

GameStop's (GME 6.33%) stock recently sank to its lowest point in nearly 14 years after the company abandoned its plans to sell itself. GameStop started exploring a sale last June, with public equity firm Apollo Global (APO) and private equity firm Sycamore Partners rumored to be the top suitors. Let's examine the three main reasons GameStop couldn't land a buyer, and how these issues could impact its future.

1. A dying business model

GameStop is struggling to counter two relentless headwinds. First, digital downloads are gradually rendering its sales of new physical copies of video games -- which generated 35% of its revenues last quarter -- obsolete.

Two figures push two puzzle pieces together.

Image source: Getty Images.

A lower number of physical games in circulation also throttles its sales of pre-owned and value video game products, which accounted for 19% of its revenue last quarters. The gross margins of both units contracted year-over-year last quarter.

Second, most of GameStop's stores are located in malls, which are struggling to attract customers amid tough competition from Amazon (AMZN 1.12%) and other e-tailers. GameStop partnered with Amazon in 2017 to pay customers for in-store trade-ins with Amazon Cash, but that deal didn't meaningfully boost its pre-owned sales.

With over 5,800 brick-and-mortar stores worldwide and a fading core business, it's likely that GameStop's potential suitors couldn't figure out how to turn its business around.

2. Murky turnaround plans

GameStop's main turnaround strategy is to diversify its stores beyond video games with gaming accessories (like headsets), pop culture collectibles, and even comic books. That's why it acquired pop culture products retailer ThinkGeek in 2015. It also started selling digital downloads, and tested out an in-house game publishing unit.

GameStop's sales of accessories, collectibles, and digital downloads all rose by double digits last quarter, but those three businesses accounted for less than a fifth of its top line. The long-term growth of all three businesses is also unpredictable.

The recent growth of its accessories business is heavily dependent on sales of gaming headsets for battle royale titles like Fortnite and PUBG, which could gradually lose momentum. The strength of its collectibles unit relies on robust sales of Funko's Pop vinyl figurines, which are widely available at other retailers. As for digital revenues, GameStop mostly sells download keys for other DRM platforms -- which Amazon, Walmart, and other retailers also offer.

Two gamers play a video game.

Image source: Getty Images.

GameStop's turnaround strategies seem murky because it still doesn't have a permanent CEO. Michael Mauler, who only led the company for three months, abruptly resigned last May for "personal reasons." GameStop recently divested its Spring Mobile business (which includes about 1,300 AT&T wireless stores) for over $700 million -- but it's unclear how much of the cash will be spent on improving its core business.

3. Unfavorable interest rates

GameStop has an enterprise value of $2 billion, which includes $471 million in long-term debt that the buyer would need to pay off. If the buyer can't make an all-cash purchase, it would need to take on debt to finance the deal.

That's not ideal in a market with rising interest rates. GameStop highlighted that problem in its press release, stating that it "terminated efforts to pursue a sale of the company due to the lack of available financing on terms that would be commercially acceptable to a prospective acquirer."

But GameStop's not gone... yet

Wall Street expects GameStop's revenue and earnings to fall 12% and 22%, respectively, next year. Those estimates look bleak, but they're amplified by the divestment of Spring Mobile -- which should significantly reduce its Technology Brands revenue (8% of its top line last quarter).

Looking ahead, GameStop could use the proceeds from Spring Mobile to extinguish its debt and continue to improve its non-gaming businesses. It could also consider cutting its dividend, which recently was yielding 10%, and reinvesting that cash into its e-commerce platforms. The appointment of a permanent CEO could also give investors a clearer view of their retailer's long-term future.

GameStop is still in trouble, but it trades at just 5 times forward earnings and its enterprise value is ridiculously low at 0.3 times next year's sales. This means that the stock could still rally significantly on any notable improvements in its core businesses.

Check out the latest GameStop earnings call transcript.

 

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Leo Sun owns shares of Amazon and AT&T. The Motley Fool owns shares of and recommends Amazon. The Motley Fool owns shares of GameStop. The Motley Fool has a disclosure policy.

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Stocks Mentioned

GameStop Corp. Stock Quote
GameStop Corp.
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$42.19 (6.33%) $2.51
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Amazon.com, Inc.
AMZN
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Apollo Global Management, LLC
APO

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