GAME Digital: Experiential Bets And Existential Threats

9th May '19 by Jack Brumby

15 comments 4074 reads

A couple of days ago, GAME Digital popped up on the StockRanks Movers page:

This one’s an interesting candidate to look into as it’s been covered in depth by both Paul and Graham in the small-cap report. The story is certainly intriguing: a cash-backed, deep-value play that is quickly reducing operating costs and rolling out a high-growth Esports division.

In the group’s own words: 'Our focus remains on our transformational strategy to move from a seller of physical products to a provider of gaming experiences and services.'

Is this strategy working? Sometimes with a good turnaround story, the facts don’t quite match the narrative.

A preliminary look at the group’s financial summary does suggest signs of progress. The group is forecast to return to net profit by FY2020 after what will have been, by that point, three years of losses.

In Graham’s recent SCVR, however, he notes that a broker on Research Tree has pushed back breakeven to FY21 - so make that (possibly) four years of losses. We might also take this revision as an implicit reminder that turnarounds can be messier and take longer than initially planned.

Profile and valuation

At 26.8p a share, GAME Digital has a market cap of £46.7m and a negative enterprise value of -£47.4m due to a seasonal high of £94m of net cash on its balance sheet. The group has a 68.4% free float and a lively mix of major shareholders:

Sports Direct sticks out here - at the time of writing, it has upped its stake to 29.89% - while Miton and Canaccord are fairly active investors. It’s not hard to surmise from the c5 year share price chart that these managers spy a favourable risk-reward tradeoff:

This is what the StockRanks currently think of GAME:

A loss-making retailer with low operating margins at the best of times is not an obvious 90+ Quality Rank company. What GAME does have, though, is a strong F-Score of 7 (which is heavily weighted in the Quality Rank) and a net cash position £94.1m.

Game’s high Value Rank is more obvious as we can see from its Growth and Value box:

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fwyburd

9th May '19

Thank you Jack for an excellent piece of analysis.

And I agree that the most likely driver of a return to profit will come from the lease re-negotiations rather than Belong. For one, that's where the existing management's core competency lies so the odds look good to me that they can achieve this in the short-term.. However, sales are in decline and margins very tight so I wonder whether they are only delaying a fundamental problem in the medium term unless they can reinvent their underlying business.

The Belong roll-out seems to be moving much more slowly that I (and probably they) envisaged and as you point out, this is an unproven category and 50% of the profits will go to Sports Direct shareholders, so not one to get that excited about. I suspect the FD resigned immediately after the SPD deal for this reason.

So for me (I am long) I don't think this is a long-term investment but a short-term play on the retail estate re-negotiations. And possibly a take-out by Sports Direct which I believe may come sooner rather than later given the unnecessary increase in their holding, most of which occurred before their results.
cheers
Francis

Gromley

Great to see you still here Francis - unfortunately I cannot be in London next week so sadly will not see you there.

Aannnyway

And possibly a take-out by Sports Direct which I believe may come sooner rather than later given the unnecessary increase in their holding, most of which occurred before their results.

Lots of people cite this, but I think it is totally baseless. My research is far from exhaustive on the topic, but when I looked I found quite a few instances of Cashley going to 29% with an investment, but I don't think I say anyway where he went to 30% and forced a bid.

It seems to me that he buys power & often de-facto control, but I haven't seen instances where he buys actual and responsibility.

In the recent case of Debenhams (LON:DEB) , I suspect that he managed to scupper and sale of Magasin du Nord which would potentially have saved shareholders - neither the bond holders nor the board co-operated with him so he didn't win in this case, but the shareholders lost in either case.

With regards GAME Digital (LON:GMD) he has already achieved the GMD / SPD tie up over Belong, which looks far more favourable to SPD than it does to holders of Game equity.

It's all a case of joining the dots, but I strikes me that having Mike Ashley as a fellow shareholder is NOT a comfortable place to be - he's more powerful and possibly 'smarter' than you and it is nott rue that "we're all in this together".

10th May '19

Hi Gromley, good to hear your views.
What I can't understand is why he needed to up his stake at all. To my mind he already had the power to exercise his will with 50% of Belong and a 25.44% stake and the move to over 29% seemed unnecessary to me. Your understanding of his history is useful tho' so perhaps I have read too much into this.
However i remain long because of the retail turnaround prospects rather than the prospects of Ashley making a bid.
cheers
Francis

Jack Brumby

Thanks Francis,

The price/sales of 0.062 says a lot... Revenue and costs are many times larger than market cap so small changes here could drive significant changes in share price. I'm presuming that's why Miton et al have taken stakes, anyway. An average 59% reduction in rent must substantially change shop profitability - and it's a reminder that retail and leisure landlords are probably viewing break clauses with a certain amount of trepidation these days

abtan

Thanks again Jack for another informative article.

To add to the above, it's worth noting that GAME Digital (LON:GMD) have stated that:

they only have a handful of unprofitable stores (as per one of the calls recently)
store sales are much higher where there is an attached Belong store
I personally believe there will always be a physical market place for gaming accessories
They have vast credit facilities but I don't think they've actually needed them in the last couple of years, and simply use their own cash for all working capital requirements.
OCF (adjusted for one-off gain last year) was c £7.5m. So even if they were to stop Belong expansion/CAPEX expenditure they would be materially cash generative relative to their size.
Belong social media interactions (on Twitter at least) have been growing in the last 12 months, especially in their internal leagues

Cheers

rhomboid1

GAME Digital (LON:GMD) most definitely do draw on their loan facility in Spain....in fact they extended it recently to improve headroom. Their Year End captures cash at or around its high point

From the AR

‘
Net finance costs
Net financing costs totalled £1.3 million (2017: £1.3 million). All
of the facilities in the UK were undrawn in the period, however commitment fees and the amortisation of arrangements fees were incurred together with interest costs on finance leases. The Spanish business utilised its facilities during the period.’

I should note that they are possibly drawing down on the facility in the U.K. too as they did have a one off freehold sale of their HQ

They also say

‘
Cash resources and financing
As at 28 July 2018 the Group had cash and cash equivalents of £58.7 million (2017: £47.2 million) and the UK and Spanish banking and other facilities were undrawn.
Borrowings in the consolidated statement of financial position are finance lease liabilities.
The Group has access to combined facilities across the UK and Spain of up to £130 million, increasing up to £169 million over the peak period, as follows:
— A UK asset-backed revolving loan facility agreement with PNC
Financial Services UK Limited and Wells Fargo Capital Finance (UK) Limited of up to £50 million, increasing to £75 million in the peak period, expiring on 31 December 2020.
— A financing facility with a syndicate of Spanish banks amounting to €28.0 million and increasing by a further €16.0 million during the peak season, expiring on 31 January 2020.
— A £20 million unsecured working capital facility and a
£35 million unsecured capital expenditure facility provided by Sportsdirect.com Retail Limited, the latter of which the Group may utilise to fund the opening of new BELONG arenas and Game Retail stores under the collaboration agreement.
The working capital facility is available until 31 January 2019, with the option to request a one year extension. The capital expenditure facility is available for drawing over quarterly periods expiring 31 January 2023.

Thanks for the clarification Rhom.

In the interim report - period ending March 31st 2019 - they stated the following:
"All facilities undrawn at end of the period and UK facilities yet to be drawn "

I, perhaps ignorantly, therefore assumed that they had not used any of their Spanish facilites,but you're correct, it looks like they did use them, but then had paid everything back by the end of March.

I’ve held GAME Digital (LON:GMD) before but exited because I lacked faith in mgt being straightforward...they always seem happy to let people assume the cash is a permanent fixture of the business but it isn’t....I’m also curious about how rigorously they write down used games & consoles...but that is another Q

Best of luck anyhow

11th May '19

Hi Abtan,

Good point about BELONG driving incremental retail revenue - now you mention it I recall seeing that in one of their presentations. As for social media, I've just been scrolling through the BELONG twitter account and the engagement does seem to be there but it's not something I've tracked over time. Who knows, maybe with a bit of patience and marketing, social gaming in-store will really take off?

nicobos

5th Jun '19

GAME Digital (LON:GMD) - for those that haven't seen - Mashley has made an offer at 30p for the Group.

"The Offer of 30 pence in cash for each GAME Share is final and the offer price will not be increased."

Seems a bit tight ! Any views?

I think Mashley has got a bargain there.

Does anyone know if it's possible for someone else to come along with a higher offer? I doubt it will happen so I am asking out of curiosity more than anything else.

I suspect he had to act now before the year end to get away with such a miserly offer. Great for him but not so good for those of us who were expecting to see more reductions in retail costs.

I can't see a higher offer coming through but you never know...
cheers
Francis

As I noted on the SCVR thread earlier, I was clearly wrong in my view that Ashley would bid and in fact now I look back Francis was right on the money, with the 9th of May comment :

In fact my response to that was to describe the view as "totally baseless" - nothing like being forthright is there!

In my defence I should clarify that I was implicitly referring to the idea that Cashley would launch a premium bid. Although the bid is at a near 30% premium to the previous day's close it is not at a level that I suspect most shareholders would consider overly generous.

In fact I am not sure what the intention here is. He is making a bid for the entire share capital because he has to under the takeover code after the latest purchase, but he may not be especially bothered whether it succeeds or not.

On another site, someone pulled out the fact that the bid is "final and the offer price will not be increased." To be fair I have not read a bid which is described as provisional and the price will be increased if not enough people accept ;-) Equally though, I don't recall previously seeing a categoric statement that the bid will not be increased - does that not box him in somewhat?

If he's not bothered about the take-over then what would be the motivation for buying this extra 10%? Does having 40% of the shares proffer significantly greater influence than having 30%? Open question - I really don't know.

The takeover is certainly not yet a done deal - a counter bid is inconceivable imho given Ashley's blocking stake, together with his >50% interest in the economic benefit of BELONG and the debt facilities.

In normal circumstances I would say that there is no rush for shareholders who consider the bid too low to act - In fact I personally made just that call recently in a similar situation with Bonmarche Holdings (LON:BON) (where I paid above the bid price for a small stake, because I feel it offers support and I believe the longer term value is potentially sufficiently greater - as it stands that bid looks likely to fail)

In this case though I would personally feel uncomfortable that all shareholders interests were aligned.

And that perhaps has to be a key consideration here.

No advice intended of course.

Vsihv

6th Jun '19

Have a question for those that understand takeover rules.

I can currently sell at 29.1p (give or take) with broker commission on top.
If I wait for the mandatory offer, I would sell for 30p with no additional commission - i.e. would not have to deal with the transaction cost.
Is my understanding correct here? Many thanks in advance.

Personally, I wouldn't call it generous, but its a small holding and I did not have the conviction to add, so quite frankly I welcome the bid which allows me to get out at a small profit as opposed to a small loss (finger was on the button just as the news broke, but then they wouldn't give me a price!!

InvestorJohn

7th Jun '19

sharmvr

There wont be any commission charged on the Takeover but you will have to wait for ages on your money...

Sometimes it is better to take the price as offered through your normal broker and move the money on to another opportunity, as long as you think that an improved bid is unlikely

GAME Digital: experiential bets and existential threats

Profile and valuation

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Jack Brumby

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