2020 BEST IDEA: LONG GAMESTOP (GME)
Happy New Years & hope you have some risk appetite left after your NYE
Crazy, I know, but let’s take a closer look before you start screaming that it won’t exist in 10 years. I know it won’t, and I doubt it gets to 5, but if it does for even 3 years, the stock will be multiples of its current $6 share price
Here’s the 4 year chart.
Not. Pretty.
So where are we now?
Napkin Math:
Market Cap: 396 mm. = $6 * 66 mm.
Cash: 290 mm.
Debt: 436 mm.
Enterprise Value: 542 mm.
Management guided 200-250mm of FCF for this year. Let’s take the midpoint so you’re buying a business that’s valued at ~2xFCF…yep I know it’s trailing just wait
Why does this “mispricing” exist?
Well I’m not entirely sure, but some prime suspects:
An accounting change this year reclassified lease obligations as debt. If you consider their current obligations as debt, the business looks overlevered and fully valued
FCF screens as -200mm because of a timing of cash flows. Management explained this on the last call
General retail sentiment. Barneys. Sears. Toys. RadioShack. Do I need to keep going? Most funds if they sent a holdings list that included GME on it they’d be insta redeemed on sentiment alone.
Inflection Points
Console refresh next year. This year we’re expecting 225 mm FCF and new consols are being released WITH disks next year. Remember this?
That’s what GameStop is going to look like this year when customers wait their brand new Console. I just don’t see how FCF deteriorates further —this is awfully conservative given that the current console cycle is at a trough at the end of an 8 year cycle
Stock Buybacks. The firm purchased 1/3 of the float last quarter AND has another 175mm in notional under the previously authorized buyback. Here’s the latest comments on the last call
Where did they buy back all this stock?
Low 5s. And the stock is at 6 right now. So you have a big buyer of stock ~10% below where the stock is trading right now
Teledyne. Unfamiliar with Teledyne? Read this and this.
The firm held massive loss reserves 69mm vs. just paying out 24,000 in claims. As a result of these held reserves the firm booked a loss and the stock sold off aggressively. The overhang of the malpractice suits loomed large and you’d have been called a fool to invest in the firm.
In 1975 the firm tendered for 20% of the outstanding shares and in 1976 the firm tendered for 20% of what was left outstanding. Take a look at Page 7 on THIS presentation by Leon Cooperman. In just 15 months Teledyne went from 7.875 to 32. 4 BAGGER.
I could go on and on about this, and maybe I will at a later time, but that’s the cliff notes. Happy to talk more offline about this…but on to the point
Teledyne Part 2. TLDR: Dr. Henry Singleton may have shaded results lower by holding reserves in excess of necessity and when panic and pandimunium to get out spread, he tendered for outstanding shares and those that didn’t sell for a small gain experienced extraordinary returns.
Now I KNOW GameStop is a different business and isn’t a conglomerate, BUT…
George Sherman the new CEO started in April. On the June call he announced a review of the business and a cut of the dividend.
Stock went from $7.82 a share to $5 overnight.
On the September call Sherman announced a “non-cash, non-operating goodwill impairment charge of 367 mm”
For those of you that aren’t familiar, this charge doesn’t affect cash flow you’re receiving as an investor. It just decreases Net Income and as result makes EPS decrease (Negative in this case).
In addition this quarter there was also one-time restructuring charges to the tune of 37 mm.
Result? $5.10 pre earnings and 4.35 in 4 days. Hmmm…
Remember the stock buybacks? Those started after this call…
And here’s what’s in the latest 10Q:
What happened last quarter? 6.5 pre and 5.5 post earnings. Same store sales were down 20% as well, but like I said it’s the trough of the console cycle. Everyone knows new systems are coming next year.
More Buybacks? Probably.
Management told you on the last call!
The CEO thinks the stock is trading at a discount and that’s why they buy back stock. How cheap do they think it is?
George is willing to sell the corporate jet to buy back stock; that’s how cheap he thinks it is
Addressing Other Looming Clouds
Default risk. Not much here. GME has 435 mm in bonds outstanding and 290 mm in cash on balance sheet. AND an untapped ‘22 revolver to the tune of 413mm
Last Q4 GME generated 500 mm in FCF and on their Q3 call guided to having 1 Bn+ in liquidity, implying just 300 mm in FCF this quarter. They could bring Net Debt to 0 and have 200 mm left for buybacks
They only have 125 mm left authorized, but that’s another 20 mm of the 65 mm shares outstanding (~31%)
When the debt has sold off meaningfully, they’ve retired it at a discount. I’d expect them to shift from share buybacks to debt retirement if given the opportunity, but the bonds continue to trade at par.
Lease Obligation Risk. I get all the retailers are crippling under severe lease obligations and they just can’t keep up with their bills. Here’s a look at their lease obligations moving forward:
So Q4 of 2020 should see an uptick in cashflow and then the leases roll off nicely. 2022 has 1/4 of the lease obligations that 2019 had. This next console cycle booms and as it moderates the stores roll off at no cost to GME
The Cherry on Top
PE Interest. In January it was reported that Apollo and Sycamore were interested in the firm. The stock was in the 12-14 share price, but remember there was also a lot more outstanding.
Let’s call it $12 a share. 12*100mm shares = ~1.2 Bn. (Let’s EVEN assume net debt of 0). We’re getting an EV that’s conservatively 2x where we are now.
What’s a 1.2 Bn. EV translate in share price now?
~16 dollars a share (thanks share buy backs!)
Why was PE interested? Same reason I am. CASH FLOW.
Short Interest. I’ve never seen this before, but:
That’s right, there’s more shares short, than there are outstanding. Best explanation I’ve read is these shares were shorted and bought back by the firm and never covered
I’d never invest based on short interest, but it’s a decent indicator of sentiment and the 12 days to cover means any unwind would really make the stock run
Anyways, Thanks for reading if you made it this far. Happy to connect via email: deepwatervalue@gmail.com or on twitter: @deepwatervalue
Feel free to send along to anyone you think might enjoy this and looking forward to hearing your thoughts. I’ll be putting more content out as I find interesting situations (oddlot tenders, deepvalue/special situations, SPAC Trades, and whatever else seems interesting)