When a company stops reporting key information out of the blue, you can be almost certain that the real reason for the change is to make the numbers look better. Management will come up with some boilerplate reasons for the move, but investors shouldn't be fooled.
GameStop no longer reports used games sales
Video game retailer GameStop (NYSE:GME) has long relied on selling used video games as its main profit engine. Selling new games comes with low margins, but the business of buying used games from its customers and reselling them at a large markup is much more lucrative.
How much more lucrative? In the third quarter of 2019, GameStop's pre-owned and value video game segment carried a gross margin of 42.7%, far higher than the 23% gross margin of the new video game software segment. Other than digital games, which generate minimal revenue for the company, used games are the highest-margin part of GameStop's business.
Unfortunately for GameStop, the used games business has been in decline since the beginning of 2016. There's no digital equivalent of a used game, so the shift toward digital downloads is hurting the company's most important segment.
GameStop reported its fourth-quarter results on Thursday, and the numbers were rough. Comparable-store sales plummeted 26.1%, and adjusted operating income was nearly cut in half from the prior-year period. GameStop spent nearly $200 million on share buybacks over the past year, reducing the share count by a whopping 35%. Even so, adjusted earnings per share were down more than 12%.
How did the all-important used games business do during the holiday season? Thanks to a reporting change, all we can say with any confidence is "pretty bad." GameStop is now reporting its results under three segments: Hardware and accessories, which includes new and pre-owned hardware and a grab bag of other types of products; software, which lumps together new, pre-owned, and digital software; and collectibles.
GameStop also stopped reporting per-segment gross margin information, which it had previously shared under its old reporting structure. GameStop's overall gross margin rose by 2.8 percentage points in the fourth quarter, but more granular data wasn't made available.
CFO Jim Bell gave a few reasons for the reporting change during the earnings call. He cited a reorganized merchandising organization, and he argued that the new structure provides a more appropriate view of the console product vertical and a more accurate reflection of how gamers are consuming video games.
Plenty of cash but little hope
GameStop has about $500 million in cash on its balance sheet, which gives it some breathing room. But the company posted negative free cash flow of nearly $500 million for fiscal 2019. The company is seeing some increased demand as people are forced to hunker down at home. But U.S. stores were closed on March 22 due to the pandemic, and any initial surge in demand will eventually dissipate, if it hasn't already.
New game consoles are set to launch later this year, which will continue to hurt demand for current-generation consoles. Combine already weak demand with what will likely be a deep recession due to the COVID-19 pandemic, and it's clear that GameStop's sales are going to be ugly for most of this year. There's also the possibility that the new game consoles will be delayed, either due to supply-chain issues or tepid demand for pricey consumer gadgets.
There was little reason to invest in GameStop prior to its fourth-quarter report. Now, with the company rejiggering its reporting to hide important information, investors should be even more leery of this failing retailer.