Video game retailer GameStop (GME 0.21%) is in a pickle. The arrival of new gaming consoles from Sony and Microsoft is supposed to save GameStop's bacon, but there are many reasons to believe that the PS5 and Xbox Series X won't be enough. The company's business plan is deeply flawed, and the stock is poised to destroy shareholder value for years to come.
That could change if GameStop decides to adopt a brand-new strategy. I might rethink my thumbs-down rating on this stock if the company accepts the changes proposed by a group of activist investors, for example. Until then, I would not touch this stock with a 10-foot Energy Sword.
Activist shareholders coming in hot
In November, activist shareholder group RC Ventures disclosed a 9.98% ownership stake in GameStop. The group also proposed some changes to how the company should run its business.
GameStop should largely abandon its network of physical retail stores as quickly as possible, shifting its focus to e-commerce sales and digital gaming services instead. This way, the company can benefit from a valuable brand name and stay relevant in a rapidly changing gaming industry.
"Regrettably, Mr. Sherman appears committed to a 20th-century focus on physical stores and walk-in sales despite the transition to an always-on digital world," said RC Ventures in an open letter to GameStop's board of directors. "The continuation of the pandemic is only accelerating this transition and, in turn, requiring businesses to take bold steps to compete."
This could become a takeover attempt
RC Ventures has increased its GameStop ownership to 12.9%, according to SEC filings from Dec. 21. Stepping across the 10% threshold is often a sign that activist investors are preparing for an outright takeover attempt in order to implement their radically different management ideas. GameStop has not yet implemented takeover defenses such as a second class of stock with massive voting powers, a classified board of directors that cannot be replaced in a single shareholder vote, or a so-called poison pill that can stop a hostile takeover attempt in its tracks by suddenly diluting the stock.
GameStop could still implement some or all of these takeover defenses, but the company likes to state that its governance policies are stronger because it has no such defenses in place. I would be surprised to see GameStop abandon that argument overnight, even if it leaves the company open to an active takeover attempt.
Hold your horses
RC Ventures is trying to convince GameStop's management to try some new strategies built around digital sales and the exploration of online gaming services under the well-known GameStop brand. The large and growing ownership stake may provide enough shareholder pressure to make this happen. RC Ventures might even escalate to a full-fledged takeover attempt.
This activist investor happens to know what it is talking about. "RC" refers to Ryan Cohen, the co-founder and former CEO of online pet toys company Chewy (CHWY 4.19%). Chewy's share prices have nearly quadrupled in 2020, supported by 45% revenue growth in the recently reported third quarter. This company knows how to run an e-commerce business. Cohen has invested $76 million of his own funds because he thinks that GameStop can achieve similar results under a refreshed strategy.
That being said, Cohen and RC Ventures may still fail to change GameStop's fundamental business strategy. I certainly don't expect the company to come up with a sustainable growth plan on its own at this point. That's why I need to see firm evidence that GameStop is getting rid of its obsolete focus on physical stores before I'll even consider hitting the "buy" button on this stock.