Bloomberg News

GameStop Future Seen in Private Equity as Shorts Climb: Real M&A

December 06, 2011

Nov. 29 (Bloomberg) -- As short sellers boost their bearish wagers against GameStop Corp. to the highest level in America, the world’s largest video-game retailer may find its best hope with a private equity buyer.

Almost 47 million, or 34 percent, of GameStop’s shares are currently shorted, the most of any company in the Standard & Poor’s 500 Index, according to data compiled by Bloomberg and Data Explorers. Speculators sold borrowed stock on the assumption prices will drop even as GameStop traded yesterday at the cheapest level relative to net assets of any U.S. specialty retailer and a 67 percent discount to its sales, the data show.

Concern that downloadable content will reduce customers at Grapevine, Texas-based GameStop’s more than 6,000 stores helped send the shares down 21 percent from their 2011 high, making the retailer less expensive versus free cash flow than 94 percent of rivals. That valuation may now help lure private equity bidders, according to Robert W. Baird & Co. and Sterne Agee & Leach Inc. Analysts project the stock will gain 35 percent in the next year from yesterday’s close, with only one of 18 recommending selling the company’s shares, estimates compiled by Bloomberg show.

“For a brave private equity firm there’s an opportunity,” Colin Sebastian, an analyst at Robert W. Baird in San Francisco who rates GameStop “outperform,” said in a telephone interview. “It’s cheaper that any of the other specialty retail stocks, it’s priced to be a declining company. That makes it interesting given the amount of cash it generates.”

Short Selling

Jennifer Henricks, a spokeswoman for GameStop, declined to comment on takeover speculation.

The company’s shares climbed as much as 3.9 percent before closing up 1.7 percent to $22.75 today in New York.

GameStop traces its roots to a company formed by Leonard Riggio, founder of Barnes & Noble Inc., which took GameStop public in 2002. The company has retail locations in 17 countries and sells video games for systems such as Microsoft Corp.’s Xbox 360 and Sony Corp.’s PlayStation 3. The retailer also allows customers to trade in old video games and gaming consoles for credit towards the purchase of other products in its stores.

More than 46.6 million of GameStop’s 139.1 million shares outstanding are currently shorted, according to New York-based Data Explorers, as competition increases. The company this month cut its forecast for fiscal 2011 revenue growth to no more than 3 percent, down from a projection of as much as 6.5 percent.

Best Buy Co., the world’s largest consumer-electronics retailer, began a used-games business last year, while Take-Two Interactive Software Inc., publisher of the “Grand Theft Auto” game, and Electronic Arts Inc., the second-biggest U.S. video- game publisher, are offering more downloadable content.

‘Completely Collapse’

Jim Chanos, who was one of the first investors to bet against Enron Corp., said in an interview last week on Bloomberg Television’s “In the Loop” with Betty Liu that GameStop is one of his current “value traps.”

“The Internet is the most efficient distribution network ever devised,” Chanos, founder of the $6 billion hedge fund Kynikos Associates LP, said. “And as the cost of transmitting and storing a bit approaches zero, anybody that’s in the business of selling you a physical product that is digitized has seen their margins just completely collapse over time.”

Blockbuster Inc., once the world’s biggest movie-rental company, filed for bankruptcy last year after failing to adapt its storefront model to online technology pioneered by rivals including Netflix Inc.

Relative Value

Short sellers such as Chanos have helped push GameStop’s shares down 65 percent from their all-time high of $63.30 in December 2007 to $22.36 yesterday. The decline left GameStop trading at 1.04 times its net assets, the cheapest level among 50 specialty retailers in the U.S. with market values of more than $1 billion, according to data compiled by Bloomberg.

After retreating 13 percent this month through yesterday, GameStop was valued at 0.33 times sales, near its record low of 0.3 in January 2003. The company traded at 7.8 times free cash flow, cheaper than 94 percent of specialty retailers in America, data compiled by Bloomberg show.

GameStop’s “very strong” cash generation and low level of debt, along with a real estate portfolio with an average lease life of two years and its business model that allows customers to buy, sell or trade video games, are among the factors that differentiate it from Blockbuster, Matt Hodges, a spokesman for GameStop, said in an e-mailed statement.

The company’s cash of almost $443 million exceeded debt of $125 million at the end of last quarter, data compiled by Bloomberg show. In the last quarter before Blockbuster filed for protection from creditors, it had $64 million in cash and $920 million in debt, the data show.

‘Not a Blockbuster’

GameStop said Nov. 17 its board authorized $500 million for share and debt repurchases in which some of the funds will be used to retire its $125 million of 8 percent senior unsecured notes that were set to mature in October 2012.

“Everybody is looking for the next easy short,” Stephen F. Roseman, chief executive officer at New York-based Thesis Fund Management LLC, said in a telephone interview. “This is not a Blockbuster.”

The Thesis Flexible Fund has about 5.8 percent of its assets invested in GameStop, the highest proportion for any fund, according to data compiled by Bloomberg.

Analysts are projecting a rebound in GameStop’s shares, with an average 12-month price estimate of $30.18, 35 percent higher than yesterday’s close, data compiled by Bloomberg show.

‘Becoming More Relevant’

GameStop announced the acquisition of two companies in March to add technology that allows users to stream video games online or download them to their Internet-connected gaming consoles as it aims to boost digital sales. While GameStop’s same-store sales slipped 0.6 percent in the third quarter, digital purchases made on gaming consoles and personal computers rose 59 percent, according to its Nov. 17 earnings statement.

“GameStop is gradually getting into the digital space and becoming more relevant that way,” Arvind Bhatia, a Dallas-based analyst for Sterne Agee, said in a telephone interview. And it “will have a debt-free balance sheet within a few short weeks. These factors are things private equity would love to see in a company,” he said.

--With assistance from Cliff Edwards in San Francisco and Betty Liu in New York. Editors: Daniel Hauck, Sarah Rabil.

To contact the reporters on this story: Nikolaj Gammeltoft in New York at ngammeltoft@bloomberg.net; Tara Lachapelle in New York at tlachapelle@bloomberg.net.

To contact the editors responsible for this story: Daniel Hauck at dhauck1@bloomberg.net; Katherine Snyder at ksnyder@bloomberg.net; Nick Baker at nbaker7@bloomberg.net.


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