GME Update

GME recently released 2017 holiday season.

There is good news and bad news; but in aggregate the news is negative. The stock responded by falling more than 10%.

The good news is that holiday sales were better than last year. The bad news is that both preowned games (key profit driver) and technology brands (expected future growth driver) declined.

My narrative on GME has been the following: “Competent management trying to manage a cash-generative core business in secular decline, by pivoting and expanding more profitable growth businesses.

Such transitions are never smooth.

The latest report seems to suggest that the core business may be declining more slowly than expected, but some of the new businesses are not ramping up as fast as one would like. Here is a decent take on the latest news release on SeekingAlpha.

My prior bear, base, and bull cases price targets were $14, $27, and $35, resepectively. I haven’t redone a complete valuation yet (will wait for earnings release), but my feel is that all these numbers should probably be revised downwards by a couple of dollars.

I have a tiny position (~1%) in GME at an average price of approximately $17.50. I will probably wait another quarter to see if my base case thesis has broken fundamentally. For the moment I continue to hold because:

  • tax bill will help lower tax rate (~35% in the past, and assumed for the future in my valuation); this will increase IV about 10-20%.
  • short interest is high; more than 35% of the float has been shorted. Based on the average trading volume, the days to cover are 15. The chance that it takes off to $25 on a good break is quite high (for example if the latest report had TechBrands neutral to positive, instead of down double digits)
  • the impairment charge is better to assume in 2017, when the tax rate is high, compared to next year, when it would be “worth” less. The most charitable interpretation of the writeoff might point to management’s willingness to acknowledge mistakes early, and monetize them opportunistically.
  • GME remains volatile and “interesting”. Option premiums are fat.
  • The stock pays a generous dividend, which makes it easy to hold on. There are no foreseeable liquidity issues. The debt is well-covered by cashflows.

I continue to believe GME is a modestly undervalued, but risky turnaround story.

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