GameStop: More Than Meets The Eye

In my previous article, which you can find here, I outlined how one can fall into value traps when searching for potential value investments. There’s been a few sectors over the course of the past few months where value traps are hidden, namely oil & gas, oil refinery, and retail (global and domestic), to name a few. After going over the value play I found in the oil and gas industry in the last article, I’m going to take this time to explain the value play in the Retail industry. Yep, that’s right. The dangerous and toxic wasteland where companies go to die at the mercy of Amazon’s Prime Delivery service. With stores like Macy’s closing hundreds of stores, and with house-hold names such as Sears losing nearly 90% of their share value over the course of the last five years, its no wonder many investors are steering clear of the entire industry altogether.

One of these companies that kept popping up on my screener was GameStop. GameStop (GME), like many millennials know, is a multichannel video game retailer. It sells new and pre-owned video game hardware, physical and digital video game software, accessories, as well as PC entertainment software, new and pre-owned mobile and consumer electronics products. What perked my interest in this company right away was its fall in price over the last year. Over the course of the last year, GME’s share price fell 31%, and over the last five years has dropped 13%. I like looking at companies that are approaching not only a 1-year low, but 3 or 5-year lows. Right away this goes against the main street thinking on Wall Street, where everyone buys high and sells low. Take a look at the flow of money between the best and worst mutual funds in the US. When mutual funds are performing extremely well, money begins flowing into them, thereby buying when its high. Then, once the fund starts performing poorly, people rush to take their money out of the fund, thus selling when its low. The problem is, people cannot help themselves to buy high and sell low.

Balance Sheet

GameStop is the perfect example of investors both institutionally and retail that are pouring out of their holdings in GME due to numerous events. Let’s dive into the numbers of GME to see how much value is left. Right off the bat, GME is trading below book value, 0.94 times. GME’s EBITDA per share is $7.80, making its EBITDA/share higher than 98% of the companies in its industry. Another key metric that I look for in a company is its Enterprise Value, or in other words, the price that is needed for someone to takeover the business. I prefer Enterprise Value over Market Cap because its market cap plus debt, minus total cash. GME has increased its Enterprise Value over the last year by $1.3B, from $2.6B in 2015, to $3.9B in 2016.

Free Cash Flow

Moving on to free cash flow, GME increased its FCF per share by close to $3.00 per share since 2015. GME sits at $4.28 per share in free cash flow currently. Due to these free cash flow numbers, GME is trading at a mere 4.88 times free cash flow. That number is good enough to beat 94% of the companies in the industry. Now, when looking at price to FCF, one can begin to see why GME slid 31% over the last year. Back in 2015, GME was trading at nearly 13 times free cash flow. At that point, GME doesn’t look like such a good investment. Yet, with the average Price to FCF for the industry at 18.43, 4.88 times FCF makes GME one of the best in the industry.

Book Value

Tangible Book Value per Share for GME has increased over the last three years while the share price declined over the same time. This coincidence always makes me interested in a company, mainly because it makes me wonder if A) Main street is missing something within the company, B) The company has assets on the books that haven’t been accounted for by the public and the analysts, or C) The entire industry is bringing them down and the underlying business is still solid. Since 2012-13, GME has maintained a relatively stable Tangible Book Value per Share of around $5.00. Last year, GME’s Tangible Book Value per Share was $2.65. However, after last earnings report, GME came in with $5.10 TBV per Share, a substantial improvement.

Debt Issues

Debt is something that I try to steer clear from. Well, that’s not 100% true. Debt isn’t always bad, in fact, if the company is smart and management is talented, they can use that leverage to help grow the business incredibly fast. However, if a company incurs too much debt relative to its cash, it can quickly become under water, and if products don’t ship and sales slip, it starts a snowball effect downward until the company cannot sustain the leverage ratios. GameStop’s Cash to Debt ratio is 0.44, which is lower than 52% of the companies in the industry. That 52% number sounds better than it actually is.

The industry mean for Cash to Debt is 0.93. When compared to 0.44 for GME, you can start to see the concerning aspect about GME’s debt. To get a better picture of the overall debt of the company, I like to use Total Debt per Share. Before 2015, GME maintained extremely low levels of total debt per share. In 2012 and 2013 GME accounted for zero total debt per share. GME started acquiring debt in 2014 at the cost of $0.03 per share. This ramped up significantly in 2015 when GME reported Debt per Share of $3.30. Currently, GME sits at $7.85. So, what does GME plan to do with this debt? Can it sustain the amounts of leverage? We need to dig into the balance sheets to find out.

Hidden Assets

I use the term ‘hidden’, but these assets aren’t hidden, they’re written right in the balance sheet. I use ‘hidden’ because unless one takes the time to read the fine print of the balance sheet, an investor could easily miss these. This is where GME’s Technology Brands business comes into play. The lower the price goes for GME, the more I think to myself, “I can get a great deal for a video game company, with real estate assets, loads of cash, and investments in Technology, Cricket Wireless, and Simply Mac. There is more to meet the eye with GME.

In 2013, GME acquired Spring Mobile. Using Spring Mobile, GME was able to grow it’s AT&T store presence from 90 stores to 1,403 stores as of January 28, 2017. Spring Mobile is under the Technology Brands which centers around those AT&T stores. This is an asset that hasn’t been properly accounted for on Wall Street, and its a valuable asset at that. For this reason, I am comfortable and confident in paying $19 a share, because GME is moving towards having most of their business be from the Technology Brands, and since Technology Brands is tied to AT&T, it presents a durable, long – lasting potential for profit.

Final Hypothesis

At current levels, GME is a contrarian play with loads of value potential. With investment banks downgrading retailers left and right, and with institutional investors shedding all retail stocks in efforts to please clients, its given contrarian investors like myself an opportunity to scrape for value in the cobwebs of the industry. Trading at 5 times free cash flow, GME is the best ranked company in it’s industry, and the biggest value play.

In terms of Margin of Safety, the entry point for me would be right about now. Anything around the low $20 – $21 range, and if somehow the stock falls below $20, I would be a serious buyer. Plus, one gets to enjoy a nice $1.48 annual dividend just for holding the company. Once the stock hits around $30, I would start to think about taking profits off the table, and if it hits anything above $35, I would be more than happy to liquidate the position entirely, take my profits, and move on to the next value play.

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