Shares of physical video game retailer GameStop (NYSE:GME) have been in a secular decline for several years as the physical video game industry has been cannibalized by a shift to digital downloads. Look no further than a five-year chart of GameStop stock to see the proof of this. Five years ago, GME was a $40 stock. Today, GameStop shares trades hands around $4.
But, this secular loser has shown head-turning signs of life recently. Over the past two weeks, GameStop stock has rallied more than 30% — marking its biggest rally of 2019. Indeed, according to multiple technical indicators, this is the strongest the stock has been in a long, long time.
The catalyst? Ironically, the “Big Short” guy. Hedge fund manager Michael Burry — who gained fame in the film Big Short as the eccentric money manager played by Christian Bale who was one of the first to identify the 2008 housing bubble — has turned into a big GME bull. He publicly disclosed that his fund owns a sizable 3.3% stake in GameStop , wrote management an open letter detailing a strategy to deliver significant shareholder returns, and jumped deeper into the bull thesis in a Barron’s interview – all in the past two weeks.
GameStop stock has rallied big on all of that positive news. The question now: will the rally continue?
In the near term, yes. The stars appear aligned for GME stock to stage a sizable rally over the next six to 12 months. Long term, I’m less convinced. This is still a dying business, and the outlook beyond 12 months lacks sufficient clarity to be bullish in anything more than a one-year window.
GameStop Stock can Rally Over the Next 12 Months
It looks like the tide has turned for GameStop stock in the near term, and that this dying retailer has enough firepower and momentum to stage a meaningful rally over the next few months.
This all starts with the fact that Burry outlined a pretty convincing bull thesis. The company has $480 million in cash on hand. GameStop’s market cap is $350 million. The remaining share buyback program sits around $240 million. Thus, Burry argued, management can use half of its cash balance to buyback essentially 70% of the company’s stock, which would burn shorts and significantly reduce the share count ahead of what could be a really good 2020, powered by new next-gen Playstation and Xbox consoles, both of which will still have disc drives (implying that those new consoles will be accompanied by a surge in hardware video game sales).
Burry also pointed out that there’s less than $500 million in debt on the balance sheet, and that this company rakes in more than $200 million in free cash every year … meaning that even after the big buyback, the company will still have enough cash flow to service its near and long-term commitments.
Thus, Burry basically said that management can buyback 70% of the company’s stock ahead of what could be a relatively blockbuster 2020 for the company, while still being able to viably service its debt and other commitments. That’s a combination which ultimately implies huge upside in GME stock over the next several quarters.
Management may or may not listen to this idea. I’d argue it doesn’t really matter for the near-term thesis. All that really matters is if shareholders listen … and they are. The stock is up 30% since Burry pitched the idea.
So long as shareholders keep listening — and the market grows more and more excited about the prospects of a big buyback and a strong 2020 — the stock will move higher. As such, I think GameStop stock has plenty of runway ahead of it to head materially higher.
Why The Long-Term Outlook Remains Bleak
Although the near-term outlook for GME stock is pretty good, the long-term outlook remains bleak.
This is still a dying business with falling sales and eroding margins. Secular headwinds imply that today’s trends — while they may reverse course in 2020 thanks to a one-time catalyst — will not reverse course in the big picture. That is, while consumers may buy more physical video games in 2020 thanks to new console launches, physical video game buying will fall right back into a downtrend in 2021, and remain there in subsequent years.
Physical video game sales is where GameStop makes most of its money. As such, the long-term outlook here is still for GameStop to experience sales, margin, profit, and cash flow erosion. That outlook does not imply big gains for GME stock in a multi-year window.
As such, while GameStop stock does look interesting for a rebound bid over the next few months, this rebound bid likely won’t be the start of a multi-year recovery in the stock.
Bottom Line on GME Stock
The tide does appear to be turning for GameStop stock. Regardless of if management listens to the buyback idea or not, Burry pointed out enough positives in his bull thesis — namely, a cash balance greater than the market cap, tons of free cash flow, and big new console catalysts on the horizon — that investors are now starting to see GME stock as materially undervalued with upside drivers coming soon.
So long as investors keep looking at GameStop stock this way, the shares will grind higher.
I think investors will keep looking at GameStop stock this way for the foreseeable future. Thus, for the foreseeable future, I think favorable optics will keep the rebound bid in GME stock alive.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
