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Upping the ante on GameStop (GME)

August 23, 2019

Since I started writing this piece, a number of articles have come out about the company and the stock price, and shares have risen more than 10%.  I still think that there is a good bit of upside in the price, as well as a possible short squeeze which could spike the share price significantly. I had planned on gradually increasing my position in GME but with the recent gains I’ll just be watching unless the share price falls under $3.50 again.

In my last blog I noted that I had taken a very small position in GameStop (GME) and would tender my shares into the Dutch Auction that was announced just subsequent to the 2nd quarter earnings/dividend cut announcement. Well, I did tender my shares but I tendered at the high end of the range, $6.00, rather than the low end, $5.20. My thinking was that since the stock price was in the $7+ range before the dividend elimination was announced  and not that many shares had traded at the low after the dividend elimination announcement but before the tender offer announcement, there would not be enough shares tendered at the low end of the range and the dutch auction price would be established toward the upper end of the range. Boy was I wrong! More than twice the number of shares were tendered at the bottom of the range ($5.20) than were provided for in the auction purchase (12 million). By my calculation a lot of risk arbitrageurs lost a lot of money on this one! (Glad to think I was not the only one who got it wrong!) With at least another 12-13 million shares returned at the end of the dutch auction it is no wonder that the share price collapsed again all the way down to almost $3.00 a share.

So now, is this stock a stinky dead duck or an ugly duckling just about to metamorphize into a beautiful swan? Most commentators agree that the business has no future, that all games will be downloaded from the internet in the future, and that a retail presence in this industry is redundant; the company will eventually wind down and the stock will go to zero. Thus, the most popular thesis is ‘sell the stinker’. But that’s just why I like it! A generally-hated stock that has a decent balance sheet and is still generating significant cash flow is something that I’m attracted to. If somehow capital management is improved and, even better,  the decline in the business is slowed, this could be a real winner.

Recent attention to the stock comes from the fact that Scion Asset Management (Dr. Michael Burry of The Great Short fame) sent a letter to the GME board on August 16 in which he states that he owns 3 million or approximately 3% of outstanding GME shares and urges management to accelerate the repurchase of shares under their existing $300 million share repurchase program. He notes that at then current market prices (mid $3 per share) GME could purchase up to 80% of outstanding shares while only using half of their currently held cash balance. Will the Board or management listen? I have my doubts! You had a new retail guy come in from outside as CEO in May; usually retail guys want to invest spend their way out of a difficult situation by growing not slowly liquidate. Here, I think it depends on how savvy their CFO is and how desperate their Board is to keep the share price up and/or keep shares out of hostile hands. The real question is how the market will react to the letter and whether other activist funds jump on the band wagon and put additional pressure on the Board.

From an upside/downside perspective I think this is an interesting situation. The probability of management doing something further to boost the share price I think is less than 50% UNLESS additional pressure is put on them (a 3% holding is not enough to go activist). But the market may not see it this way. With some 56% of the float short (that’s right, close to 60%) the share price is inherently unstable.  Any significant move of the share price to the upside caused by repurchases, other actions or even just a change in perception that these things might happen (read ‘a mood swing’ caused by the publication of the Burry letter to the Board) could be exaggerated. Could we be in for a classic short squeeze?

Interestingly, yesterday, August 22, over 29 million shares traded and the price was up 9%. That’s over 30% of shares outstanding! Of course the same shares may have been traded several times during the day so that the 30% is likely overstated. In any case it is a significant number. Are the shorts covering? Is the company buying back shares?  are ‘traders’ simply trying to make a buck on a volatile stock? or is the company ‘in play’? stay tuned! It should be fun to watch.

3 Comments
  1. While it was interesting that you pointed out the opportunity in GME , it would have been more enlightening if you provided some fundamental thoughts.

    • Unfortunately there is not much ‘analysis’ that can shed light on where GameStop as a company will be in a year or two. The three key factors as I see it are 1) how fast the market for in-store game sales declines, 2) what strategic direction the company will take under the new CEO, and 3) how management will approach capital allocation.

      We know the market for in-store game sales is shrinking but anybody who thinks they can predict just how how fast it will shrink is kidding themselves. And with new management it is difficult if not impossible to say what direction they will take the company in and how they will allocate the cash they currently have. The best that can be done is to wait and see, perhaps on next quarter’s earnings call, what management is planning (and implementing).
      In the meantime, it seems to me that there is a case for a significant increase in the share price …. and a case for saying that nothing can help this company and the shares will go to zero. You have to assign your own probabilities to the possible outcomes to reach an investment decision.

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  1. Weekly Investment Reads - 8/25/19 - Foresight Value

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