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Is GameStop Headed For Bankruptcy?

By Will Healy - Feb 22, 2020 at 11:35AM

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Industry trends have brought down GameStop, but they could also delay its demise.

The prospects for GameStop (GME 0.92%) stock have appeared increasingly grim. The market has steadily shifted away from the physical games GameStop sells, pressuring earnings -- and the stock price. Cool Holdings missing its first installment payment on the Simply Mac business and a recent debt downgrade by Moody's have added to the troubles. A string of losses and massive revenue declines also cast doubt on GameStop's ability to survive.

However, while industry trends have pummeled GameStop stock, other opportunities in gaming may throw it a lifeline. Despite a tenuous outlook, GameStop is still unlikely to go bankrupt.

The case against GameStop

It does not take a financial journalist to figure out why GameStop stock has plunged since 2013. As consumers switch from physical to downloaded video games, they have fewer reasons to walk into a GameStop store, let alone make any purchases. As with numerous other consumer discretionary stocks, many investors have turned on GameStop for this reason.

One could argue that the advent of Netflix and the decline of Blockbuster Video was a clue that video games would come next. The fact that Amazon could offer a larger selection was another indication of looming problems. However, GameStop did not adapt, and it now finds itself struggling to survive.

Boy sitting on a floor in front of a couch holding a game controller.

Image source: Getty Images.

The struggle was apparent in GameStop's most recent quarterly report. Year over year, total global sales fell by 25.7%. Comparable store sales dropped by 23.2%. Adjusted losses for the quarter amounted to $40.2 million, or $0.49 per share. Due to the stock price declines stemming from plunging sales and earnings, GameStop's market cap has fallen to around $270 million. Meanwhile, the company still has $419.4 million of long-term debt.

Many investors expect further share price declines. As of the end of January, 63.37 million out of its 65.92 million shares had been sold short. The fact that so many people remain bearish about GameStop despite its low market cap suggests that they believe this game retailer will go bankrupt.

Why bulls may get a reprieve

Despite this deeply negative sentiment, there are still reasons to believe in GameStop, at least for now. For one, not all of the financials appear grim. As of early November, the company held $290.3 million in cash, offsetting most of its $419.4 million debt load. While this is less than the $448.6 million cash balance GameStop held at the same time a year earlier, this cash cushion makes a near-term bankruptcy filing unlikely.

The video game industry will also see an upgrade cycle later this year as Sony and Microsoft release their next generation of consoles. If history serves as a guide, this bodes well for the video game retailer. GameStop stock more than doubled between January and October of 2013, as anticipation built for the launch of the current generation of PlayStation and Xbox consoles.

GME Chart

GameStop Stock Performance, data by YCharts.

Even if the trend toward downloaded games mutes this growth, GameStop can still benefit. For now, analysts forecast a 4.11% compound annual growth rate through 2023 in the gaming console market.

GameStop could also continue to attract business for a reason urbanites may forget -- broadband access. According to the FCC, approximately 19 million rural Americans still lack access to fixed broadband. Netflix cited this issue as one reason for the continued popularity of its DVD-by-mail service. This could also signal a lingering demand for physical video games.

Furthermore, of GameStop's more than 5,700 existing stores, approximately 3,800 are in the U.S. This gives the company a broad footprint from which to maximize the benefits of omnichannel retailing, a strategy that has helped Walmart to recover.

Despite optimism, long-term prospects remain tenuous

Given the prospects for a sales rebound later this year and GameStop's significant cash cushion, a bankruptcy this year appears unlikely.

However, while positives such as the console upgrade cycle should help the company to survive, mere survival may not foster significant stock price appreciation. Even if sales improve after the next generation of consoles comes out, GameStop's long-term prospects remain uncertain.

Moreover, the Moody's downgrade and the missed payment on the Simply Mac business highlight the risk of setbacks derailing a potential recovery. So far, profit forecasts do not inspire confidence. Analysts predict an adjusted loss of $0.05 per share in fiscal 2019. The analyst consensus still calls for earnings of $0.25 per share in fiscal 2020, but that estimate has fallen from $1.15 per share just 90 days ago.

Given the potential tailwinds, GameStop will likely keep its doors open. However, that does not mean investors should look for a sustained recovery in GameStop stock.

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