Small Cap Value Report (30 June 2017) - GMD, TNI, FJET

30th Jun '17 by Graham Neary

36 comments 17791 reads

Good morning,

It's the last day of H1, which means that some companies are producing results today because they have to (if their calendar year-end is December).

Better companies tend to have their results known long in advance of deadline, and it puts investors at a disadvantage when they have to wait so long to see what is happening, so this is a red flag. It's not that any company which does this is uninvestable - it's just something which should spark extra caution!

Onto a few updates:

Game Digital (LON:GMD)

Share price: 23.6p (-28%)
No. of shares: 170.9 million
Market cap: £40 million

Trading Update

I last covered this games and console retailer at the interim results in March, when the share price was 42p (for context, it IPO'd at 200p in 2014).

Value destruction in terms of the share price has therefore been immense and investors are now again pricing in financial distress. It last went into administration in 2012.

Consumer demand for Nintendo Switch has been, and remains, very strong, however the level of supply to the UK market has been lower than expected. These lower levels, combined with continued softness in our core Xbox and PlayStation markets, have impacted sales.

The Group still expects to deliver positive Group GTV² growth in the secondhalf of approximately 5-6%, however this is below our previous expectation. As a result, we now expect Adjusted EBITDA for the full year to be substantially below previous expectations.

You don't need a particularly long memory to know that when things go bad at GAME, they go really bad.

But since already halving its UK stores from the peak, and disposing of nearly all the international operations, it seemed to have a much better chance of sticking around for a decent period of time in its current incarnation.

The harsh share price reaction today may also be related to this paragraph:

Significant efforts are being made on reducing fixed and variable costs across the Group's UK retail footprint, where we have over 220 lease events to manage by the end of 2018.

That sounds very complicated but the average UK lease length is just 1.2 years, so it's not a surprise that there would be so many lease "events" over the next 18 months.

I'm intrigued as to…

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bestace

2nd Jul '17

Game Digital (LON:GMD) is an interesting one. It's not a company I've looked at previously, having just assumed it was another HMV in the making. However although it appears to be priced for terminal decline (after Friday's sell off, P/E is less than 6, Price/Book is just 0.27, Price/tangible book 0.44, Enterprise value is negative £32m, EV/EBITDA is negative 1.6), it is still profitable and has a sizeable cash pile, so there may well be a value-based case for investing at this point.

Despite all the gloom surrounding high street retail, I was surprised to read in their last interims that they only had one store out of 316 in the UK portfolio that was loss making. I would have expected a pretty lengthy tail of loss making stores that were holding back overall profitability, but that's not the case.

So even if you accept the premise that the high street retail business is in terminal decline, the extremely short lease lengths means it should be possible to manage this decline in a relatively orderly fashion.

As an aside, the presentation accompanying the last interims included a chart of the lease expiry profile:

Paul has highlighted how the investment case for him rests on this being a 'cigar butt' investment, but it seems to me there is also a longer term investment case, namely looking at whether there is any value in the non- high street retail activities and secondly whether the company can successfully transition to refocus on those activities before the high street cash cow expires its last breath.

Having dug into the company a bit further since Friday's RNS, I was reminded of the story of Western Union declining to buy the patent for the telephone from Alexander Graham Bell in 1876, because they saw themselves as being in the telegraph industry when they would have been better off seeing themselves as being in the communications industry.

So with Game Digital (LON:GMD), I think it could be a mistake to write them off as a high street retailer of games when it might be more accurate to view them as, to use their own words:

a leading gaming company, providing an authoritative range of gaming and gaming lifestyle-related products and services to its customers.

Perhaps that is just marketing guff, but viewed from another perspective, the dying high street retail business is but one of several strings to their bow.

The core retail business is, for the time being, still profitable and generating cash. If it can continue to at least wash its face for a few more years, and taken together with the existing cash balances and lines of credit available to them, there appears to be some breathing room to allow management to execute on the transition away from high street retail towards their other activities.

This can be contrasted with the case of HMV which was also trying to diversify away from high street retail when they went bust. In their case they had little breathing room to execute on that transition because they were heavily loss making, cashflow negative, had high net debt, were in talks with the banks, had going concern 'material uncertainties' and ultimately had to sell off their live music arm in a last ditch attempt to remain solvent. None of those things currently apply to GMD.

Notwithstanding this, I would hope GMD's core retail arm can do a bit more than just wash its face given that online and digital sales are also included in this segment. According to Edison they received 121 million visitors to their website in FY16 with online sales accounting for 17% of gross transaction value. Digital sales exceeded £110m of gross transaction value in FY16 and has been growing at around 18% per annum.

By comparison, £G4M received 12.6 million visitors to their website in their last financial year, yes that's just 10% of GMD's website traffic and G4M has a market cap of £150m which is now 5 times larger than GMD's. G4M may well have a higher growth rate in retail sales and slightly higher gross margins, but given that GMD currently has a negative enterprise value, the growing online/digital sales and non-retail activities are effectively thrown in for free.

So what about these other non-retail activities? At present, the company lumps them into a single reporting category 'Events, Esports and Digital' (EED). It's interesting that neither Graham nor virtually any of the other posters have mentioned these activities. As I alluded to above, many seem to be writing off the company based only on the traditional high street retail business as if there are no online/digital sales, or that there is no transition narrative at play here, or assuming that the company will fail in that transition.

Perhaps that is fair enough given EED activities in aggregate are currently loss making and its revenues in the last interims amounted to less than 2% of total revenues. However EED grew at 120% and they are expecting these "newer areas of the business... to develop substantially over the next three years, recognising that it will take time for these areas to mature and contribute at similar levels to our core retail businesses."

Given the currently negative enterprise value of the company, I don't even think the new business areas need to grow to become similar in size to the retail business, I think all they would need to do to provide upside from the current share price is to mature into viable businesses in their own right, even if at a much smaller scale than the traditional high street retail business.

From my brief research I don't think the company have provided enough information to be able to estimate a sensible bottom up sum-of-the-parts valuation of their EED activities, which is a shame. However the BELONG gaming arenas look interesting. It costs between £50-100k to refit a store (sounds low to me given the hi-tech spec of equipment required, but those are the figures they are quoting) and they anticipate payback between 6-18 months with a 12% operating margin. Taking the mid point of both ranges, that implies a contribution of around £75k per store, multiply that by say 50 stores and you start to see where there might be some value.

Despite minimal marketing, this is what has happened to sales at stores which have been refitted as BELONG gaming arenas:

Then there is esport events from which they can generate ticketing income, merchandise, sponsorship etc., the Insomnia NEC convention which grossed £5m last year, various enterprise server hosting activities, VR/AR advertising and a bunch of other stuff, so it's all small scale but has potential for growth.

So I'm sticking a finger in the air by saying I could envisage them turning over £50m within a few years from EED, making a profit of say £3-4m. Adding another £5m from digital/online retail profits and applying a multiple of 10 (more fingers in the air) would get to an enterprise value of around £85m.

That would be upside of around 70p per share, a trebling from where we are today ignoring movements on cash balances. Clearly the execution risk is high and my fingers in the air may be way off base, but given the enterprise value is negative at today's share price, and given the overwhelmingly negative commentary on the company's prospects, it seems to me at least arguable that the risk/reward lies considerably to the upside.

seadoc

30th Jun '17

Avingtrans (LON:AVG) Hayward Tyler (LON:HAYT) Job done. Bit surprised Avingtrans (LON:AVG) dropped today, perhaps they (shareholders) were hoping to get Hayward Tyler (LON:HAYT) out of the cash? But I have been buying Hayward Tyler (LON:HAYT) on all dips so, having tendered my half of Avingtrans (LON:AVG), and put into Hayward Tyler (LON:HAYT) I do not think I am out of pocket. As for the deal, probably made in heaven, great match and full marks to board of Avingtrans (LON:AVG) Clearly Hayward Tyler (LON:HAYT) was a distressed sale, the board held on for best (lowest) price and an agreed sale.

Seadoc

PS Phil, last comment I can find from Paul was 26th?

Thunderball

For Game read Blockbuster or HMV. This is a redundant concept in its death throes. Personally i would avoid, surely the clever money will look to abandon resulting in no support for the share price - buy as a short term value play at your own risk. I think the cash pile and zero debt is the trap awaiting the unwary. Their stores once had the highest turnover/sqft of any retailer, they are now a clumsy mess giving the impression of desperation and looking like a kiosk/market stall. I dont think they know where they are going.....

Paul Scott

Hi Thunderball,

That may all be true, but the key point of difference with GMD is that most of their UK leases are expiring, or can be broken, in the next 18 months. That gives the company amazing flexibility to ditch the loss-making sites, and negotiate substantially lower rents on other sites.

Therefore, there seems to be the potential for the company to re-organise itself in such a way that costs could be greatly reduced, and cherry-pick only the best, most profitable stores. The rest it can just hand back. That's a very interesting situation, and I don't recall ever seeing a retailer which has such short lease expiries on the bulk of its estate.

The current valuation of just under £40m is not much more than half the company's own working capital, and there's no debt to worry about.

Liberum say today that consensus FY17 forecast EBITDA is likely to fall from £19m to £6-9m. So it's still cashflow positive, in a bad year, and the company seemed to be saying today that next year should be better.

For all the negatives views, this is a company generating c.£800m of revenues, so it's clearly got a market - even if we can probably all agree that it may not still be around in 10 years' time.
There could be decent disposal value in its Spanish business.

So I think this is a very interesting special situation. It might be that the UK business could be wound down on lease expiries, the successful Spanish business sold, and then there could be a resulting cash pile of maybe double, or more the current market cap.

I should disclose that I've picked up a bit of stock today, seeing this very much as a special situation - and unique - I don't recall ever seeing a similar situation, where the bulk of the estate could be restructured inside 18 months, from a business that is still generating positive cashflow, and has a sound balance sheet.

This is definitely not a good long-term investment, but it could well be a lucrative special situation maybe? Thanks for flagging this one Graham.

I should add that it was easy to buy stock, so there is clearly Institutional selling. Therefore, the share price could well go lower in the short term, and probably will! It's very difficult trying to time the low point, and personally I don't even try. The good thing about a falling share price is that you can buy easily, and in whatever size you want. Although it depends on your attitude towards short term losses - personally, a 20-30% loss doesn't really bother me, if I'm confident that the final outcome is likely to be 50%+ profit on my original purchase, which I think is a distinct possibility here.

Have a good weekend, all!

Regards, Paul.

Star8

Perhaps in order to get a perspective on GAME one should review Gamestop, a US quoted stock symbol GME in the same business and situation.

Disclosure: I hold GME to my chagrin.

GME is massively bigger than Game and the shares have about halved in the past year or so.

Summary from Standard & Poors: This company is the largest U.S. video game and PC entertainment software
specialty retailer, with about 7,500 stores worldwide, as of March 23, 2017

From memory they have about 7500 stores in a North America and Europe - but none in the UK.
Sales from gaming and even more, profits have dropped. GME is trying to diversify into having outlets for
1 - Apple
2 - AT& T mobile phones.

While apparently successful to date ( these activities are profitable and growing) but overall profits are being swamped by the decline in Games sales hardware and software.

GME has sales which are growing or slightly declining over the last 6 years. The company has been profitable in 5 of the last 6 years. EPS has been maintained/declined somewhat over the last few years mainly by extensive share buybacks - which seem to be tailing off.

S & P has them rated as a Buy (4 stars out of 5).

However the GME PE of 6.5 and a Dividend of 7% says it all: the Dividend could be cut if sales and profits drop (at present the company is net cash positive).

Overall this seems to be a bet as to whether an industry operator can survive a structural decline in the industry mode of operation. Considerable risk ?.

Re Game Digital (LON:GMD) - I've been refreshing my memory of what happened why it went bust in 2012, in a previous incarnation.

I can remember it well, as I (foolishly!) thought it might survive, and bottom-fished the shares. However, the warning signs of impending collapse became very obvious from the various RNSs in early 2012, and thankfully I realised in time that it was no good, and managed to sell out at a profit, on a brief spike up. More luck than judgement, that's for sure! A narrow escape, hence why I'm nervous about looking at it again, now.

The key issue then was both the bank & suppliers lost confidence in the business, and withdrew funding.

So how does GMG in 2012 compare with the situation of Game Digital (LON:GMD) today?

Interestingly, there are marked differences between the balance sheets. If you look at the last reported balance sheet of GMG from July 2011, it was poor - the current ratio was just under 1, and the company relied on a lot of bank debt - it had cash of £41.0m, less bank debt of £132m, so net debt of £91m. The company was also a good bit bigger than it is now.
http://www.investegate.co.uk/g...

To compare that with now, if you look at GMD's seasonally comparable balance sheet, as at July 2016, it's much better: http://www.investegate.co.uk/g...

The current ratio was 1.62 (pretty healthy), and it had net cash of £38.5m.

Moreover, GMG couldn't get out of loss-making sites. Whereas GMD has the opportunity to renegotiate or exit the bulk of its UK leases in the next 18 months. Sure that means more capex, if it relocates, but it might also be able to negotiate landlord cash bungs (reverse premiums and/or rent-free periods) to alleviate this.

As Graham says in the main article, GMD is clearly NOT in financial distress. Although it's a very seasonal business, which relies on a (secured) bank overdraft to get through the peak Xmas stock build-up. So it's not without risk. In my experience, banks like seasonal lending - because they get their money back reliably. What they don't like is quasi-equity lending, where it's difficult to get their money back.

So the risk with GMD is seasonal I think - the biggest danger of the company going bust would be after Xmas, when it's strongly net cash, and the bank could withdraw overdraft facilities without losing a penny. Although I cannot see any reason, from the figures, why they would do that. This seems a well-financed business, with a sound balance sheet.

The valuation, market cap of c.£40m, seems amazingly low, considering that the company's own net cash was £69m when last reported, and creditors were not stretched at all - quite the opposite, they had just been paid (due to timing difference in H1 period end, the monthly supplier payment run had already been done - which gives considerable confidence I think - this business is NOT stretching its creditors, and has no need to do so).

All in all, this stock won't interest many people, as it's a special situation. But I think it looks potentially very interesting. You very rarely get the chance to buy a cash generative business for considerably less than its own working capital.

Definitely worth a look at this price - as a special situation only - i.e. I'd want to be out of this share within, say 1 year. But likely to get cheaper next week, I reckon - Instis seems to be dumping.

Regards, Paul (at the time of writing, I hold a long position in this share)

Heisenberg

Paul. Selling consoles and games from physical stores is a really hard game these days (pardon the pun) . It seems any title Game have is cheaper on Amazon (plus if you have Prime you have it next day), but more to the point that is increasingly irrevelvant with digital downloads and upgrades direct from game studios or PS / Xbox. I thought that retailers such as Game may have had a place on pre-owned where margins can be quite attractive but evidently that is also not the case - perhaps the digital era is also killing this off. Just think this is a structurally challenged market and it will not matter who runs the company or what they do because the economics now are totally stacked against them.

Heisenberg,

Yes, you're probably right.

However, to reiterate, the reason GMD might be interesting right now, is as a special situation.

What I mean by that, is that the market cap is now well below the company's own working capital. So this is a value situation. Therefore we need to look at it differently. It doesn't matter whether the company still exists in 5 years' time or not. The investing opportunity is that it could be worth more than the current market cap in a wind-down scenario. Plus the costs could be slashed within the next 18 months, as leases expire.

Special situations are not like normal investments. We're not trying to decide whether or not it's a great business long-term (as it clearly isn't!). It's all about whether the shares are worth more than the current price, based on the facts & figures. I reckon there's a good chance they might be, as explained above.

ricky65

I agree with others that Game Digital (LON:GMD) appears to be in terminal decline. Combination of Amazon and digital downloads/streaming will be too much for it. Shame, as in my youth I used to pre-order and buy games there fairly often.

It's telling to compare the charts of Game Digital (LON:GMD) with video game developer Frontier Developments (LON:FDEV) (where I hold a long position).

1st Jul '17

Incidentally, I can't understand why Game Digital (LON:GMD) doesn't have the the StockRank Style "Sucker Stock" instead of "Contrarian". The SP has been in decline since the 364p high in Nov 2014 and those who've attempted bottom fishing the stock and holding long term since then haven't done very well, to say the least.

cig

Doesn't Game Workshop make plastic toys that could be 3D printed (either at home or from a Vistaprint-like service) from public domain files?

What customer are they trying to satisfy here? The guy selling his second hand game, or the one buying them? The former is likely to give back the money he gets immediately... As long as they don't accumulate too much second hand stock, they´re probably pricing it right.

If they manage to become gamer-oriented event spaces they could have a prosperous future, in the same way as online is unlikely to kill restaurants and bars just because it's easy to get food and beer delivered to your place.

Gromley

A bit of an anecdotal re GAME (LON:GMG)

I went into town this week to buy a Nintendo switch for my daughter only to find in Game that they were only available to pre-order. So we went to look elsewhere and finding that no-one had one, we went home and "pre-ordered" online.

In the end we pre-ordered directly from nintendo because; (1) I'd presume Nintendo will get stock in at least as quickly as anyone else and (2) Nintendo actually gave an estimate on when they'll have stocks in (mid-July).

Poor execution imho by Game - if there signage in store had been clearer (ie that nobody has stocks currently and giving an estimate - accurate or not - of timescales) then I would probably have pre-ordered in store then and there.

Maybe I was in a small minority being unaware of the overall stock situation re switch, but nevertheless by being just a little smarter Game could have made the sale.

That said , I think the profit warning needs to be taken into context - sales will be down because nobody can get hold of the product that was going to drive this seasons sales. Assuming that Game don't lose out too badly in the pre-order market (as they did with me) then this ought to be a case of delayed sales rather than lost sales.

Also just a thought that is swishing around in my head, there seems to be a strong consensus (not just here) that traditional retailers are going to be swept away, by the new fangled internet disruptors.

It all feels reminiscent of about 20 years ago, you think from some comments that the internet had only just been invented. Sure some traditional retailers have gone to the wall and some more will and others have struggled and had to adapt which also will continue .

It's almost always a mistake to uncritically follow the herd mentality and I certainly think so here.

Purely a personal point of view, but if a bricks and mortar retailer can meet the online price point (as they regularly do these days) I'd almost always buy from the real shop :

> Touch and feel the goods before you buy (obviously aware of "showrooming")

> Get your mits on the goods straightaway.

> Better access to aftercare etc.

None of this of course says whether GAME (LON:GMG) would be a good investment from here or not, but all food for thought. (Certainly worth a detailed view imho).

matylda

With £69m in cash and a market cap of £36m - And not losing money, why is this not a no brainer?

QuaysideCapital

In theory I guess you could... sort of defeats the purpose of building them yourself though (which is part of the whole hobby).

Forgive me though... I'm failing to see your point

There's also some people in this world who would be very upset to hear you describe GAW's product as 'toys'

The net cash figure at the end of Jan is highly flattering as that is when they have all of the cash from Christmas & post-Christmas sales, but have yet to pay for all of the stock.

Cash at the YE (July) is always lower and over the course of full years cash has been on the wane.

It's also most likely that they again made a loss in the quieter H2.

nicobos

3rd Jul '17

Fair point. The business should continue to generate cash though during the period.

A broker's note I've seen says "GMD started FY17 with net cash of £38.5m; we forecast an increase to £49.4m by July 2017."

A word of caution -this was from an Edison April report -i.e. before the recent profit warning...

monions

13th Jul '17

Interesting that Mike Ashley (Sports Direct) thinks GMD has a positive future as he has increased the holding to more than 25%. This would mean Mike Ashley and Neil Woodford must now own the bulk of shares.

Howard Marx

Ashley bought his shares from Woodford & Invesco. Woodford is no longer a shareholder.

So Game Digital (LON:GMD) shareholder list is now stands as:

Elliott 43%, Ashley 26%, others 31%

lemonjar

20th Aug '17

@bestace, I like the way you picked up on the EED side of GAME Digital (LON:GMD), in particular the Belong Arenas. Take a look at this recent Reddit thread - exactly the sort of reaction from punters you'd want to see if you're Game. I think this is really interesting, it feels like they're onto something...

https://www.reddit.com/r/pcmasterrace/comments/6p775u/strolled_into_game_for_the_first_time_in_years/

Small Cap Value Report (30 June 2017) - GMD, TNI, FJET

Game Digital (LON:GMD)

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Graham Neary

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