Game Over for GameStop Stock?

While it’s too early say with any level of certainty, it appears GameStop (NYSE: GME) is on a path to exit the public markets. Reuters broke the news that the video-game retailer is talking to private equity firms about a possible takeout transaction, returning to a private company.

In totality, it’s hard to classify GameStop’s public performance as anything but a disappointment. Once considered the hottest specialty retailer, the company at one time had a valuation approaching $10 billion and a stock price of $60 per share. Shares currently trade hands at $15.50, less than its 2002 IPO price of $18 per share. Should GameStop join a list of retailers and go private?

Image source: Getty Images.

Private equity’s track record with retailers has been less than stellar

Private equity’s ownership of retailers has become an acrimonious debate. Many blame private equity firms for hastening retailers’ demise, as the leveraged-buyout process loads up the company with significant amounts of debt. Others, myself included, feel the failure is more nuanced, and blame can be spread more equally, including changing consumer tastes and the rise of technology, particularly the growth of e-commerce from Amazon.

Regardless of your opinion, though, you can’t help but notice that private equity’s strategy to revive retailers doesn’t appear to be working as of late. Payless ShoeSource, Gymboree, rue21 Inc., True Religion, and Toys R Us are all examples of private-equity owned retailers that filed for bankruptcy recently.

Echoes of Blockbuster and Tower Records

GameStop’s situation is similar to that of two other failed retailers: Tower Records and Blockbuster. Under pressure from new content-delivery models — Tower Records via both legal (Apple‘s iTunes) and illegal (Napster) downloads, and Blockbuster from Netflix — both companies were forced to file for bankruptcy.

Initially, it appeared that GameStop would be inoculated from this fate as gaming required more data transfer than music and movies, and console gaming companies resisted the trend to digitally deliver games. However, those days are over: Game-maker Electronic Arts estimates that 40% of new console game sales are delivered as digital downloads. In response, GameStop wisely transitioned its business model as a used-game retailer, but eventually, digital downloads will end that business as inventory will eventually be exhausted or rendered obsolete via technological upgrades.

Sometimes things are cheap for a reason

The argument to buy GameStop, both for individual investors and from a private-equity standpoint, is the stock is extremely cheap on a relative basis. The company is valued at five times consensus forward earnings, versus 17 times the multiple for the greater S&P 500.

As a mere comparison, if investors assigned the same multiple as the greater market, GameStop stock would trade for more than $55 per share. At 11%, its dividend yield is six times that of the greater S&P 500. The company is cheap on a free-cash-flow basis, which is the metric private equity uses to gauge return in a leveraged buyout investment.

However, sometimes things are cheap for a reason. Long-term focused individual investors should understand that without a significant intervention, one that probably won’t occur as a publicly traded company, it’s likely GameStop will follow the path of Blockbuster and Tower Records. Against these odds, GameStop’s best bet may be to exit the public markets via a leveraged-buyout transaction. But as we’ve seen, there’s no guarantee this will revive the company’s fortunes either.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Jamal Carnette, CFA, owns shares of Amazon and Apple. The Motley Fool owns shares of and recommends Amazon, Apple, and Netflix. The Motley Fool owns shares of GameStop and has the following options: long January 2020 $150 calls on Apple, short January 2020 $155 calls on Apple, and short July 2018 $14 calls on GameStop. The Motley Fool recommends Electronic Arts. The Motley Fool has a disclosure policy.

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