The Music Will Stop On GameStop

Why is there a used game industryThe arrival and growth of the used game stores 1990s to early 2000s

After baseball cards, the next ‘collectible thing’ was used and collectible video games. The new era of technology help produced video games frequently and created a secondary marketplace for older games. There were then many new game releases, and customers who finished a game would be willing to trade their games for a new or used game.

Since customers didn’t know how much their games were worth, it was easy and convenient to sell their used games to the game store. The similarity that baseball cards and used games share is that it was missing an official marketplace for customers to know if the products are price-efficient. A guy named David Pomije from Minnesota saw the opportunity in the used game market and established Funoland. Funoland was doing so well that in 1998, Forbes listed it second place on the magazine’s list of 100 of the fastest-growing companies.

(If you want to read more about Funoland history and how it became Gamestop go here: FuncoLand History: The Company Behind Used Video Games written by Ernie Smith)

As a teen, my favorite store was Funoland. Funoland was the easiest place to buy video games and it was a fun place to play the demos. In the early 2000s, Funoland was merged with EB Games to become Gamestop.

1. 2010 to Present –  Gamestop business model will continue to decline because of decreasing consoles unit sales, weak pricing power, digital downloads, and used games are less valuable In the final 10 years, many retailers fought for survival but eventually failed. Specialized private equity groups operated in the retail industry like surgeons, but failed to revive retail stores. The days are getting darker and PE firms have recognized it is not worth saving the retail industry. Many retail giants have disappeared or greatly reduced in size. Millennial customers love their 90s nostalgia moments, but they are not going to shop at Gamestop because it is expensive, inconvenient, unethical, unauthentic. All niche communities are built on authenticity, it’s the currency that GameStop lost many years ago.

  • Management is speculating that New Game console would recover sales in 2020. In the most recent 2019 quarter, GME’s CEO was surprised by the steep sales decline. There is an oversupply of GameStop stores,new games and used games are so much cheaper everywhere else. Bullish investors believe Gamestop can automatically recover sales through the new gaming cycle.Over half of Gamestop console market opportunities disappeared between 2008 and 2020. 2008 total consoles sells were 90 Million consoles were sold Worldwide in 2008, but 2020 total estimated around 30M to 40M.

Overview

The Global Unit Sales of Current Generation Video Game Console in million units (2008 to 2017)Infogram.

  • Used games are less valuable each year and Download games are more popular each year. Used games remain a substantial income for GameStop, but its sales in that category have fallen every year since 2011. In 2019, Sony sold over half of its game sales came through downloads. Microsoft, Nintendo, and Google have invested heavily in online gaming.

Playstation 4 was released on Nov 15, 2013. GME stock from Nov 2013 to Nov 2017 is -67%

  • Gamestop supply chain and marketing are some of the worst in the retail industry. GameStop does not offer free shipping unless its over $50. The top competitors are upgrading their business with robotics, software, and logistics innovation.
  • Corporate culture is toxic and the business execution is mediocre. The gaming culture is really aware of Gamestop’s misleading business practices. What will make Gamestop more successful than their competitors? I’m still searching for answers. If anyone told me they found Santa Clause on the North Pole, I would trust you before I ever believe in Gamestop’s management plan.
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  • Weak Pricing Power– New and popular games are typically discounted 10% cheaper. If the games are not discounted, the customers can still earn 5% membership discounts from using the retailers’ branded credit cards. Also, used games are cheaper on eBay, FB, and Craigslist.
    • GameStop cannot compete against cheaper alternatives. Major retailers are taking losses with their gaming discounts, with the promise that it builds brand loyalty and customers buy other higher-margin products to make up for it. Competitors are beating GameStop through pricing, convenience, and superior Omni channels. GameStop knows it cannot compete on price, so it makes up creative membership deals that will mislead customers into buying overpriced used games.
    • Used Cheap Games are recession-proof, not expensive used games Consumers will buy the cheapest alternatives in a recession, not overpay for discretionary goods. In an economic system where customers could use an extra buck, they would prefer to make $10 on eBay than to lose $10 at GameStop. GameStop trade-in value doesn’t make economic sense to a consumer.  Gamestop will always offer a lower trade-in price, and then force the customers to buy merchandise that are typically 10% or more expensive than Walmart, eBay, and Amazon.
    • Low Trade-in value – Customers can get a better value from eBay, Facebook or Craigslist. There are multiple ways to sell and buy games online that are more convenient and price better.  The cost of shipping video games is really affordable, and you still make more money selling games on eBay than you would at Gamestop.
  • Not Convenient to drive to a game store – It’s easy to find popular games from large retail spots when customers can drop by for other items. If customers are looking to buy video games, they aren’t rushing to store for it. The supply of used video games is plentiful and fairly easy to find popular game titles from other marketplaces
  • Lack of Customer Service & Knowledge – GameStop has unrealistic sales goal and use the forceful sales tactic. Gamestop’s innovation is making membership points misleading and confusing.

2. History of Poor Capital Allocation – Low ROIC, no investment in business and waste of share buybacks.

  • Aggressive Share buyback won’t work – Since 2010, GameStop has had a Capital Allocation Strategy that wasted over $400 Million in Share Repurchase. This number doesn’t take out the recent $120M shares buybacks from 2019. A company should simply buy back shares if it has ample funds to take care of the operations and the stock is selling at a large discount on a conservative calculated intrinsic value.  Gamestop will run out of cash by the remainder of the year, and it will depend on revolving high-interest credit to pay for their operations.
  • Liquidity Fallacy –If customers don’t shop at GME, then Cash flow doesn’t matter. Surly, Michael Burry understands liquidity and cash flow, he’s one of the few investors that bet on the Real Estate liquidity crisis. But Burry and many other investors failed to see the cultural currency in the gaming community. Clients are the most important currency on GME balance sheet not USD dollars. Much like how Eddie Lambert said Sear’s had enough liquidity to carry through a turnaround strategy, but customers were not shopping at Sears. Price-cutting can quickly stabilize a financial statement, cutting too much cost will deteriorate the customer’s shopping experience. There are over 10,000 companies in the world, but Burry chose GameStop as one of his TOP ideas. I was initially shocked at his decision to buy GameStop, but I wasn’t totally surprised. Many investors believe their skills and knowledge are transferable in a different industry.
  • Fallen ROIC since 2014 – GameStop ROIC has fallen every year since 2014. It had not made any significant investment in their business in the last four years.
Historical 10 year ROIC of GME

3. Proposing unproven Strategies – gaming events, retro games, and merchandise will not replace the loss of used games revenue.

  • Store gaming events are not proven strategies – Management has not provided information that shows gaming store events could create profitability. Most GameStop stores are too small for hosting gaming events. Gamestop had a press release about their gaming events in Spring 2019, and it has been quiet ever since.  Gamestop probably most already failed its first gaming event attempt. The best gaming hosts in the industry are only mildly successful.
  • Increasing Retro and Rare Game sales will not stabilize revenue – Rare games sell on eBay at a much lower price than Gamestop trade-in value. Collectible Games will slow down the turnover inventory, it will take up shelf space from other products.
  • Shifting sales to nongaming merchandise will turn GameStop into another commodity store – GameStop owns the ThinkGeek store that sells nongaming merchandise and its sales are going down too. GameStop eliminated the position of Chief Operating Officer and in recent months has begun to switch some of its business models toward collectibles and trading merchandise. In other words, GameStop is basically converting its store into another failing business which is its sister brand ThinkGeek. GameStop best non selling items are BoobleHead that are made by Funko.  Gimmicky products like Bobbleheads are the beanie baby 2.0… Bobbleheads’ are high-net income margins, but it doesn’t add any value to GameStop. GameStop does get some foot traffic from Bobbleheads, socks, T-shirts, and other random merchandise, but total sales are not great enough to offset declining game sales. In the early 90s, Trading card stores attempted to switch from baseball cards to other popular merchandise, but eventually, the hobby store industry disappeared.

Gamestop is hoping for Collectibles to turnaround the company

Valuation Verdict:

GME at its best would be worth $5/Share, assuming a small decline of -2% revenue CAGR and an average 3% EBITDA Margin.    Bullish investors estimate GameStop valuation between $6 to $10, but it doesn’t require complex math to explain GameStop’s valuation. Analysts are overcompensating on complex valuation because they believe used video games can be a sustainable business model. The next 12 months will be critical for Gamestop to improve its revenue or else the stock price will take a nose dive. 

Gamestop has less than 1 year to prove to investors that they can stabilize and better sales. GameStop holds $290 million in cash and $419.4 million in debt. Gamestop had many years to turn round the company, it just burned through its cash to buy back a company that offers customer zero value. Buybacks are great if the company is greatly undervalued and if it receives enough funds to support both business operations and buybacks. In Gamestop case, it only has adequate money to pay down debt or buy back shares.

GME will drop to $3 again and become a penny stock in the next two years. Private Equity dry powder is at an all-time decade high, and there is still no offer for Gamestop. Based on the last 4 quarters, GME is projected to lose a minimal of $160M to $200M in 2020.

Conclusion:

The existence of Gamestop came from the void of the used game market. The industry has evolved and that used game void is available through multiple channels that offer cheaper prices and better value.

A new generation of game consoles is arriving later this year, buying GameStop sometime to hold out. The question remains, how much longer can GameStop business model remain relevant in a fast-growing digital distribution era? Get ready to Say Rest In Peace, GameStop will join it’s non-innovative retail family members shortly.

Can’t stop, won’t stop, Gamestop selling drops ’cause it, it gets down baby, it gets down baby

The GameStop, gameflop, and StockDrop

The 1970s-1990s – Hobby stores arbitrage and demise

Long before the days of the internet, auction platforms and hobby stores, it was a very simple arbitrage market for collectible shoes, artwork, games, and cards. The market wasn’t efficient at pricing hobbyist collectibles. 

Finding rare cards was difficult, it was only available through newspaper ads, neighbors, acquaintances, and hobby stores. Rarity was empowered by the proximity of where, and how you can buy a product. Baseball cards’ popularity grew in the 1970s – 1990s and spurred the growth for new hobby stores to sell the trendy commodities. It costs very little to produce baseball cards, and it was easy to sell paper cards for a significant profit.

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By the early 1970s, the first professional card dealers emerged

During the dial-up internet era in the late 90s, consumers were not familiar with the internet and suspicious of buying products online. Consumers still trusted a local hobby store over the internet. Hobby stores took advantage of customers’ distrust of the internet products and sell the same merchandise for a much higher price.

There were many times, I paid a premium price at the store over the listed “official card price index” report from hobbyist magazines. It wasn’t easy to buy from the internet, there was no way to confirm or guarantee that the money you paid online was going to honored. It was common for hobby stores to list the same merchandise at higher prices than the market’s selling price.

Over time consumers started trusting online marketplaces like eBay and slowly collectible items became price efficient. Sports card revenues hit their peak in 1991 at $1.2 billion, and the cards were flooding the market. Since then, it has dropped to under $200 million and Hobbyist lost interested in baseball cards. The saturation of hobby stores hit a peak after owners realized there were more baseball cards than they could sell. Hobby stores started looking like junk storage rooms and most baseball cards lost its value. 

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Baseball Cards Liquidation sale

Savvy-experienced store owners who recognize the early demise of their baseball cards quickly sold their entire inventory and stores. The market gave plenty of signals that Baseball and collectible cards were not worth much. The hobby store owners that were smart made it out with a decent profit and shift their attention to the next collectible thing. The new owners who took over the hobby stores were the last ones holding the bankruptcy bag.

The Millennial ‘Frugalpreneur’ lifestyle

It’s 2020, it’s time for Millennials to live the ‘Frugalpreneur’ lifestyle, keeping the biggest expenses as low as possible. You hear notorious stories about how entrepreneurs kept their expenses low as possible to fund their business. If Millennials and Generation Z can apply the same financial mindset as entrepreneurs, then finances will be so much easier to manage. It is easy to save money, but why are some Millennials so broke? It’s about making savvy financial choices, money is a limited resource just like your time. Learn to spend money wisely and avoid purchases that doesn’t add value to your life.

There are many brand name activities in society that pressure Millennials into expensive social obligations. Social branding activities like weddings, wedding rings, cars, luxury items, living independently, traveling, and etc are causing financial stress. Whom are you trying to impress? Most of the social branding are just ways for corporations to make money…it has little to do with adding value in life. If you can afford social branding, then do it wisely, just don’t socially brand yourself through debt.

The average professional millennial makes about $60k to $100K salary…The HENRY millennial (High Earners Not Rich Yet) makes $100K and above. Saving and investing early on might not look like much, until you reach your 30s. Young millennial AND generation Z – if you want a better life, your priorities will have to change. Money cannot solve personal life issues, but financial flexibility can relieve some of life’s hardship. Focus your money on purchases that will provide the most value to your life. Living a smart financial lifestyle does not sound sexy because society is dictated by marketing your life into perpetual spending habits with overrated experiences, temporary homes and worthless cars.

Living independent – Very Overrated 

The easiest way to save money substantially is to live at home or have roommates! Rents are the highest recurring obligation, start cutting down on rent first because everything else is chunk change.

Society should be impressed with Millennials living with their family or having roommates. It shows a sign of maturity and logical reasoning. Even if you make a lot of money, why bother living alone, when living at home could be free or cheaper? Unless there is a problem at home, living at home should be the number one option.

The millennials that cannot afford living alone is often pressure by society to rent their own place. People put themselves into so much financial obligation to impress others that they are doing well by living alone, buying a new car, and none of these spending adds value to their life besides the illusion of their financial status. 

A few years ago, one of my colleagues at KPMG asked me how I could afford to eat out for lunch every day. For this story, I will call him Kevin.

Kevin’s background: Kevin lived with roommates for two years, and then rented his own one-bedroom apartment in Arlington, VA for $2300 a month. 

Kevin: “Tom you are wasting a lot of money eating out” 

Tom: “How much are you saving from not eating out?”

Kevin: “$200 a month” and he showed a big smile. 

Tom: “Wow that’s great, but I like eating out. I am sacrificing my personal space to live with roommates.” 

Kevin: “Oh you’re saving a lot of money living with roommates, I can’t do that though, I want my own space.”

Tom: “Yep, I am saving a lot of money” I showed a big smile back to Kevin and left to lunch

How much was I saving from living with roommates? 

$0 Dollars – I didn’t have to pay for rent at all.

During college and my first two years of my career, I paid $600/month living with my family. I saved a majority of my money to buy a home. After I saved for a down payment, I bought a townhouse near a college campus. My mortgage was $2000/month and HOA was $100/monthly. I did not waste any time posting up the available rooms. I lived alone for less than a month before I had a student roommate that moved into my home. By the 2nd month, all of the rooms were rented out. There were times I rented out my room on Airbnb, which was the master bedroom, and I slept on the couch. Sleeping on the couch was a bit extreme, but it helps accelerated my savings.

Some people have very bad experiences living with other roommates and it is understandable. Living with a roommate isn’t convenient. It takes time to interview roommates that have good etiquette.

Many people are complaining about money, but make a half-assed attempt to saving.  Everyone is talking about how hard life is, and while it isn’t easy to save money, some of my peers seem too lazy to make a real effort. American culture has nurture people to become entitled.

I’m not saying Millennials should live with their family, but who are they trying to impress? You can still be independent living with family by paying rent and helping to care of the house. If living with family isn’t an viable option, then find a good roommate.

If you want to live independently, rent an affordable basement, and share a kitchen. Whatever you do, minimize your rental expenses. Saving money on coffee, eating out, and other smaller discretionary spending is not comparable to rental savings. 

Traveling often – Overrated

Traveling is great, but why are Millennials traveling so often? There should be a budget set for traveling. I am freaking out for my generation that are taken out loans and paying interest to travel more often. Does traveling often add value to anyone’s life? It could, but at what cost?

Eating out – Underrated

I can’t eat simple prepared meals like sandwiches, pizza, and etc. I prefer meals that have seasoning taste, which means longer cooking time. I have to spend a lot of time grocery shopping, preparing, and cleaning just to make one meal. It’s not worth the time to cook unless the household is at least three people. The economic cost and time are wasteful. It would be just as affordable, and sometimes cheaper to eat out than making the food at home.

10% minimal saving & 10% Retirement – Very Underrated

  1. Pay off your discretionary debt that is above 5% interest. This means all credit cards should be paid off monthly. There are zero reasons to have a carry-over monthly credit card balance.
  2. After you pay off your credit card, then start saving 10% each month, but don’t let your cash sit in a savings account. Put your savings into a higher paying account like buying a stock market index, do not pick stocks (over 95% of investors will underperform the index) until you are educated about investment fundamentals like reading a financial statement, and financial risks.

Everyone should always invest in their retirement to get the employer’s match. The average employer’s match is 3%, which means it would require the employee to put in 6% to get the additional 3% from their employer. If you are 1099, or an entrepreneur, you still need to have 10% invested in your retirement.  

Buy a used affordable Car – Very Underrated

Again, you are not impressing anyone. Until you have a secure financial life, having enough money to put down on a home should be the first priority. The only people that will be impressed by your nice cars are hidden fees that will view you as a financial resource for their amusement.  

Expensive Wedding and Wedding Rings – Overrated 

The average wedding in the United States costs more than $20K and it usually requires immediate payment. It’s crazy to hear how some people have to borrow a loan to have a wedding… If you need a loan to have a wedding, forget it! Your close family and friends will still love and celebrate you the same way! 

In many Asian cultures, cash is a standard wedding gift. My wedding was expensive, but our family and friends’ generous gifts to us helped recover a portion of the wedding costs. Although our wedding could have been a lot cheaper, my wife and I wanted our wedding to be a memorable experience as gratitude to our family and friends for supporting us through our lives. We budgeted and postponed our honeymoon so that we wouldn’t incur any financial challenges. If you have the financial means for an expensive wedding and can afford a home quickly, then go ahead…But if a wedding or ring will set delay your ability to afford a home, then do not attempt to have an expensive wedding. 

Birthday Gifts and Christmas Gifts – overrated 

We do not have to buy random gifts for an adult or kid. If you have to buy a gift for a special event, make sure it’s very practical or better to give cash instead of gift cards. Most of the time, we buy the wrong gifts or attempt to gift frivolous items that end up in the yard sale or donation pile. Instead, pay for an activity, lunch or something that allows you to maintain and build a good relationship.

Fast Fashion and Cheap Fashion – overrated

Fast Fashion clothes are usually low quality. Buy quality items that cost a little more, and have less junk in the closet.  Buy higher quality dress shoes suits, and purses. Some items like Louis Vuitton are entry luxury items that comes with lower end material that you would find in $300 items. If you can afford luxury, then buy a brand like Hermes because the resell value is better than most Louis Vuitton. I am not a fan of Michael Kors, their $300 bags aren’t high quality vs other $300 bags out there…there’s a reason why MK has been losing their brand equity for a long time.

Used Electronics – Underrated

I rarely ever buy any new electronics. I buy used electronics on eBay. Unless you know how to get the max capability from an electronic product. There is no need to buy the newest electronics. Go for cheaper used 2nd or 3rd generational products that can get the job done.

Under Armour, Under Pressure

Under Amour crashed over 15% after their earnings report on OCT 2016 down to $30 per share… Then on Jan 2017, it reported a second straight quarter of sales lower than anticipated. UA stock is steadily declining to $19-20 per share (4/9/2017). Under Armour is facing challenging sales growth and public relations challenges.

Team UA
Under Armour Sponsored Athletes

UA sponsors some of the biggest names in the industry, including Stephen Curry, Tom Brady, Micheal Phelps, Bryce Harper, Jordan Spieth, Cam Newton, Clayton Kershaw, Lindsey Vonn, Misty Copeland, and many more. Major League Baseball also struck a deal with Under Armour to supply the league uniforms beginning in 2020. UA has one of the best brand ambassadors with MVP recognition from Football, Baseball, Basketball, Swimming, and Golf. The Sponsored athletes are making UA brand relevant as Michael Jordan made Nike relevant in the 90s.

A month ago, Under Armour CEO, Kevin expressed his favorable political views on President Trump, but Stephen Curry, Under Armour top sponsored athlete did not partake the same sentiment about Trump.  Referable to the current political climate, Consumers already have pledged to boycott companies that support Trump. When can we expect Under Armour problems to reset, and refocus itself to become a better company?

What happened to UA?

Under Armour was worth more than $20 billion in 2015 and surpassed Adidas to become the #2 sportswear brand in the U.S. But it rapidly ran into problems that were caused by bad strategic choices.
In the past few years, they have created some critical mistakes investing over $710 Million on fitness apps, and over $100M on R&D for gimmicky tech products like weight scales that provided no value.
1. $150 million for MapMyFitness in 2013
2. $85 million for Endomondo
3. $475 million for MyFitnessPal, both in 2015.

Is Under Armour a digital health, tech or an apparel company?

One of their biggest strategy announcement in recent time was selling more clothes at Khols, which will temporarily add revenue, but it will KILL the BRAND. Do we see any Lulu stuff in Khols? It made a half-ass attempt on Athleisure and said they are departing to focus on PERFORMANCE apparel, it sounds as gimmicky as their tech strategy.

Business Profile
UA expanded their business and signed multiple famous athletes like Tom Brady, Steph Curry, Bryce Harper, and Jordan Spieth. Most of these athletes are MVP or very recognizable athletes in their sport. In recent years, Under Armour stock the market, but it still has all the winning traits to become a great stock to win in the long-run.

UA’s brand identity uses a combination of strategies:
1) On-field authenticity with professional athletes and teams that use its brand and marketing
2) Brand-building activities that position Under Armour as an authentic lifestyle brand with the broader consumer market of active lifestyle consumers, where we think it is beginning to make inroads. 

Supporting UA’s penetration into the sports apparel market is their investments in direct to-consumer business (e-commerce, catalogs, less than two dozen retail stores, and 143 factory outlet stores in North America at the end of 2015), expansion of domestic and international wholesale distribution, and adjacent products. UA offers a wide range of products, including performance training, cleats, running and basketball shoes. The company’s accessories include baseball, football, golf and running gloves incorporating HeatGear and ColdGear technologies, as well as socks, mouth guards and eyewear developed by licensees


UA has 4 product categories: Apparel, Footwear, Accessories, and Licensing all product category has grown 10%+


UA Revenue Distribution: UA’s penetration of the active use sports apparel market is being supported by investments in its direct-to-consumer business (e-commerce, catalogs, less than two dozen retail stores, and 143 factory outlet stores in North America at the end of 2015), expansion of domestic and international wholesale distribution, and product adjacencies.

Can it continue 2016 Growth or will it decline?
As Uncle Ben would say to Peter Parker’s business ‘ With great growth, comes great responsibility to shareholders’. When UA signed Steph Curry to Under Armour, it helped propel UA basketball sales to compete directly against Nike signature shoe brands like LeBron and Kobe. Investors became over enthusiastic about the sales growth and valuation high as 80x P/E between 2014 & 2015.


From 2012-2016 UA CAGR growth was 27%, but the company has reported a trend of declining earnings per share over the past two years. There was a 60% revenue growth in countries like the UK, China, and Germany. In recent earnings, management has lowered its 2017 revenue forecast for 10%-12% growth. UA still has great brands, profitable products, and revenues over 10% a year, but the stock went down ~50% in valuation. Investors are left to once again marvel and question of the power of the Under Armour brand, made famous by catchy commercials, and famous sponsored athletes.

Valuation $24 Per Share
Revenue expected to grow 10  to 12 percent to reach nearly $5.4 billion
Gross margin expected to be slightly down compared to 46.4% in 2016 with benefits in product costs being offset by changes in foreign currency and shifts in the overall sales mix, as the footwear and international businesses continue to outpace the growth of the higher margin apparel and North American businesses;

  • Operating income expected to reach approximately $320 million
  • Effective tax rate of 30 percent
  • EBITDA – 10 to 12%
  • Growth: Assuming UA can maintain the same growth rate of 10-15% for the next 5 years, then the fair price is a 15% to 20% upside.
    • Shoes sales drive by basketball shoes
    • International expansion
    • Direct Revenue from E-commerce
    • Increase sales from Woman’s apparel
    • Supply chain improvements

Risk-
1. Macro – a slowdown in spending on discretionary

2. Distribution problems – Large chains such as Dick’s and footlockers are still expanding their Under Armour assortment. The business partnership has to grow and the logistic operations need to stay lean to keep operating cost low.

3. Direct to consumer problems – While the direct-to-consumer business appears to be enhancing returns, it carries higher risks through markdowns and operating leverage, and requires ongoing investment in stores, websites, marketing, and customer service.

4. Brand dilution – UA is selling at Khols, and discounting products too often. Clearance of excess product through outlet stores

5. Confusing Strategy and Overpaying for Apps and hardware – using a majority of its cash and resources to launching a digital health service and gimmicky tech products. Under Armour culture and talent is not known for health or tech.