In this episode of Industry Focus: Consumer Goods, Emily Flippen and Motley Fool analyst Jim Gillies talk about the bull case for owning GameStop (GME +3.88%). Jim has been following GameStop since 2009. They talk about what GameStop is and how it got to the point where it is today. They discuss its various revenue streams and its management shuffle and the changes it brought. They get into its financials and various investors backing the company, look at the risks and what makes it a good stock, and much more.
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This video was recorded on October 20, 2020.
Emily Flippen: Welcome to Industry Focus. Today is Tuesday, October 20th, and I'm the host of this Consumer Goods focused episode, Emily Flippen. I am joined here by everyone's favorite Canadian Fool and advisor for the market-crushing small cap service Hidden Gems Canada, Jim Gillies, to talk about the bull case for owning GameStop. Jim, thank you so much for joining.
Jim Gillies: Thanks for inviting me; this is a treat.
Flippen: I have to start off by calling out your performance on GameStop, not just within Hidden Gems Canada, but I actually want to throw back to September 2019, because we have a backend system here at The Fool where analysts, such as yourself, can put in conviction ratings and thesis for companies. And you have a conviction and a thesis for GameStop dating from September 2019, and GameStop stock has risen by over 200% since you laid out that call for it in our backend system called Fool IQ. So, I'm really excited to hear about this bull case. Maybe it's changed over the last year or so, but either way I'm excited to hear about it.
But before we do so, I do have to repeat my favorite investing analogy, because I really think it applies here, at least for me. I always say investing can be like dating, and I think in the case of GameStop I'm like a jaded ex-girlfriend of GameStop. We had a little bit of a rocky run in the past, things maybe didn't end [laughs] on the best note. And now I'm not sure there's anything you can say to me that would make me ever want to give GameStop that second chance. So, I have to be honest here, I think you may be fighting a little bit of an uphill battle with me, either way, though, I'm really excited to hear why you think GameStop has potentially turned around its business, and maybe why should I go on that, you know, second date here with GameStop? [laughs]
Gillies: Well, I've actually written a number of articles or had columns in various or, like, headings in various articles, where I liken investing to I would say, date, don't marry, you know, I don't want to marry any of my stocks and hold them forever and ever, so maybe we'll have a meeting of the minds here with our taxed-out dating analogy. It's been a while since I've been in the dating pool, so. [laughs]
Flippen: [laughs] Myself included actually. It's funny, I think that analogy works so well. The same way you always say you don't marry someone on the first date, you have to wait 'till you have that first fight, I feel the same way about buying companies. You can have a company, maybe it's newly public, maybe you just did some research and everything seems perfect, I promise you, as with humans, there's always something wrong with a company, there's never going to be a 100% perfect company, the same way there's not a 100% perfect human. So, give yourself the opportunity to have a little bit of a fight with the companies that you invested in [laughs] before going all in on them. That's the way I like [...]
Gillies: I've had my fights with GameStop over the years. So, I'll second that. Yeah, I followed GameStop for a long time, going back to 2009. So, I've used it a lot as not just the call and Fool IQ, you mentioned, but I use it a lot as, as you know I like to play options games and I fronted the Motley Fool Options service for a decade, and GameStop has been one of my perennial options for income strategies going back to about 2009-2010, so a long history here. But as you mentioned, Fool IQ in September of 2019, I think it was, yeah, I said, guys, I think there's something here, so.
Flippen: Well, you mentioned that you've been following the company since 2009, let's maybe start with a little bit of history on GameStop here. For our listeners who aren't in the 16 countries that have a GameStop or have otherwise been living underneath a rock and have somehow managed to avoid seeing the over 5,000 retail GameStops there are across the world, what is GameStop and how did it get to the point where it is today? Or maybe I should say, how did it get to the point of September 2019 when you maybe laid out that initial bull thesis?
Gillies: Sure. So, GameStop, briefly, is a bricks-and-mortar video games and collectibles retailer. And you can see in my background here, there might be one or two collectibles in this house. So, I am not -- what's the Peter Lynchian phrase, buy what you know, I could show you a few of the pictures, but I won't bother. So, it's basically video games. So, new console systems, new video games. It is also used video games. So, you can even buy a video game, like my 16-year-old will buy a game and he'll play it for two or three months and then he'll take it, plus two or three other ones that he's simultaneously played out or he's finished with them. He'll package them up, he'll take them back to our local GameStop and he'll sell them back to the company and he'll then use the credit he gets, which of course, is far less than what he paid for the games in the first place, but as someone who's active investor in the company I like that I guess. And then he'll use that credit to buy the next round of games for his addiction. And that traditionally has been the highest margin business.
And then, of course, there's also the collectibles business, so action figures and games and that sort of thing. But the main thrust is the video game system. And so, there's a lot of things that roll into creating value at GameStop. So, there is that, what we call, the overarching console cycle. So, we are on the cusp, Emily, we are on the cusp of the console refresh cycle, which is a main part of my thesis, by the way. And that is, this holiday season, coming soon to a GameStop near you, and a Best Buy (BBY +2.48%), and an Amazon, and a Target, will be the PlayStation 5, Sony's PlayStation 5, and the Xbox Series X. Why Xbox could never come up with a snazzy name like 1, 2, 3, 4, 5, like PlayStation did, I don't know, but whatever.
So, traditionally these console cycles take about six, seven years the PS4 and whatever the prior version of Xbox were for 2013. The PS3, and again, the two prior's iteration of Xbox were 2006, 2005; I think Xbox came out a year earlier. And so, what these things tend to do is they go in broad seven-year cycles and they spike console sales in the first year or two, OK, everyone has got to have the latest and greatest.
And then with that you also start spiking new game sales, because everyone starts publishing the new games for the new console. And then, you know, the consoles tail off but, dirty little secret, most of the consoles are sold low margin, actually, the gross margin on consoles, if I remember correctly, is about 10%. So, they're almost selling it at cost, and you could think of this as a razor-and-blade model. So, I mean, they sell you the razor, the console, because the real money is in the blades, it's in the games. So, the consoles sales tail off naturally over the next seven years. The game sales spike and stay a little higher, but then also, toward the end of the console cycle, like say, 2019 or 2020 even, the console cycle is largely played out and everyone knows the new consoles are coming, so why am I, like for example, I could go out tonight and buy the new Star Wars: Squadrons game for my PlayStation 4, right, I could, but PlayStation 5 is going to have games for it in probably another month or so, including that very game. I'm just going to wait until I have a PS5 under the tree at Christmas, don't tell my kids, and then, you know, I'd start adding games there.
But there's a few other hooks that go into the console cycle. So, one part of the thesis was the console cycle. Now, you mentioned there's over 5,000 GameStop stores; that number has been shrinking. I'm sure some of the listeners and some of the viewers will be saying, but, Jim, have you not heard about digital games, don't you know anything about this intermediation? I do, but you know, I've talked enough for now and [...] you can get into that if you want, or my personal favorite, my personal favorite, like I said, I've been following this company since 2009, my all-time favorite comment is, GameStop! Don't you know they're the next Blockbuster? Boom!
Flippen: [laughs] I actually do have a question, because the console cycle makes sense to me, but that's how it's always been for GameStop, right? And it really hasn't saved the company up until to this point. So, maybe you're alluding to, one you mentioned, that was just the first part of your thesis. But what's different about this console cycle versus ones that we've seen in the past that make GameStop more appealing now versus where it was maybe, you know, five years ago?
Gillies: Can I go back to the date, but don't marry the analogy that we tackled at the beginning?
Flippen: [laughs] That would be great.
Gillies: Okay. Perfect. Go back and pull a stock chart from about, I'm going to say, June, maybe, May-June-July of 2012 through to November 2013 when the last console cycle ran. And what you're going to find -- I'm going to be precisely wrong, but roughly right here, because I don't have a stock chart up here -- the stock basically went from, like, $15 to over $50. So, to say that it hasn't helped the company, is I think to miss the point of running a console cycle or running an investment thesis along with a cycle. This is a cyclical company. I mean, we tend to think of cyclical companies as maybe oil and gas or commodity chemicals like methanol, for example, there's a big company here in Canada called Methanex. And so, what you want to do typically with a cyclical company is you want to buy when things look really bad, because it's the end of the cycle and you want to ride the cycle up and you want to get out at the top of the cycle. So, you know, this is very much a dating company, it's not a marrying company.
So, that's the general thesis of what's going on. But the other part is why it's not been a strong recommendation, and what led to my original write-up. And spoiler, I've since recommended this at, not in my $4, $5 price back in September, but I've talked about it in various Motley Fool Live things, I recommended it in Hidden Gems Canada a while back. And I've been very open about saying, we're not going to marry, we're going to get out at a certain point when we have -- this is your analogy [laughs] -- you know, we're going to get out at a certain point either when we think the cycle has played or the cyclical turn has played, or when I am proven to be wrong, because there's always a chance that you're wrong, and you should always be aware of what are the risks and what's going on.
But I think here, the other main reason why things haven't looked great has been this broad, this is the next Blockbuster, the broad you're going to be disintermediated by GameStop, your business is going to migrate away from you. All games, Emily, will now be delivered digitally, so you won't need the CDs, like the physical media. And you know, the bulls here would point to GameStop and the console cycle and say, well, the PS5 and the Xbox Series X are coming with physical drives, so you're going to need physical media, which is what GameStop sells. Moreover, the PS5 is going to be backwards compatible with the PS4, which means all the games you have for your old system, you can play them on the new system. Which then means, you can also trade in and out of GameStop's higher margin used games business. The games you have for your prior system aren't useless when you buy the new console. So, this is what the bulls would say, will point to the physical media drives and the backwards compatibility.
The bears would point and say, well, yes, but there is an Xbox Series S, not X, and a PS5 Lite or basic or whatever like that, that are coming with only drives, only hard drives. So, no physical media. And those will, obviously, be required to download digital games only, which of course is the death of GameStop, right.
Except, at least in the case of the PS5, I'm not sure about the X versus the X, or I know one of them, I'm probably wrong on one of them, but I know one of them, the hard drive on the nonphysical media version is actually smaller than the hard drive you get on the more expensive version. So, the Series X or the PS5 Standard, they're about $500, the lighter versions are about $300. So, you know, if you want to cheap out you can buy those. But you're getting a smaller hard drive, and the problem is, this is the second part of the thesis, the physical media or rather the digital-only stuff, as these consoles come out they're always making better use of graphics and sound and in-game video and they are far more complex than games of the past. I mean, I still have a working Atari 2600 downstairs. [laughs] They're far more complex than games of the past and so the files are bigger. The game files are bigger, and you were going to give me a cheaper version of PS5 with a smaller hard drive, no, on my PS4 now, my family, we're constantly moving games in and out of the hard drive, like pieces of the game, because we don't have the storage now. And that's not something that's going to get better with the new consoles and with the new games. So, I still think that the entry consoles, they're there but they're not the homerun that the bears think they are.
Flippen: I'm kind of interested, though. We've seen this push toward cloud gaming and you mentioned that the console cycle is five to seven years typically, historically. Do you think this is the last console cycle we've seen for companies like GameStop, do you think whatever the next cycle is, it's a company launching their own cloud gaming platform which would require no consoles, no downloading, no games because you would just directly stream it from a company servers or are we still really long way off from that even being feasible?
Gillies: I think it's feasible. I have, if I can go in a little strange direction here, if that's OK, but that's kind of my stock in trade, so. Again, I've written a lot of columns over the years. So, I've written one where I talked about, what's the only thing faster than change? And my answer has always been, investors' expectation of change. So, GameStop, yeah, what you just said, another six, seven years, Microsoft (MSFT +0.66%), Sony, whomever, Nintendo, could end up saying, you know what, it's all cloud all the time, we don't need physical consoles, you're just going to pay a monthly fee. You know, with this fee, you have access to these games.
But the problem is, again, the speed of change, while it can be very rapid, sometimes it's not as rapid as we think it is. And so, I would point to a little company called Ballard Power, which is a fuel cell maker, they trade on Nasdaq and trade in Canada. And about 20 years ago, I remember this, I was watching it, 20 years ago during the tech bubble, it went from about $10/share to $200/share, in like six months or something like that. 20-bagger, that's great. Fuel cells power electric vehicles, but they do so using hydrogen in, you know, split the hydrogen into protons and electrons, make the electrons flow along a path, we call the flow of electrons electricity, drives the car, reassembles out the tailpipe, turns into water vapor. Good. Cool. Everyone was really excited about this, this is the future, right, it almost sounds like Nikola Motors, because Nikola, you know, they are big on hydrogen. This is 20 years ago, Emily.
And I just sat back watching in horror as the stock went from, like, $10 to $200 and listening to friends of mine who were telling me how much money they were making and I'm stuck in stodgy steel mills and bank stocks, but that's another story. And they're telling me how much money they're making, and I'm just sitting there going, where is the infrastructure? Because if I want to put gas in my car, I can probably find a gas station pretty quick; I want to put hydrogen in my fuel cell vehicle, this could be really hard for me to find. And we're sitting here 20 years later with the electric -- I would argue that the electric vehicle revolution is upon us now. But we're no nearer to fuel cell vehicles than we were 20 years ago, because, again, what I say the expectations have changed, tends to be more enthusiastic than the change.
And I will fully cop to being, I'm very much a value investing kind of guy, I'm a cash flow kind of guy. You know this, but maybe some of the listeners don't. And so, that these kind of things, you know, they take more time than we think, and in the meantime, you get the cash flows out of the business today, I guess Benjamin Graham would probably call them cigar butts or Warren Buffett would call them cigar butts, we're not quite with a cigar butt with GameStop, there's more upside with GameStop, I think.
But I think your possibility of this being the last physical console, I think, is real, but then, like I said, we're dating, we're not marrying. I have no intention of being in GameStop in seven years for the PS6, so.
Flippen: That makes complete sense. And selfishly, as a somewhat casual gamer myself, I'm actually hoping that that day doesn't come as soon as [laughs] some people may expect, because the idea of paying a subscription for my games, adding it on to all of the other subscriptions I have in my life, just sounds like a headache. But alas! We'll wait and see.
So, you've answered my questions about the consoles, about the fact that we're dating this company, we're not necessarily marrying this company, what else is there to your thesis on GameStop, is there anything else?
Gillies: There is. So, I'm just going to stroll up to, well, basically the three counter-arguments. Because one of my favorite quotes is from Mark Twain, and I'm probably going to mangle it, but I'm desperately looking on my other screen for it here. So, this is one of my all-time favorite quotes, "It ain't what you don't know that gets you in trouble, it's what you know for sure that just ain't so." So, I've hit the next Blockbuster theme a number of times. There's a reason for that. Everybody knows, right, everybody knows that GameStop is doomed, this has been a story for years going back to, like I said, 2009 when I first started looking at it, late-2009. GameStop is destined to be the next Blockbuster.
Blockbuster, of course, was disintermediated by some little company called Netflix, that started sending DVDs through the mail, it's not entirely the full story, but that's the popular story. And I think we as humans, we like simple stories, right, we like simple explanations, we don't do nuance very well a lot of the time. And so, Netflix kills Blockbuster. And people probably, reasonably look at GameStop and say, Sony and Microsoft are going to do exactly what you've said, Emily, which is a cloud-based only, subscription-based only, cut out the middleman. You know, they don't have to make physical games, they don't have to give away physical media, and so, you know, GameStop will die. Let's sell our shares now and get out. It's one of those things that everybody knows. And my argument is simply, that just ain't so.
Because everybody knows GameStop was going to go down, in my opinion, nobody was looking. And all I did was go and look. So, I'm going to hit the next Blockbuster head-on here, if that's OK for you.
Blockbuster files for bankruptcy in September of 2010. At the time, that's about halfway through their fiscal year, at the time they had burned close to $100 million that year in free cash flow. Do we call it free cash flow when we burn it? I've never figured that out. Anyway, they burned $100 million -- $98 million, but who's counting -- in the first half of their fiscal year. In their last balance sheet before they file bankruptcy has about $64 million on it. So, if you're burning at a $100 million clip in half-a-year, you are going to run out of money, but it gets better. At the time, they had almost $1 billion of debt on their balance sheet as well to offset that $64 million in cash. Of that $1 billion in debt, $300 million, or almost $1 billion, $300 million is at 9%. That's the cheap stuff. $675 million is at 11.75% that they issued at a 6% discount. So, in other words, I'm going to sell debt -- for every dollar in debt I sell to you, Emily, you only pay $0.94. And there was a mandatory repayment, one-thirtieth of that amount every quarter until the final. And you had to pay the mandatory repayment. You know, I've looked at the stuff. That mandatory repayment was at a 6% premium.
Flippen: That's just crazy.
Gillies: Yeah, well, what it is, it's effectively 16.5% debt, or 16.2% or whatever. If you actually work out the cash payments. So, the coupon was 11.75%, but between the discount and the mandatory repayment is at a premium. That is vulture financing. The last week of September of 2010. Blockbuster was on the hook to pay that quarter's interest, plus that quarter's one-thirtieth of that vulture debt that they have to repay. So, they had about $42 million cash payment facing them in the face. Now, assuming they hadn't burned any cash in the third quarter of that fiscal year, when again, they burned about $50 million on average the first two quarters, but assuming they did nothing. Remember, at the start of the quarter they had $64 million cash on the balance sheet, they owed two-thirds of what little cash they had, assuming they were able to stanch the bleeding and go free cash flow neutral that quarter, they were still paying two-thirds of it. And they ran it for a week until that payment was due. They ran this company into the ground. That's a Blockbuster story.
Let's look at the GameStop story. And this is the third piece of the thesis that I put forward when I recommended it and when I talked a little bit about on our Fool IQ. So, the first two pieces were the console cycle, the second is the digital realities. Change happens a lot slower than people sometimes think it does. The third piece is financial stress. GameStop is nowhere near the financial stress that Blockbuster was. And Blockbuster was bleeding profusely, and they still ran it right to the end.
GameStop, as of the most recent balance sheet, $735 million in cash, $472 million in debt. So, yes, more cash than debt ...
Flippen: Is that including their leases or is that just long-term debt?
Gillies: I don't count leases because you can get out of leases, because the dirty little secret is, you can break a lease. No, I don't count leases, because everyone goes sideways, some people will argue that operating leases are equivalent to debt, they're not. In the worst-case scenario, in bankruptcy, so let's say I go bankrupt, I'm leasing a warehouse from you for, for example, five years. Well, you know, in bankruptcy court, you can come after me for 15 months, and you're probably going to get $0.30 on the $1. But that's a worst-case scenario. GameStop is not going bankrupt for the simple reason that A. $735 million in cash against $472 million in debt. So, when I was talking about this back in June, we had a couple of people on Twitter who were paying attention on Motley Fool Live, when I said, hey, it's about $4, you know, the net cash on the balance sheet is about $4/share. I mean, you know, that buys you a lot of leeway, there's not a lot that can -- it's real hard for a company to go bankrupt -- oh, and the other piece of the puzzle here, Emily, is, they are cash flow positive. So, they're producing cash and they have $4/share in net cash. So, they have more cash than debt on the balance sheet, it's really, really hard for a company with more cash than debt, with positive free cash flow to go into bankruptcy. I don't think it's impossible, but I've certainly never heard of that.
Subsequent to the last quarter, they've raised, it's funny you brought up leases, because they've actually sold and leased back a couple of their facilities. So, their Canadian and their Australian headquarters buildings, they sold and leased back for $44 million. So, there's more cash, it's out of there, no problem.
They've recently sold a corporate aircraft. Why did GameStop need a corporate aircraft? A little beyond me, but it's gone now.
Flippen: [laughs] Maybe that speaks to past management, if anything.
Gillies: And that is an excellent point. Past management. The management track record has not been great here. But here's why it's different. So, there was a long-term CEO. So, this originally years ago spun-out of Barnes & Noble, and the long-term CEO wasn't on the board, then they brought another guy in, and he was a long-term CEO going back to '90s. He had some health issues, ultimately resulting in his resignation and his unfortunate, untimely demise. He was the guy that started a diversification strategy; that was pretty much doomed from the start. But he bought a bunch of things that they called tech brands. So, they had the AT&T selling AT&T DirecTV, and they owned Cricket Mobile and they bought a bunch of these things. They sold them all, is the end of the story. They said, yeah, you know what, this didn't work, they're out. So, that's good.
So that one CEO passed away, unfortunately, they brought in a guy on an interim basis, who then hired -- sorry, they brought the first guy back in, then they hired this new guy from within. And he had a cup of coffee and was gone in three months. I'm not sure if he was pushed, I'm not sure if he left of his volition, he just cracked up and said, I'm out, but he's gone. And so, they lost a year, frankly, that was a critical time for them. But they lost a year under this guy, you know, he's there, then he's gone.
Then they did a more comprehensive CEO search and they settled on George Sherman, the gentleman who's now in charge, he's been there for about a year. And he came in, and he's a no BS kind of guy. And he's like, OK, here's our plan. The dividend, they were paying a fat dividend, OK, credit for -- dividend is gone, we're husbanding cash, we're building up our balance sheet, we're going to improve our working capital turns, our inventory turns, we are done being everyone's patsy. And that was about a year ago he came in.
We haven't even talked about the activist story here yet. But so, the management has changed over, and he cleaned the executive suite out. He took, basically, anyone who had a C-level job before that, they're gone, his people are in. One unified vision.
And what I've said before to some other people, what if -- let's go with another doomed company, OK -- instead of Blockbuster, what if GameStop -- and remember, I'm pounding the drum at, like, $4, $5 here, now it's at $13, $14, so I'm less enthused. But what if, instead of being the next Blockbuster, what if GameStop is the next Best Buy. You might know Best Buy is the company known as Amazon's warehouse, right, Amazon's showroom ...
Flippen: Another ex-boyfriend, let me put it that way, the one that got away, maybe is the good word to describe my relationship with Best Buy.
Gillies: Okay. That is a great analogy, because you, I think already know that over the last decade, Best Buy has been a 10-bagger. And everybody knows -- we're going back to that "everybody knows something" analogy, right -- everybody knows, it's Amazon showroom, why would you want to buy Best Buy? Well, if you bought Best Buy in its doldrums in 2010 or 2011, I, again, don't have the chart up, you were buying it at $12, and last I saw, it was about $120, so. Oh, and you got a dividend over the way too, I believe. So, you know, this is one of those things where everybody knows something that just wasn't true. New management came in, had a vision.
And so, but all of this, my thesis was, look, this is a company with basically $4-and-change cash on the balance sheet, net cash, so net of their debt. You asked about leases earlier, their average lease, Emily, is only two years. So, what they do is they let the leases run out, and if your store is not profitable, they kill the stores. They're in the middle of a consolidation. The city where I live here in Southwestern Ontario, about 45 minutes to an hour outside of Toronto, five years ago there were three GameStops, today there's one. There were two stand-alone stores and one in a local mall. The local mall store closed, it was right beside Sears in the local mall, so whoop-de-doo there, but they closed that store along with the other two stores, the stand-alones. And they reopened in a flagship location in the mall with at least double the floor space, it's big, it's clean, it's well-lit, it's dead-center of the mall now as opposed to being stuck off by the failed Sears. They've expanded, and so obviously, they signed a new lease when they did that about two years ago. But they've consolidated the three stores in town to one. It's bigger, it's brighter, more selection. And I guarantee you, that one store costs GameStop less than running the three stores they previously had here in town in terms of the sum of their rent and the number of personnel they have to do, and utilities and whatever, whatever.
And this is part of the new CEOs deliberate plan, we are reducing our stores, because they know that when they closed down a store, they capture at least 40% of the revenue and profits from the store they close, if the store had profit, they capture +40% of that, minimum, at the store they leave open in the geography. You know, people say, well, they're closing stores. That's not necessarily a sign of failure, that could be a sign of good management and prudent strategy.
Flippen: Yeah, 5,000 stores would always be too much, in my mind, for GameStop, even in its heyday. It's a large number of stores, it's a huge retail footprint that, I would agree with you, I think, has historically, unnecessarily dragged them down in a way that didn't necessarily need to. So, what I'm hearing you say is, is there's, kind of, like a three-pronged approach or approach back in September 2019, that included historically lucrative console cycle, a business that, regardless of the console cycle has always generated free cash flow, has a large amount of cash, negative net debt, excluding ...
Gillies: Nowhere near as financially stressed as Blockbuster ever was.
Flippen: Exactly. So, so not immediately headed toward any, sort of, bankruptcy or liquidation. And then also with a management team that seem to be taking a new strategy that includes shrinking its retail footprint, presuming that the new management team is married to this company, not dating it, historically, management at GameStop has maybe just been on a couple of quick dates, assuming that this management team is married to GameStop -- is this analogy boring yet? [laughs] I don't know -- assuming that they're married to the company, what is their plan, what's their 10-year plan for the company? How is management going to turn this ship around, even if you're not invested in it when it happens? Do they have a plan?
Gillies: Well, I'm sure they have a plan. So far, it's been reducing -- basically, it's cleaning up working capital, reducing the cost structure of the business, pulling a lot of cost out of the business, which they've been successfully doing. You know, cleaning up the balance sheet in terms of the debt-to-equity. So, there's two. So, one, cleaning up the working capital and improving the inventory turns on the balance sheet; so that's one form of improvement. Another one is just setting up the debt structure for basically, for a long life kind of thing. So, they've largely turned that.
The big thing they have to do, though is, let's assume disintermediation is coming, because it's coming. But who knows that better than them? Like, we know it, I mean, it's not like they've just like, you know, you're going to call them up and go, hey, George, you're going to get disintermediated. He's going to go, what, can you spell that? Like, no, they know, OK. And so, the prior management, their plan, I mentioned earlier, was diversification; steal from Peter Lynch, OK. They went into adjacent business models that they frankly didn't understand, got their lunch handed to them, and frankly, were lucky to get out with as much cash to offload the business as they did.
The big thing, and I think they're already doing it, and it's responsible for some of the recent stock price increase. The big thing they have to do is figure out a way to monetize some of the digital game sales, they want to get a piece of that. So, they have been over time -- they have various digital offerings and digital programs that they always tout, but they really haven't moved the needle very much, it's still been new game sales, used game sales, new console sales. But this may have changed, we're not sure yet, but we may have seen the first salvo. This is something that I had no potential to forecast at all. But when you're buying a stock that was so beaten down and killed as GameStop was at $4 and $5, when something like this happens, it can only be accretive.
And so, they signed a deal recently with Microsoft. And part of the deal, it's a new, basically, inventory management and the way we manage our business and our stores, [laughs] we're all going to be using Microsoft Surfaces and we're all going to -- and we're going to be using Microsoft Outlook for our email server or whatnot, you know, stuff you're like ...
Flippen: [laughs] They weren't already?
Gillies: Well, yeah, you're kind of like, well, how does this benefit? Like, what do we care? I mean, it just sounds like you're buying crap from Microsoft. But of course, Microsoft is the maker of the Microsoft Xbox, so one of the big two consoles; apologies to Nintendo, but we tend to focus on the big two, the Xbox, the PlayStation. And they, of course, want a relationship with the GameStops of the world to continue pushing the game out. And GameStop in return, on those consoles without the physical media, so the digital-only drive, GameStop is now sharing in the revenues. So, you sell that through, you sell a diskless console, the lower-priced console from a GameStop, and of course you have to sign up for those games, GameStop is now going to be getting a piece of that revenue of the digital revenue that Microsoft is bringing. That's the first step in transitioning GameStop to more of the digital world getting away from physical media. And that is, it's small, we don't yet have the details, we might get some more details in Microsoft's next earnings report, probably not, GameStop is pretty small potatoes for them. I guarantee you, this will be the first question, probably the second or third question asked on the next GameStop conference call. And that is the interesting piece.
Because again, I was just pointing to a cigar butt and going, no, I think there's some value here, more than we think there is. Now, it's like, oh, here's the potential growth avenue. Well, that's interesting. So, does that answer your question?
Flippen: It definitely does. I have a couple more questions; I apologize to you, because I'm making you talk a lot and I still have more questions left, so we may run long here, but it --
Gillies: Because I hate talking a lot. [laughs]
Flippen: [laughs] It's worth talking about. And one of the things I want to talk about is the recent -- I'm not sure if I want to call them activist investors, I'm not sure activists is the word ...
Gillies: Call them activists.
Flippen: Sure, let's call them activist investors. Basically, I'm a big Chewy fan. Everybody who is listening right now is already aware of that. My cat is sitting on my keyboard right now. But Chewy has a Co-Founder who's no longer involved with the company, who actually, after he left the company, started his own fund, his name is Ryan Cohen. And recently, Ryan Cohen's fund recently invested in GameStop, took a large stake in the company. And sources were claiming that they wanted to make it a competitor to the likes of Amazon. I'm not sure I understand the idea of competing with Amazon in an area where Amazon doesn't really compete right now, which is games, but sure, that's what they said.
Does Cohen's presence, does it change anything for you in this thesis?
Gillies: It doesn't. In that, remember, this was a value cigar butt thesis that only improves when good things, but unexpected things happen; I mentioned the Microsoft deal. So, this is not the first activist to come in rattling chains, rattling for change. So, we have, and this is another interesting piece of the GameStop. So, first of all, we had a couple of activists who fought these guys or they fought prior management for a while. That would be a couple of -- they signed a 13D group, but it was a couple of activists called Hestia Capital and Permit Capital.
And they're long-term, long suffering shareholders. They launched a bid for the company two years ago, the company promised, oh, we'll listen to you, no problem, we'll put -- so, they signed a one-year standstill agreement. And then, you know, the previous management promptly forgot about them, they probably had another year to sit and stew. So, this year, they came around, they were loaded for bear, the stock price is way down, it would have been hard to lose the proxy fight, they didn't.
So, Hestia and Permit, they have 7% ownership, they get a couple of seats on the Board, that's the first one. Second of all, you remember that wonderful book and even more wonderful movie The Big Short?
Flippen: Of course.
Gillies: Okay. Remember Michael Burry who made bank on The Big Short? About a year ago he, The Big Short, of course, was shorting the U.S. housing market in '08-'09. Michael Burry, his kids hedge fund, has purchased 5.3% of GameStop, and he has very publicly agitated for more share repurchases. By the way, GameStop has taken down about a third of their own shares in the last year, yes, a third. But he was advocating for that, as well as, bringing in new management. Donald Foss, who is a billionaire, he's the Founder and former CEO of subprime auto finance company, Credit Acceptance Corp., he's bought 5.4%, he's been a silent partner. But you mentioned Ryan Cohen taking a small stake, 10%, and driving, you know, more conversation about wanting to take on Amazon.
And one thing here, taking on Amazon is absurd, right? I mean, everybody knows it's absurd.
Flippen: I just don't know, you know, how they would try to compete with Amazon? To me, it feels like their competitors are, you know, to the extent, they don't have agreements with Microsoft, you mentioned Sony, these are the people I think they should be competing with, right, not Amazon.
Gillies: Well, I have no idea what's in Ryan Cohen's head as to how he thinks he can do this, but A., he's put his money where his mouth is, and B., this is a guy who's taken on Amazon before and won. He founds Chewy, he sells it to PetSmart. I mean, you know, you've got pets, I've got pets, pretty much anything my pets get either. If I'm buying, I'm ordering online; if my partner is buying, she's going to Walmart. But this is like, I don't know I'd be thinking, I'd be just like, oh, the dog needs this toy, whatever. Okay. Amazon Prime. Boom! Done.
Chewy, he sells it for $3.5 billion to PetSmart. PetSmart subsequently spun it out a number of years later. Last I checked, it had a $20 billion handle on it, I think. So, there's a man that created something. Yes, he didn't create Amazon, per se, but he took on Amazon in a very specific niche and won. So, when that guy comes calling, I'm going to take his call.
So, we got Ryan Cohen and his group of 10%, you've got Donald Foss with 5.4%. You've got Hestia and Permit with 7%. You've got Scion Asset Management with 5.3%. Last week we had yet another major investment group, Senvest Management, they've come in, I believe, they have about another 5.5%. And one of the other reasons why GameStop has gone from $4 and $5 in June to $13, $14 today is because, the number of shares short here, OK -- imagine you're Michael Burry or Ryan Cohen, you're lending out your shares to borrow for the shorts to then turn around, you're probably charging a few percentage points or maybe more than a few for the privilege of shorting this thing. Last I checked, which was about two weeks ago, last I checked, there were more shares of GameStop short than there were shares of GameStop. In other words, more than a 100% of the shares of GameStop available were shortened. That's dangerous if you're short, [laughs] because if some good news comes along, like say, Ryan Cohen announcing his presence, like say, a Microsoft deal being signed, like say, maybe decent results when Q4 in the fiscal year we start seeing new console sales, there could be a rush to buy your short position back. We call this a short squeeze, and I think you've been seeing some of that recently.
But the number of activists, engaged investors on one side is now north of 30%, I believe; and a lot of these other shares are held by Vanguard or Fidelity or BlackRock in probably index strategies. So, they don't particularly care about GameStop's fate, they're just owning it because it's a piece of an index. But there's a lot of people who really care about GameStop's fate here and about their own money. And if you're short, if you believe this is the next Blockbuster, you are lining up some pretty dangerous people on the other side in my opinion.
Flippen: Especially when your short as a percentage of holdings is so ridiculously high, when people try to cover their short positions, you know, they can't do it a lot of times and you have unlimited losses when you short a company. So, not to get on a stance here, but it's a good reminder of why we typically don't choose to short companies at The Fool, we choose to invest in good ones.
I want to close up here with just a last question, we mentioned at the offset that GameStop has risen over 200% since that September 2019 call, and a number of others, [laughs] a handful of percent since you recommended it in Hidden Gems Canada in those services.
Gillies: A handful, like, 45% or something like that. [laughs]
Flippen: A large amount, [laughs] a fair amount, let's say it that way.
Gillies: A fair amount; not bad for a month.
Flippen: For any of our listeners today, would you say that GameStop is still a "buy" today?
Gillies: It is a cautious "buy" in my opinion, because my other opinion with this company, given all the activists and given Ryan Cohen's rattling the cage, shall we say, I don't think -- because, I mean, you were talking earlier about, you know, couldn't the next console cycle be the last? And I actually, because I want to see, I think that could happen or I think we have to assume that could happen, because you know, if it doesn't happen, then it's this gravy for shareholders. But you know, assume the worst, and if you get better than the worst, we're happy, right.
I don't think GameStop as a publicly traded entity is going to exist two years from now, I think it will go somewhere, I think it will be bought. I think either Cohen will take it private or a group will take it private. Because, again, more cash than debt. If they demonstrate they can do a lot of cash through the first, say, year or a year-and-a-bit of the console cycle, the debt might be irrelevant, the debt might just be gone entirely. Well, it's already kind of irrelevant, because we have more cash than debt, but if you're generating a lot of cash. You know, private equity will see that or other entities will see that, and if they have decent strategies, particularly one in terms of by Cohen or some of the other people here, they could -- they'll say we'll take this thing trading, what, 4X free cash flow. Yeah, it's elevated free cash flow, but we'll take that and harvest the cash for ourselves. So, I actually don't think it's going to be around much longer.
Maybe I'm wrong, and it wouldn't be the first time, but that's kind of -- I think their success might come similar to what happened with Chewy, not that it wasn't a success, but he sold Chewy for $3.5 billion, today it's at $20 billion. You know, that great trade for PetSmart. But a lot of that value appreciation came away from the public eye. And I kind of think that might happen here. I hope that answered the question.
Flippen: It does, and I'm excited to see what happens with GameStop in the future. We might have to have you for a victory lap if it gets --
Gillies: Well, have I converted you, I mean?
Flippen: You know, I might send GameStop a text. You know, maybe I'll just feel out how things are, you know, see if they respond to me back. We'll see. I don't want to go crawling back quite yet, but I also -- your analogy to Best Buy ...
Gillies: [laughs] Never go crawling back.
Flippen: [laughs] Your analogy to Best Buy did hit at my heartstrings a little bit, because that's a company that I owned at a pretty decent cost basis, but I actually sold out of against my better thoughts because of the very pervasive belief that Best Buy was going to be killed by other online retailers, and it's really carved out a strong niche for itself, so I'm excited to see if the same ends up being true for GameStop regardless of whether or not -- you know, we talk about dating, not marrying, I'm excited to see what will happen to the person or companies that choose to marry GameStop, it's an interesting story one way or the other.
Well, Jim, thank you so much for joining me and dealing with my terrible analogies for the last 50 minutes or so. [laughs]
Gillies: No, that was fun; I enjoyed that.
Flippen: Yes, definitely. And listeners, that does it for this episode of Industry Focus. If you have any questions or you just want to reach out, you can always shoot us an email at [email protected] or tweet at us @MFIndustryFocus.
As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don't buy or sell anything based solely on what you hear.
Thanks to Tim Sparks for his work behind the screen today. For Jim Gillies, I'm Emily Flippen, thanks for listening and Fool on!
