5 Simple Reasons to Give Up on GameStop

GameStop's (NYSE: GME) stock has plunged more than 80% over the past five years as digital downloads disrupted sales of its physical games and mall traffic dried up. With fewer physical games in circulation, trade-ins and sales of preowned games also ground to a halt.

GameStop tried to stay relevant by selling more collectibles and gaming accessories, but those businesses failed to offset the declines in its core software and hardware businesses. GameStop's single-digit forward P/E attracted some value-seeking investors to the stock, but its latest earnings report indicates that its stock is still a falling knife.

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GameStop's sales fell 13% year over year during the first quarter (its fourth straight quarter of negative growth), its comparable store sales fell 10%, and its net income plunged 63%. Those numbers already look awful, but I'll highlight five other reasons investors should avoid this broken company.

1. It suspended its dividend

Back in April, I warned investors that GameStop's double-digit dividend yield wasn't worth the risk. Therefore, I wasn't surprised when GameStop announced that it would suspend its dividend and devote that cash to reducing its debt and rolling out new "transformation initiatives."


That divestment also boosted GameStop's cash and equivalents 124% annually to $543 million. GameStop stated that the elimination of its dividend will help it conserve about $157 million annually.

That will strengthen GameStop's balance sheet, but it also eliminates one of the last reasons for investors to own the stock. It would have been smarter to reduce the dividend to a more reasonable yield of around 5% to prevent income investors from abandoning the stock.

2. It canceled its buyback plan

GameStop had approved a new $300 million buyback plan, which equals about a fifth of its current enterprise value, during the fourth quarter. Yet it canceled that plan in the first quarter; George Sherman, who took over the CEO position in mid-April, stated that the company would reserve that cash for "opportunities in the future."

Once again, strengthening GameStop's balance sheet is important, but calling off the big buyback a mere quarter after announcing it doesn't instill much confidence in the company's board.

It also indicates that the company doesn't consider the stock -- which trades at less than four times forward earnings -- undervalued at its lowest level in over 16 years. But that isn't surprising, since GameStop expects its sales and comps to both fall 5%-10% this year.

3. No next-gen console releases expected until 2020

In the past, GameStop's sales improved when new consoles were released, since they still drew shoppers back to its brick-and-mortar stores. However, Sony (NYSE: SNE) and Microsoft (NASDAQ: MSFT) probably won't launch their next-generation consoles until 2020.

The launch of two new Nintendo Switch models this year might breathe some life back into GameStop's new hardware business, which generated 15% of its sales last quarter, but sales will need to be extremely high to offset its lower sales of PS4s and Xbox Ones.

4. Unclear turnaround plans

GameStop axed its dividend and buyback to fund its turnaround, but its plans are still murky. It wants to expand its PowerUp Rewards program, which has about 60 million registered members, to bring shoppers back to its stores. But that's not a fresh strategy, since plenty of failing retailers are hinging their last hopes on stagnant loyalty programs.

GameStop also wants to expand into the esports market. It recently opened a "performance center" in Frisco, Texas, an 11,000-square-foot facility that features esport and public gaming facilities. That might keep GameStop's brand relevant among hardcore gamers, but it's unclear how it will generate fresh revenues for its core business.

5. It can't "transform" quickly enough

During the conference call, Sherman repeatedly stated that he wanted to "transform" GameStop's core gaming business instead of diversifying it into other markets. Unfortunately, GameStop already missed the leap from physical games to digital downloads, and it will likely miss the upcoming transition to cloud gaming platforms like Sony's PS Now, Microsoft's Project xCloud, and Alphabet's Google Stadia.

Faced with these bleeding-edge digital challenges, I think Sherman -- who previously worked for nongaming companies like Home Depot, Best Buy, and Verizon -- can't "transform" GameStop's core business quickly enough. As a result, GameStop's death spiral will probably continue and burn any value-seeking investors.



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*Stock Advisor returns as of March 1, 2019

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Leo Sun owns shares of AT&T. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Microsoft. The Motley Fool owns shares of GameStop. The Motley Fool recommends Home Depot, Nintendo, and Verizon Communications. The Motley Fool has a disclosure policy.