Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

Market Insanity

Is GameStop Making Money?

Retail apocalypse poster child GameStop (NYSE: GS) has an unlikely savior in the form of Big Short hero Michael Burry.

Bizarrely, Burry’s investment firm Scion Asset Management admits to owning three million shares; or 3.3%, of GameStop Corp’s stock, a press release reveals.  To elaborate, Burry is the speculator who sort of predicted the collapse of the mortgage market that triggered the Great Economic Meltdown of 2007-2008.

In detail, Burry bet against mortgage-backed securities. Burry has folk hero status because of his role as the hero of Michael Lewis’s book The Big Short. Moreover, the Dark Knight Himself; Christian Bale, plays Burry in the 2016 movie version of The Big Short.

Is Michael Burry right about GameStop?

GameStop claims to operate 5,600 stores in 14 countries that sell video games and game paraphernalia.

However, GameStop makes little money from those stores. In addition, Game Stop reported an operating income of $18 million and a net income of $6.8 million on May 5, 2019. Tellingly those numbers were down from $28.2 million and $45 million on 5 May 2018.

In addition, GameStop reported revenues of $1.548 billion on 4 May 2019, down from $1.786 billion a year earlier.  Plus, GameStop reported a gross profit of $448 million on May 4, 2019, down from $503 million in May 2018.

Notably, Stockrow reports GameStop’s revenue growth rate fell by 13.33% in the quarter ending on 4 May 2019. Moreover, GameStop’s revenue growth fell by 7.26% during the quarter ending on 2 February 2019.

GameStop is Losing Money

I wonder if Burry bothered to look at GameStop’s financial numbers because the company reported all negative cash flows on 4 May 2019.

For instance, GameStop reported an operating cash flow -$665 million and a free cash flow of -$683.6 million on the same day. Tellingly, the negative cash flows exceed GameStop’s cash and equivalents.

GameStop reported $543 million in cash and equivalents on May 4, 2019. Thus, GameStop is the opposite of a value investment it burns cash instead of generating cash.

Is GameStop a Contrarian Play in Video Games?

Yet, Burry thinks GameStop is a contrarian play in today’s retail landscape and video game market. On the positive side GameStop (NYSE: GME) is cheap its shares were trading at $3.97 on 30 August 2019.

My guess is Burry thinks GameStop’s share price will grow because it is in video games. However, very few of today’s gamers buy games from a store. Instead, today’s gamers buy their games digitally online.

For example, Epic Games generated $2.4 billion by selling digital paraphernalia for Fortnite in 2018, USA Today estimates. In fact, Fortnite generated $203 million in revenues in May 2019.

Epic Games; however, generated that revenue by selling digital costumes, characters, prerelease game nodes and the V-Bucks digital currency. Notably, all those items are digital goods, players buy directly online not at a store. No Fortnite player goes to GameStop to pick up a cosmetic skin for her character.  

Instead, the gamer stays on the couch and orders the game paraphernalia directly online. The only item gamers might get from GameStop is the console, which they can also order from Amazon (NASDAQ: AMZN).

Why GameStop Does Not Make Money from Today’s Video Games

Thus, the profit from today’s video games goes to game companies like Epic Games and to tech giants like Microsoft (NASDAQ: MSFT) and Tencent Holdings (OTCKTS: TCEHY).

Gaming accounted for 9% of Microsoft’s 2018 revenues, USA Today estimates. Therefore, Microsoft had $11.3256 billion in gaming revenues in 2018. To clarify, Statista estimates Microsoft’s 2018 revenues at $125.44 billion and I calculate 9% of that is $11.3256 billion.

Microsoft makes money from the popular Xbox gaming console and the Game Pass gaming network. Statista estimates Microsoft sold 6.96 million game consoles in 2108. Notably, Microsoft sold 85.8 million Xbox 360 gaming consoles between 2005 and 2017.

Meanwhile, Riot Games a subsidiary of Chinese telecom giant Tencent Holdings made $1.4 billion from its League of Legends Massive Multi-player Online Game (MMOG) in 2018, Statista estimates. In addition, Tencent owns Fortnite’s creator Epic Games.

So What does Michael Burry see in GameStop?

Thus the real money in today’s games is being made by tech giants not brick and not mortar retailers like GameStop. So what does Burry see in GameStop?

It’s not a dividend, GameStop stopped paying that in June 2019 to save $157 million, Reuters reports. Nor is it leadership, GameStop had five Chief Executive Officers in the year ending in May 2019.

I suspect, Burry believes older investors who know little or nothing about gaming could buy GameStop because they see the word “Game” in its name. In addition, older people could have bought something from GameStop for their grandchildren.

However, I think such plays will only create a short boost in GameStop’s share value. Burry could make a quick killing if GameStop doubles or triples in price; before collapsing when the next earnings reports comes ou, but I cannot see any long-term value at this company.

Ultimately, GameStop is on the fringe of gaming in today’s world. Today’s gamers either play MMOGs or buy their games digitally from services like Gog, Steam, and the Epic Games Store. In fact, Daily Variety estimates one game platform; Steam, had one billion accounts and 90 million active users in April 2019.

In addition, the modern gamer is likely to order a new console from Amazon rather than drive to the strip mall. Thus, GameStop’s future market could  be aging soccer moms or grandparents buying games for kids or grandkids.

Why Investors need to stay far Away from GameStop

Thus, Burry could bet that older stock pickers could boost GameStop’s share value soon. I think that’s a poor bet that shows Burry’s ignorance of gaming.

In the final analysis, I think GameStop will soon collapse leaving its stock worthless. Consequently, I think tech stocks like Microsoft (NASDAQ: MSFT); chip makers like NVIDIA (NASDAQ: NVDA), or game makers like Electronic Arts (NASDAQ: EA), will be better serve investors who want to cash in on gaming.

All of those companies are generating large amounts of cash from gaming. In contrast, GameStop is burning cash and will continue burning cash until it goes out of business. Thus, Burry will lose money if he tries to hold GameStop for a long time.

Investors need to stay away from GameStop and put their money in the companies making money from games.