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GameStop (GME) Part I - How Has Business Been For This Video Game Retailer?

by Alex Mason | Oct 7, 2020 | Companies, Episodes | 0 comments

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Mental Details

Description

  • GameStop has made some waves in recent weeks. After Reddit investors began piling into the stock, the company made headlines because of the stock’s meteoric rise and subsequent crash. What is the nature of the company and what do they do? How has business been for this game retailer?
  • In today's episode we cover the history, business model, and financials of GameStop.

Transcripts:

  • Alex Mason: Today, we're going to talk about a stock. That's been in the news a lot lately. It is a video game retailer. Today. We're going to talk about GameStop I'm Alex Mason, host of Stock Stories. This is the podcast where we decode investing principles by analyzing the business behind the stock, as well as learning about mental models in order to help you become a better investor.
  • [00:00:25] You ready? Let's go.
  • [00:00:54] right. Welcome. Welcome to the show. This is the Stock Stories podcast. My name is Alex Mason, and I am your host and stock storyteller. Thank you so much for joining me today, whether you're a new listener or you've been listening for a while. I really appreciate you listening right now. This very moment you chose to listen to this podcast over so many other things you could be doing.
  • [00:01:21] And I respect that. I appreciate it. And I appreciate you. So I just wanted you to know that upfront today, we're gonna be talking about GameStop. We're going to be talking about another company. Now, this company is actually not in the S&P 500. Part of the goal of this show is to go through. Every single component in the S&P 500, as well as mental models in order to become a better investor, by understanding the businesses, we get a better sense of what the stock and the investment outlook is.
  • [00:01:54] And we can take that knowledge and build wealth for our families and improve our lives. So that's the whole purpose of this podcast right here. So even though this stock that we're going to be talking about today, game stop. Is not an S&P 500. The reason that I'm going to talk about it and I've done research on it is because of you because of your feedback.
  • [00:02:18] And I know it's been discussed on a lot of other investing podcasts, and it's been all over the news for various reasons, but. I try my best, not to get caught up too much on what's going on in the moment in the market. Because a lot of times I just kind of see it as just like a passing fad or, or just as something that is not really going to impact my investing personally that much.
  • [00:02:46] So it's why I don't really discuss current events as much on this show. But, you know, I'm thinking about changing that because sometimes it really is important to discuss. Things that are going on in the news. And I want to help you be informed as well as be informed myself. So it's something that I'm considering incorporating more into the show, but that's probably a story or a topic for another day.
  • [00:03:13] GameStop is something that has been on my mind lately. And I got an email from Eric. And he basically asked me if I would do this episode. And I said, you know what? Yeah, it's been on my mind. Um, I'll do some research and let's just go for it. So, Eric, thank you so much for email and thanks for listening to the show.
  • [00:03:33] I appreciate that. And I appreciate you reaching out. If you want to reach me for any reason, you can email me at alex@stockstoriespodcast.com or on social media at stock storyteller. So today we are going to talk about GameStop and without further ado, let's just get into it.
  • [00:04:04] All right. So today we're going to be talking about game, stop, ticker symbol, G M E. And the way that these episodes are structured, if you're unfamiliar is first, we go through the history of the business. We try to understand the context. Why is this business exist? Where did it come from in the first place?
  • [00:04:23] And from that foundation, we go into the business overview. We try to understand at a fundamental level, what is the business model that this company is using? Uh, in its course of business and why do investors succeed or fail with this business based on that business model. So that's next. And then we move on to financials.
  • [00:04:45] Of course the numbers have to work, right? The companies have to be making a profit, ideally a growing profit over time. And then lastly, we talk about the synthesis and valuation and trying to put everything that we've learned together in order to make. Our own decision as investors. So that's the structure of this episode and every company based episode that we do on the show.
  • [00:05:09] So first let's get into the history of GameStop. Now, GameStop was initially founded actually as a different business. As many of these companies often are, you know, a company will start in one form and change forms again, then change forms again. And if you stuck with me fully through all three parts of the Keuirg Dr.
  • [00:05:28] Pepper series, you know that very well and GameStop wasn't quite as complicated as far as its history, a little bit easier to research in that way, but it did have a few changes. And it started as this business called Babbage's and it was founded in 1984 in Dallas, Texas by two Harvard business school, classmates, James McCurry, and Gary Cuson.
  • [00:05:53] And they were together to found this company called Babbage's and. That's kind of like an interesting name, right? Like where did they get that from? Well, they named it after an English inventor, whose name was Charles Babbage. And he first conceived of the digital programmable computer. So pretty interesting stuff.
  • [00:06:12] They wanted to pay homage to, to him. And so what did they do? They wanted to sell software. So that's what they did. They sold various types of software, but over time, they began to focus more and more on video game sales, for example, for the Atari 2,600 and then Nintendo game systems, as well as other systems.
  • [00:06:37] And that was their niche. Remember at this time in the early to mid eighties, video games were really just. Exploding in popularity. And you had our arcades, you had the emergence of these household game systems that were beginning to come out. I mean, just the Nintendo was, was huge and the Atari was huge.
  • [00:06:59] And so they wanted to sell software for these specific products that were booming. So they did that. And then just two or actually it was four years later in 1988, they went public. And then in a few years after that, they merged with another company, um, a Minnesota based company called software, et cetera.
  • [00:07:20] To become what was known as Neo star retail group. I just love these like super corporate-y sounding names. Like you have no idea what the business is about by the name. Right? Neo star retail group. Sorry, that just kind of cracks me up anyway. The two subsidiaries. They basically operated separately, but when time moved on and we got into the 1990s, the companies ended up merging their operations because sales were actually declining around this time.
  • [00:07:53] So the business had a bit of a rough patch, but things were about to change. So the business actually got bought out by a man named Leonard Riggio in 1996. And the reason this is interesting is because he was actually the founder of Barnes & noble. So you might be familiar with Barnes and noble booksellers.
  • [00:08:15] It's still a business that's around today. Although the business has definitely changed radically. Since the days of the nineties, but Leonard thought that he would want to own this business. So he bought it for $58 million and then things kind of kept moving along. The business, got reorganized yet again, and this is where the game stop brand was born in the year 2000.
  • [00:08:41] And then they focus at this point exclusively on selling video games. And then of course, video game related merchandise. So this was when GameStop really became a thing. And the business focus just on video games, not on other types of software, because by then there were so many other. Software sellers out there and all these different niches and they decided to focus just on the games.
  • [00:09:09] So they've launched this program that was kind of unique at the time in the industry. And this was the game stop buy, sell trade program. So you could buy new games from them. You could buy used games from them. You could sell your games to game stop, or you could trade your games in for another one. And this is really interesting to me because.
  • [00:09:32] It shows that they essentially wanted to create a marketplace for video games on the secondary market, not just the new market. And it's interesting because if you're a gamer, this kind of makes sense. It appeals to you, right? Because once you've beaten a game, you probably won't get that much more enjoyment out of it, unless it's really that good of a game, you kind of just want to move on to the next game.
  • [00:09:57] So it might make sense to trade it in for another game that you want. Or you could sell it and get some cash and why not sell it at the place that you bought the game it's familiar to you, you already know that you can get some money and it just makes more sense. Now on the other side of the equation, Let's think about this from the corporate perspective, if you're a game stop, this makes sense too, because you can expand your market and you can cater to more price conscious shoppers who just aren't willing to spend that much money on a new game, but you know what, maybe they would want to spend money on a used game.
  • [00:10:34] And they don't really care if someone's played it before, but they just want to play it. So they had this unique program, which kind of differentiated them from other players in the industry at the time. Now a few years after the game stop brand was born in 2000. They actually had their IPO on the New York stock exchange in the year 2002.
  • [00:10:56] Now, at this point, they were still controlled by Barnes & noble and Barnes & noble owned. Two thirds of the shares. But for all intents and purposes, they might as well have owned all the shares because they had virtually all of the voting rights. But things started to change a couple years after that in 2004, when Barnes and noble, who's stake had come down by this point.
  • [00:11:17] So 59% decided to just distribute their remaining shares of GameStop to Barnes & noble shareholders. Now, this is a really important point and I want to pause here because a lot of times we talk about. Just the single business on this show and how it could have. Change the lives of potential shareholders, but sometimes we have these special situations that can be creators of wealth as well.
  • [00:11:45] And this is one of those situations it's called a stock spinoff. When a stock is spun off from the parent company, it's basically the parent company saying, you know what? We don't really want to be in this business anymore. But this other business over here that we own should still exist. They should just operate independently of us.
  • [00:12:05] And there are a couple of different ways that this can happen. But a common way for this transaction to happen is let's say that you own shares of Barnes and noble. Well for every share of Barnes and noble that you own, you might get something like. Point five or 0.4, or you might get one whole share of the new company, the newly publicly traded listing GameStop, but you'll still keep your Barnes & noble shares.
  • [00:12:30] It's just something extra that you get. And. In true economic terms. You're not really getting something extra because you're just kind of splitting one thing into two halves so to speak. But at the same time, I believe there's a certain psychological component to a spin off because when it becomes its own publicly traded listing on the market wall street takes notice.
  • [00:12:58] And once the business kind of grows legs, It starts to be treated truly independently of the business that spawned it, if that makes sense. So it can be basically, it can be a significant potential wealth generator for investors sometimes not always, but pay very close attention to spinoffs because I think that there can be.
  • [00:13:20] And history backs us up too. If you look at a lot of examples, they can be some big wealth creators in the right circumstances. So GameStop actually was a spinoff of Barnes & noble, which is so interesting to me, something I didn't know before doing my research for this episode. But after that, what happened is.
  • [00:13:41] GameStop kind of went off on its own and started doing their own thing. And they still remain exclusively in the video game niche. Now throughout the two thousands, they began to acquire other businesses within their industry. Most notably there was a business called electronic boutique and they bought that business for $1.4 billion in 2005.
  • [00:14:05] And the reason this was a big acquisition for them was EB was one of their big competitors. And they had an international presence with GameStop didn't really have at the time. So by annexing them into their umbrella, they were able to automatically become the world's biggest video game retailer. So this was a big deal in their, in their turning, in their history.
  • [00:14:28] And it was a big turning point for them. So let's talk about the industry dynamics a little bit around this time. Now video games had increased in popularity throughout the 1990s and in the two thousands and kids and their parents were busy buying new. Console's like the Nintendo 64, the PlayStation two and three, the X-Box et cetera.
  • [00:14:53] And there were lots of new titles that came out on these platforms. And you can learn more about those by checking out the episodes for electronic arts Activision blizzard and take two entertainment. I've covered all three of those companies and those stocks on this show. And I'll link to those in the show notes.
  • [00:15:12] Now the game sales of the industry in general started rising steadily throughout the two thousands. But what's interesting to me is that they actually peaked. In 2008. Now let's talk about this for a second. What could explain this peak in video game sales, why did it peak there and why did they go down?
  • [00:15:32] Well first there was a global recession that when there is a global recession, I mean, people are just not going to spend money on things that they normally would spend on. And that's just a fact, especially things that are considered discretionary items. And this includes games. Now second, the internet was changing.
  • [00:15:52] The internet was getting faster and better, more and more homes had internet around this time. And then the homes that did already had it have internet they were upgrading their speeds. So they were able to get more access to. Websites that were able to do different things. Like, for example, YouTube was invented around this time.
  • [00:16:13] Google really came into its own around this time. So these were revolutionary websites that still influence the internet period today and the culture at the global culture at large. And. Because of this, it opened up the ability for people to play games for free off of consoles and in their browsers, or even on their phones.
  • [00:16:36] Now, mobile gaming was still very much in its infancy around this time, but phone technology was getting better and better by the year. So we have these different forces that kind of took the wind out of the sails. So to speak of video game sales and 2008 was the peak and actually. Industry-wide sales have not recovered since 2008 now GameStop, they.
  • [00:17:02] Weren't just sitting around seeing these trends and not doing anything. Thankfully, they were sensing these changes that were coming and they did their best to adapt. So they started doing some different things in the year, 2010, they release. Digital downloadable content or a DLC. And this was done in an effort to compliment the physical video game sales with digital sales, which makes a lot of sense.
  • [00:17:28] And then they also decided to launch the digital version of their magazine, which was called game informer. And by the year 2013, that actually became the largest digital magazine in the world with over 3 million subscribers. So they had this huge marketing engine via this magazine because people want to learn about the new games that are coming out.
  • [00:17:51] They want to get reviews, they want to do comparisons. They want to get sneak previews, and they'll go to things like game informer to see what's what's coming up on the horizon. What about that next sequel for that franchise that I really liked? So that's one of their big marketing engines. Historically.
  • [00:18:10] Now the company then did something industry by beginning to diversify its way out of just video game sales. So in 2014, they created this new segment of their business called technology brands and that consisted of two different businesses. So the first is spring mobile AT&T wireless. And this business was a large seller of cell phones.
  • [00:18:35] Cell phone plans and then other related products. And then another business was called simply Mac, which was the largest certified reseller of Apple products, which is interesting. Basically what they did was they joined forces with leaders in the electronic industry to sell AT&T and Apple products.
  • [00:18:54] That's basically what they did. So instead of just fixing fixating on video game sales, they branched out into other tangents within the electronic space. Another notable acquisition was in 2015 when they acquired a company that owned the think geek brand. And that brand is the largest seller of video game, licensed merchandise.
  • [00:19:18] Because remember is not just about the game itself. It's about the whole experience, the whole world of the brands that you interact with. So t-shirts collectible dolls, all those kinds of things related to the actual video game itself can actually make a decent amount of money. And so GameStop decided they wanted to be in that business too.
  • [00:19:40] In 2008, I seen GameStop ended up selling both the spring mobile. And cricket wireless. I forgot to mention cricket wireless segments. So they're no longer involved in the AT&T side of the business. Now by 2019, they began their foray into e-sports. We've talked about e-sports. In the episodes with Activision blizzard and electronic arts e-sports is becoming a big trend.
  • [00:20:08] Now, basically video game athletes effectively is what it is, and they created this video game training center in Frisco, Texas as a way to kind of get into this space. All right. So now let's talk about the business overview. What is the business of GameStop like today? Well GameStop, they call themselves in omni-channel retailer, which is a mouthful, but it means that they sell both online and offline.
  • [00:20:42] Now, most of the time they sell games, but they also sell digital products and they sell collectibles and they also sell their services for Apple through their simply mac subsidiary. So that's a subsidiary that they still retain to this day. They have a decent global footprint. They've got over 5,500 stores and it's a relatively international business.
  • [00:21:05] They're actually in 14 different countries around the world. So not incredible international presence, but definitely not just in North America either. So that's another positive thing from a diversification standpoint. And the store count has actually decreased quite a bit over the years. And that's kind of the first sign of trouble.
  • [00:21:26] When I was researching this business. When I started looking at the store count, it used to be over 6,200 stores, but now it's down to just 5,500. So there's certainly still very big as far as their retail presence, but they have shrunk in recent years. As far as the locations of those stores, most of them are in the us.
  • [00:21:48] I mean, they are in 14 countries, but when I looked into the details of the numbers, They have over 350 stores just in the state of Texas. And if you look at the international side of the business, about a third of the stores are an international locations, but, but I looked a little deeper. Most of those are in Europe.
  • [00:22:09] And they have a really small presence in Canada and Australia too, but you know, the international diversification, wasn't quite what I hoped when I first read 14 countries, but they're still very much a us focused business with a little sprinkling of European countries, Canada and Australia, in there as well.
  • [00:22:31] So where do they get their products from? GameStop doesn't make the games. Right. We know that it's the game studios, the game companies that make them, but they're the ones who sell them directly to consumers, at least some of them. So they get the games from the game manufacturers and sell them to customers.
  • [00:22:50] Now their top suppliers are companies that you probably heard of before Nintendo is their biggest. Vendor they account for 28% of their sales. Sony is next with 18% of their sales. And then you've got Microsoft at 6% electronic arts at 5%, take two interactive at 5%. Now it's interesting to me looking at this list that, you know, Activision blizzard is not on the list.
  • [00:23:19] But I think it's because they're really big in the PC gaming space. For example, the world of Warcraft franchise is owned by them and also with mobile gaming, which is the King brand of games like candy crush. So I think that they're not on that list because they just pretty much go direct to the consumer.
  • [00:23:39] They don't, they don't need a company like GameStop to sell games for them. So that's something that's is an interesting little tidbit there. Now about a third of the sales are made actually during the holidays. So I would definitely classify this as a seasonal business. This is not a business that has regular sales month in and month out.
  • [00:24:01] When the holidays come, people buy more games and they buy more collectibles. And in fact, if I was to boil down their business model in simplest terms possible, They sell video games and they sell collectibles. That's what they do. And it's a relatively easy business to understand. I like that. It's an easy to understand business.
  • [00:24:19] They get the games from the manufacturer, they sell it. That's basically what they do. And sales are roughly split between the hardware that they sell, as well as the software that they sell. And then there's a small portion of revenue that they make from collectibles. They do make some money from collectibles.
  • [00:24:38] But it's not as much as I kind of hoped for because they spend a lot of money and time acquiring the business that we just mentioned in the history section a little bit earlier, but it doesn't seem like it's really contributing to their revenue that much, they still really survive based on their hardware and software sales.
  • [00:25:03] Right. So let's get into the financials of game. Stop. Now remember, no matter how great a company's history is or how interesting the business model is from a qualitative perspective, we've always got to look at the numbers too, because if the finances don't work, then the business doesn't work. So let's look at the numbers now for the sake of comparison, what we're going to be doing is looking at.
  • [00:25:27] A span of several years, we're going to be looking just at fiscal year of 2012 and then fiscal year, 2019, the most recent full year fiscal data that is available. So first let's look at the sales, how much money did this business make in sales? That's the start of everything. If you don't have sales, then you don't have a business.
  • [00:25:50] So in 2012, the company made just under $9 billion in sales. And then in 2019, that number actually decreased to about six and a half billion dollars in sales. So pretty disappointing there, right off the bat. I mean the first number topline. We just see this, this big decrease over time in the past decade.
  • [00:26:13] And that's immediately concerning because that just raises a red flag in my mind, as an investor, as saying like, Whoa, something is wrong. Like sales have declined and it's not a one time. One year blip sales have decreased a significant amount and it's over a seven year period of time. So that is a red flag to me right away.
  • [00:26:35] But, you know what, maybe this business cut, its costs a lot. Maybe it's making a lot of money, right? So we turn our attention to the net income. How much profit did this business make? What's the bottom line look like? Well, in 2012, the company actually lost money. They lost almost $270 million. And then in 2019, when I look at the income statement, what I find.
  • [00:26:59] Is they've lost $460 million that year. So they lost even more money. So not only have sales gone down over this timeframe, but they started this period at a loss and then the loss got worse. And then we see this translate into the earnings per share figures. When we look at that in 2012, the business lost $2 and 13 cents per share.
  • [00:27:23] And in 2019, they lost $5 and 31 cents per share. So this is just not looking good, losing money all over the place, but keep going. Let's look at the rest of the numbers cause we want to get a complete picture of what this business is about and what's really happened. So we turn our attention to the balance sheet.
  • [00:27:42] Remember the balance sheet shows the assets and the liabilities. So what the business owns versus what the business owes. So, one thing I like to look at is the cash balance. How much money do they just have laying around in cash? Because cash allows businesses. To do things. It allows them to act quickly and you can deploy cash into a lot of different things.
  • [00:28:06] Well, in 2012, the business had over $600 million in cash. And in 2019 they had just 500 million. So their cash balance went down a little bit. And then as far as debt, here's one positive thing I found when looking at the balance sheet, they had no long-term debt back in 2012. So that was a positive sign.
  • [00:28:27] They actually eliminated their debt in that year, but they added more later because we can see in 2019, they had over 400 million in debt long-term debt. So they became more indebted as their fundamentals deteriorated. Let's look at the cashflow. Now, now the operating cashflow. Remember this is the actual money moving in and out of the business as a result of regular business operations.
  • [00:28:55] So in 2012, the company had actually positive operating cash flow. It was over $600 million. And then in 2019, it was negative 400 million over 400 million of a loss of operating cashflow. But I do want to point out looking at the operating cashflow that was really positive in 2012. In that year, there were a whole lot of restructuring charges that were added into the net income to arrive at that number.
  • [00:29:25] So just looking at that number is actually a bit misleading. The business, it was losing money in reality, that was the economic reality of the situation in 2012. And that was the economic reality of the situation at the end of 2019. And then the investing cashflow. Shows a similar story. They spent 150 million in 2012, 60 million in 2019.
  • [00:29:48] So they're investing in their business, but it's decreased over time. And then as far as the financing cashflow, there has been a lot of money going out of the business, flowing out through this line item in the cashflow statement. So they spent 500 million in 2012 and over 600 million in 2019. And just as an example to show what that was used for in 2019, over 400 million of that 600 was used to repay their notes.
  • [00:30:16] So to repay their debt. So they kind of do this dance with their debt. They pay it off, they borrow more and then they start paying it off again. Now, one other thing about this business that's important to look at is the dividend. This is a company that historically has paid a dividend. Now in 2012, they paid over a hundred million dollars in dividends.
  • [00:30:37] And in 2019, that number was just $40 million. So that decreased a lot. And that's actually due in parts of the fact that they cut their dividend. And actually right now it's eliminated. GameStop does not pay a dividend right now. So they have this track record of creating a dividend, raising it, freezing it, then cutting it, and then now eliminating it because they're now in more trouble.
  • [00:31:04] And as far as the shares outstanding. This normally would be a positive thing because they had over a hundred million shares outstanding and have just around 60 million now. So they've really reduced that share count at a really fast paced at around 8% annually, which normally I would be really excited by that, like, remember the auto zone episode that.
  • [00:31:26] We went through it together. AutoZone has this historical, the really powerful share buyback program that has really returned cash well to shareholders. But in the case of GameStop, it hasn't worked out that well because they're spending all this money on. Basically financial engineering, trying to destroy the share, count to make their earnings per share figures look better, but it's not really helping because their earnings per share figures are still deteriorating because they're still losing more and more money.
  • [00:31:59] So unfortunately that is the state of affairs here.
  • [00:32:14] Intro Music: All right.
  • [00:32:15] Alex Mason: So that is going to wrap up today's episode, be sure to tune in next week, we're going to take all these things that we've learned about GameStop and try to synthesize them together and form some kind of opinion about what do we, what do we do with this information, is Gamestop worth looking at, is it not?
  • [00:32:34] And why? So. I'll kind of piece those things together for you next week. And then in addition to that, I'll also be providing some thoughts about the recent market volatility around GameStop. What I think it means, what are my thoughts on it? And just trying to get a handle around what is going on in the market right now, because there's a lot of stocks.
  • [00:32:54] It's not just game stop. There are other stocks like AMC bed, bath and beyond there's all this market volatility. Brokers are halting the ability to make trades. Like what do I make of all of those things. So be sure to listen next week, where I go into more detail on that subject, as well as wrapping up the game, stop specific content.
  • [00:33:16] All right, thanks again for listening to the Stock Stories, podcast, again, my name is Alex. Your stock storyteller. If you want to connect with me, be sure to send me a DM or tweet on Instagram or Twitter @stockstoryteller. Again, that's @stockstoryteller. Happy to connect with you there. Or you can send me an email at alex@stockstoriespodcast.com
  • [00:33:39] all right. Well until next week, have a good one.
  • [00:34:00] The information presented here on Stock Stories is for information educational and entertainment purposes only, you and you alone are responsible for your investment financial decisions. Please consult an appropriate tax legal or financial advisor that analyze your specific situation in the context of your goals and circumstances.

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