Coronavirus Exposes Danger of Short-Term Activism at GameStop
Activist Investors Want Board Representation at GameStop Corp.
When it comes to short-term activist strategies, the coronavirus should teach investors to beware of playing risky games.
In February 2019, video-game retailer GameStop Corp. received a demand from activist investors Hestia Capital and Permit Capital: Take virtually all of the $700 million from the recent sale of Spring Mobile and pile it into share buybacks. But rather than follow Hestia and Permit’s advice, Gamestop allocated the cash more cautiously – to about $400 million in debt reduction and $220 million in share buybacks and dividends.
The decision by GameStop now looks smart in multiple ways. First, and most obviously, the share price of the company has fallen precipitously in the last few months. Much of that decline coincided with the coronavirus selloff that hit companies across the board.
More important was GameStop’s decision to keep a strong balance sheet. As of November, the most recent point in time disclosed, the company had $419 million of debt – or just $129 million net of cash. Also, the company has a full year before the debt will need to be paid off or refinanced.
Even with the reduced debt amount, the bond market suggests GameStop isn’t quite out of the woods. GameStop received a credit downgrade in January from Moody’s and the bonds due next year have plummeted in the last few weeks, now yielding well north of 20%.
Had the company elected to spend all of its cash on buybacks, its leverage would have been far higher. In turn, its cost of financing would likely have risen significantly. And with the credit market seizing up, it could be impossible to refinance, potentially leaving GameStop facing much deeper issues.
Despite all of that, the activists made another demand last week: to put one of their representatives on GameStop’s board. “We believe a fully-aligned stockholder representative can make an enormous difference in the boardroom by advocating on behalf of all GameStop stockholders on a regular basis,” the activists wrote in a letter to the company.
But it’s hard to imagine what wisdom the activist shareholders could impart at this point. A decision to buy back a larger number of shares could have been catastrophic. And the company has taken steps to fill its board with people who bring experience as operators – not portfolio managers.
Indeed, GameStop announced earlier in March it would undergo a board overhaul, with four directors stepping down this year and two more in 2021. The company also announced the appointment of three independent directors, including former Nintendo of North America President Reginald Fils-Aimé, former Walmart U.S. President Bill Simon, and current PetSmart, Inc. CEO James Symancyk.
And, of course, the activists already won a place for one of their own nominees, Lizabeth Dunn, who joined the board last April. The company also selected Raul Fernandez – a director the activists supported – who joined the board alongside Ms. Dunn.
Where will the company go from here? The reality is that that video-game retailers face serious challenges as games are increasingly downloaded rather than bought in stores.
The good news is that GameStop should see bumper sales in 2020, when the major console makers all release their latest editions. Those consoles are big-ticket items and should also bring a surge in sales of physical games. All that points to a much-needed windfall of cash from operations, keeping the balance sheet strong.
GameStop shares could be a bargain at current levels, which reflect an enterprise value of just 2.8 times 2021 consensus Ebitda, according to Sentieo, a leading AI-enabled financial research and workflow platform. But the company still has its work cut out to adjust to the structural shift toward digital games. At this phase, GameStop would be better served listening to a seasoned board than agitated shareholders who have already had their say.
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John Jannarone, Editor-in-Chief
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