Can GameStop Change Its Model?

As physical video game sales drop, GameStop (GME 6.16%) has struggled to find a model that works. The company does have a strong balance sheet, but that might just extend its slow demise. It's a chain that still makes money -- and it offers value for investors -- but its longer-term future remains in doubt.

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This video was recorded on May 21, 2019.

Dan Kline: One of the challenges is, a lot of times, you look at a company like this that's struggling, and you can see a logical pivot. The only logical pivot here was pay for play virtual reality, in-store gameplay. And more and more malls have those as stand-alones, the GameStop footprint largely doesn't lend itself to that. They're generally smaller, crammed stores. I've been in retail, I've run a toy store, we've talked about this a lot of times. You look and go, OK, what's the retail niche that they could jump into that would be adjacent? Hot Topic T-shirts? There's no obvious play here. Will they add self-serve frozen yogurt to all the stores? Sell gelato? Just, since they got out of the cellphone business, which was a logical adjacent, it doesn't seem like there's anything other than little incremental things. And if you don't need a video game, I doubt you're going to GameStop to buy Pokémon cards or whatever other thing they might sell.

Nick Sciple: Yeah, I think this is one of those where, if there is a meaningful floor up underneath these operations at some point, like what Jim was talking about with backwards compatibility, that's going to keep people coming back and put a floor up underneath that decently high-margin used business, there's clearly some valuation here. However, if we continue to see that decline, and the free cash flow that they're generating starts to stutter or move down, the valuation may fall apart.

But I think what this company is an example of, at least in my experience, if you're going into investing when a company has a value play, and you feel super, super comfortable that everything's going to work out perfectly, it's probably not as good of a value as you think it is.

Before we move on to Funko, any last things you guys want to mention on GameStop, and what to pay attention to going forward with this company?

Kline: It's not an immediate risk. I think this isn't Radio Shack, this isn't a company that's out of money on its fifth chance. It really is healthy grandma. If she falls ill, it might be three years, it might be 10, but she's not going to live to be 140.

Sciple: Jim?

Jim Gillies: Yeah, I... I'm struggling with the healthy grandma metaphor right now. I feel like we're talking down Grandma. But, no, I think, watching the new CEO, what he does, he does have, I believe they called it substantial retail experience in the glowing press release when they hired him. But we really don't know anything about him or what his strategy is going to be. They just filed their proxy statement last week. I have not had a chance to read it yet. We literally know nothing about what his strategy is going to be. Now, I would presume -- and this may be dangerous -- I would presume they hired this guy because he was able to go into the job interview and lay out a vision for where he thought GameStop could go. I would hope they would hire a CEO based on that criteria.

Sciple: [laughs] Right.

Kline: [laughs] They went based on height.

Gillies: Yeah, like, he knows a guy who knows a guy. But, I would assume that he went in with some sort of a vision, and that we are going to see in the weeks and months ahead the initial steps for that vision coming to fruition. I don't disagree terribly much with what Dan says. There's no obvious pivot. The pivot they did try to do... obviously, the other pivot too is, I'm old enough to remember GameStop before the collectible stuff. And now collectibles are everywhere. In certain stores, they're cluttering the place up. In other stores, as I said earlier this morning on our private call, the store in my town at the mall, it's a couple of miles away from the house, they went from a small, cramped store, well packed in, to a store that's easily two times the footprint, and -- everything that Dan is not seeing in Florida. Everything he's saying he's not seeing in these stores, I'm like, come to Guelph, Ontario, I'll take you to the one in the mall downtown. It's exactly what you're calling for. If they're going to go for those types of remodels, you go and you can play the games, that sort of thing. I want to see what the CEO does. A 19% dividend clearly says the market does not believe that your dividend is adding any value. You may as well cut it to, oh, I don't know, 8-10%, which is still far more generous than anything else out there, as long as you're going to use the cash for something value accretive. They have a $300 million stock buyback. The only thing I know from the proxy, which was, as I said, just released last week, the only thing I checked, they have not bought back any stock between announcing that program and the proxy that came out. A little disappointed in that.

The last thing I would say is that they had a couple of very small activist investors sniffing around. Somewhat strangely, GameStop welcomed the two of their director nominees to the board. Because these guys don't own enough, I would have thought they would have brushed them away. I think they only own about 1.5% total shares. But they welcomed a couple of new people on the board. I'm assuming they're not there to collect $50,000 a year in director's fees. Again, I'm assuming that someone has a plan. One of those small hedge funds, the activist, I think he's been an investor since 2012. I'm looking to see anything concrete from these guys. Do you have ideas? Because right now, Dan sitting here saying, "There's no obvious idea," OK, GameStop, there's the gauntlet. It's thrown down by Dan Kline.

Kline: Now, if I said there was an obvious idea, will they put me on the board? [laughs] Because it really seems that they are looking for ideas.

Gillies: They are looking for ideas, because the one that they did go with, the tech brands initiative, the rug got pulled out from under them there.

Kline: Walk-in medical clinics? Cannabis sales?

Gillies: Hey, cannabis sales. But, no, I'm watching to see what's going to happen. I'd like to see things that, obviously, are value accretive. In a world where Redbox can get acquired -- which, I mean... Redbox was acquired, I think, at about 4.5X or 5X EBITDA. GameStop is trading way below that, and yet they couldn't sell themselves. Find me a more pessimistic stock out there that has the quality of balance sheet and cash flows currently. Clearly, people are suspecting or seeing that there is no future here. They're all on Dan's side, is my point.

Sciple: Yeah. For our listeners, we are taping this on May 21st. You'll get this episode probably right after GameStop has reported earnings by the end of May. It's very possible that, by the time you hear this, GameStop's management has laid out their entire reorganization strategy and makes us all look really dumb. But we'll see how things go. Really interesting business. Classic valuation story, where the company's left for dead, but there could be some real meaningful opportunities to squeeze some more value out of these assets.