Do not touch the GameStop stock until it happens
Video game retailer GameStop (NYSE: GME) is in a pickle. The arrival of new game consoles of Sony and Microsoft is supposed to save GameStop’s bacon, but there’s plenty of reason to believe that the PS5 and Xbox Series X won’t be enough. The company’s business plan is deeply flawed and the stock is poised to destroy shareholder value for years to come.
That could change if GameStop decides to adopt a whole new strategy. I might rethink my negative rating on this stock if the company accepts the changes proposed by a group of activist investors, for example. Until then, I wouldn’t touch that stock with a 10ft power sword.
Activist shareholders in turmoil
In November, activist shareholder group RC Ventures disclosed a 9.98% stake in GameStop. The group also proposed some changes to the way the company should run its business.
GameStop is expected to largely abandon its physical retail store network as soon as possible, focusing instead on e-commerce sales and digital game services. In this way, the company can benefit from a valuable brand name and remain relevant in a rapidly changing gaming industry.
“Unfortunately, Mr. Sherman appears determined to focus in the 20th century on physical stores and walk-in sales despite the transition to an ever-active digital world,” RC Ventures said in an open letter to the board of directors of GameStop. “The continuation of the pandemic only accelerates this transition and, in turn, forces companies to take bold steps to compete.”
It could become an attempt to take control
RC Ventures increased its stake in GameStop to 12.9%, according to documents filed with the SEC on Dec. 21. Crossing the 10% threshold is often a sign that activist investors are preparing for an outright buyout attempt in order to implement their radically different management ideas. GameStop has yet to put in place defenses against takeover bids such as a second class of shares with massive voting powers, a classified board of directors that cannot be replaced by a single shareholder vote, or a so-called poison pill that can stop a hostile takeover bid in its tracks by suddenly diluting the stock.
GameStop could still implement some or all of these takeover defenses, but the company likes to claim that its governance policies are stronger because it doesn’t have such defenses in place. I’d be surprised to see GameStop drop this argument overnight, even if it leaves the open company in an active buyout attempt.
RC Ventures is trying to convince GameStop management to try new strategies based on digital sales and exploration of online game services under the well-known GameStop brand. The large and growing ownership stake can put enough pressure on shareholders to make this happen. RC Ventures could even degenerate into a real takeover attempt.
This activist investor knows what he’s talking about. “RC” refers to Ryan Cohen, co-founder and former CEO of the online pet toy company soft (NYSE: CHWY). Chewy’s stock price nearly quadrupled in 2020, supported by 45% revenue growth in the recently released third quarter. This company knows how to run an e-commerce business. Cohen invested $ 76 million of his own funds because he believes GameStop can achieve similar results with a renewed strategy.
That being said, Cohen and RC Ventures could still fail to change GameStop’s fundamental business strategy. I certainly don’t expect the company to come up with a plan for sustainable growth on its own at this point. That’s why I need to see strong evidence that GameStop is getting rid of its outdated focus on physical stores before I even consider press the “buy” button on this stock.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.