No matter what GameStop Corp. (NYSE:GME) does, the video game retailer just can’t seem to shake the Blockbuster Inc. comparisons.
GameStop has pushed into the mobile arena, including operating a whole bunch of wireless retail stores. In fact, GameStop is the largest authorized retailer of AT&T Inc. (NYSE:T) mobility offerings. GameStop also owns Simply Mac, the largest certified re-seller of Apple Inc. (NASDAQ:AAPL) products.
GameStop has also fully capitalized on what has been huge demand for the Nintendo Co., Ltd (ADR) (OTCMKTS:NTDOY) Switch console. New video game hardware revenues are up more than 20% so far in 2017.
Yet despite all the hype around mobile phone growth, Apple, the iPhone X, the Switch, and augmented/virtual reality, GME stock has sputtered to its lowest level since 2012. The valuation (just over 5-times earnings) is as low as its ever been.
Right now, there is simply no investor demand for GME stock. The Blockbuster comps remain far too relevant.
But that doesn’t mean investor demand can’t ramp up quickly if GameStop shakes off those Blockbuster comps.
I think that is exactly what GameStop will do over the next 12 months, and that is why I’m buying GME stock here.
Parts of GameStop’s Business Will Survive the Video Game Apocalypse
You would never guess it by looking at the stock, but GME has actually largely beaten analyst estimates so far this year.
The problem is that the beats are being driven by the Switch. The market doesn’t like that. Switch is a one-time hardware revenue boost. Same with the new iPhones, which is why despite management’s best efforts to play up growth from these new products, investors aren’t buying it.
Investors are instead focusing on continued erosion in the pre-owned business, which is the company’s biggest profit driver. Declines there aren’t moderating at all. Last year, pre-owned sales fell 5.1%. Last quarter, they fell 7.5%.
The writing is on the wall. The pre-owned business, much like Blockbuster, is doomed. Digital games will eat this business alive. Same with the new software business.
But the rest of GME’s business will be just fine in the long-term. Hardware sales have longevity because that isn’t something that can be replicated by a digital sale. Same with accessories and collectibles. The tech brands business is fine because consumers will always need to buy smartphones and other mobility offerings. The digital business will grow for the same reasons the software business will continue to decline.
All together, those revenue streams accounted for 44% of revenue last quarter and grew by 18% year-over-year. Those businesses also accounted for 47% of total gross profit last quarter while gross profit rose 16% year-over-year.
Numbers Imply Favorable Risk-Reward Asymmetry
The bull thesis is simple.
With a 5-times earnings multiple, an 8.5% dividend yield, a near 30% free cash-flow yield, and a pretty big cash pile on the balance sheet, GME stock is about as cheap it gets.
The only reason you don’t buy it is if you think the business is going under.
Because of the revenue diversification in mobile, hardware, and toys, I don’t think GME is going under. It will take the market time to realize this. As ironic as it may seem, we may have wait for the Switch and iPhone X catalysts to come and go. Once those catalysts are gone, investors will be able to see GME for what it is without one-time boosts to revenue.
I think investors will like what they see, especially against the depressed valuation backdrop.
Bottom Line on GME Stock
It’s a classic case of near-term pain, long-term gain. This business isn’t going the way of Blockbuster because it has necessarily and effectively diversified away from selling just video games. The market has yet to bite on this turnaround narrative, but I think it’s only a matter of time.
At this point, the valuation feels sufficiently depressed to protect against further downside. Mitigated valuation risk with promising turnaround potential implies a good time to buy to GME stock.
As of this writing, Luke Lango was long GME.