U.S. Markets closed

Not Even an Activist Investor Can Improve GameStop's Chances in Q2

Rich Duprey, The Motley Fool

Scion Asset Management founder Michael Burry recently staked out a 2.75 million share position in GameStop (NYSE: GME), for about a 3% holding. Burry, who famously called the subprime mortgage implosion and was the subject of the book and movie The Big Short, believes there is still value left in the video game retailer despite -- or perhaps because of -- its having lost 70% of its value in 2019.

As GameStop is scheduled to report its second-quarter earnings on Tuesday, September 10, let's take a look at what Burry might be expecting and whether investors may want to follow him into this company.

Kids playing video games

Image source: Getty Images.

Playing the long game

Part of the rationale behind Burry's investment thesis is that GameStop will rebound in the 2020-2021 video game console upgrade cycle. Both Sony (NYSE: SNE) and Microsoft (NASDAQ: MSFT) will soon be releasing new Playstation and Xbox consoles, respectively, which will help GameStop boost hardware sales, which accounted for just 15% of sales in the first quarter, down from 20% a year ago.

During the last upgrade cycle, when the Playstation 4 and Xbox X were introduced in 2013, hardware sales surged 88% in the quarter they were released and represented over 31% of total sales. For the full year, hardware sales were up 17% and accounted for almost 22% of sales. In 2015, however, sales dipped 4% and hardware dipped below 20% of sales again.

Coming into focus

Yet Burry might not see the same kind of bounce with GameStop with this generation of consoles. No doubt there will be an increase, as not everyone is willing or able to fully move over to digital downloads or online games, the main obstacles to GameStop's recovery, but the technological improvements for the Playstation 5 and the new Xbox also likely won't be as grand as with prior upgrade iterations, inhibiting greater uptake.

Going from the 8-bit graphics of the very first systems to the 1080p video resolution of today's consoles was dramatic, but with the leap to 4K -- and in some cases 8K -- the enhancement isn't as great for most gamers because most don't have 4K screens, let alone 8K.

Most will be able to happily play games on the current consoles on their current TV sets without any real noticeable deficit in quality. Sure, some videophiles might be able to tell the difference, but not the vast majority. And a higher price point for negligible performance gains might be a tough sell. GameStop sales might rise for a quarter or two, but it's likely any such rise won't have a very long tail.

Rejiggering the share count

The other rationale behind Burry's investment was the potential for GameStop to buy back a huge chunk of stock to eliminate the number of shares outstanding and thereby give earnings per share a dramatic boost.

In his letter to GameStop's board when taking his stake in the company, Burry told the retailer it must "complete the remaining $237,600,000 share repurchase at once and with urgency" because it would boost EPS far more than any other single action the company could take. 

He says the market has no faith in management to take the proper course of action. As GameStop was fiddling with buying and then selling its mobile phone assets, Amazon (NASDAQ: AMZN) was scooping up Twitch and GameSparks. "Shareholders are right to worry" about management's capabilities. Reducing the share count ahead of the console upgrade cycle will have a "multi-fold greater impact per share" (emphasis in original).

While that smacks of a bit too much short-term thinking that really does nothing to change the underlying health of the business, it's also predicated on the new consoles' being big sellers. As we've seen, that may not happen, or last for long if it does.

Still a dark future

None of this will affect the current status of GameStop, which is likely to see the same downward pressures on its business that have afflicted it for the past few years. There's been no catalyst to reverse the trend and turn the video game retailer into a growth stock again, and with GameStop's stock trading below $4 a share even after Burry announced his activist intentions, it seems the market isn't holding out much hope, either.

Analysts are looking for a 17% drop in sales this quarter to under $1.4 billion and expect earnings to turn from last year's $0.05 per-share profit to a $0.22 per-share loss this time around. Even with Burry's involvement, investors shouldn't expect things to get much better, either.

More From The Motley Fool

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Rich Duprey has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon and Microsoft. The Motley Fool owns shares of GameStop and has the following options: long January 2021 $85 calls on Microsoft. The Motley Fool has a disclosure policy.

This article was originally published on Fool.com