Change In Strategy – Reviving the Portfolio

I’m going to avoid the Euro Zone and allocate assets to North America (Canada and the USA). I believe all my subscribers live in North America anyways, so it’d better suit your portfolios.

The Euro Zone remains weak despite all the measures the ECB has taken to ‘revive’ it. And the Euro as a currency looks extremely suspect at this point. The Grexit episode is likely to repeat itself in a few years, maybe a Spain-exit and an Italy-exit as well?  Pooling multiple non-correlative economies with independent debt loads under one currency was clearly a mistake. Negative interest rates are supposed to revive the euro-conomy, but hasn’t worked. I don’t know what is going on, but I want to minimize my exposure to the Euro Zone. 8/10 of Britain’s top trading partners are European countries. The other two are U.S. and China, with the U.S. being the largest and accounting for 14% of Britain’s exports.

There’s also the Brexit – Britain potentially exiting the European Union. The career politicians in the U.K. are spelling doom for the U.K. if they leave. If history does indeed rhyme, then Britain is probably more likely than not to benefit from leaving the European Union. These corrupt career politicians always seem to think they know what’s good for the countries, but usually get it wrong. People are starting to realize that creating the Euro was a mistake in the first place – the same politicians back in 2000 said it would be great for everyone, ‘facilitate efficient trade,’ ‘cut transaction costs’ – they forgot to mention the cons. It’s a good thing Britain avoided it.

This is something I’ve been debating for a while, and I’ve finally decided to cut ties with Europe. The portfolio will be approximately 25% Canadian stocks and 75% American stocks. I have just sold off Game Digital. Will be selling Tilly’s later this week. If Tilly’s drops to my break even point before I sell, I’ll immediately get rid of it. CBK will stay until I fill up 80% of the portfolio. I’m going to be coming up with a few more write-ups over the next few weeks. I’m hoping to have one more up by Thursday night.

Mazi Ume

Added more DX Group PLC (LON:DX), Sold some Game Digital PLC (LON:GMD)

Just Increased my stake in DX Group by 20% at £18.75, average purchase price now sits at £19.81 and Sold 20% of my stake in Game Digital at £1.10. The purpose of this is to reduce my exposure of GMD. Remember I bought some more at an average price of £1.09 in January. Also, Crude is down, and so are world markets. I will be increasing the Reitmans position if it drops today.

Update: Added some Reitman’s at an average price of CAD $3.90

Game Digital PLC (LON:GMD): Is the stock market over-penalizing the Gaming Industry?

Note: All figures listed are in Pound Sterling (GBP), unless otherwise noted. Also, the price shown on Google Finance is in Pence and not Pounds. 1 Pound (£) = 100 pence. Pence will be noted with ‘p’ when applicable in this article.

Purchase Price: £1.26 (12/29/2015) Market Capitalization: £214 million
Enterprise Value: £153 million TTM EV/EBITDA: 3.52
Price Target: £1.76 (~40% upside) Time Frame: 0 – 18 months

 

Real Time price: GMD 33,25 -0,38 -1,12% (This price is in Pence, so divide it by 100)

Game Digital PLC (LON:GMD): is a leading specialist retailer of video games in the U.K. and Spain. Game Digital (GMD) divides its operations into  four segments:

  1. Content – Video Game software (Fifa, Call of Duty et al.).
  2. Hardware – Includes Console sales such as Sony Play Station, Microsoft Xbox, Nintendo Wii.
  3. Pre-Owned – Customers are given the option to trade in games for cash or credit applied towards a different purchase.
  4. Other – ‘Toys to life’ and the new GAMEtronic, which includes trade in of technology devices such as smartphones and tablets. This also includes the newly introduced GAME Marketplace where vendors can directly sell goods directly to the customers (similar to Amazon).

 

GMD Price Chart – Yahoo Finance
(Chart 1) LON:GMD Game Digital PLC Price Chart (Source: Yahoo Finance)

GMD fell off a cliff a few days ago for the second time this year. They were driven by two headwinds:

Profit Warning

  • Total Group Gross Transaction Value (“GTV”) of £466.8 million was down 6.7%, largely explained by the reduction in low margin console sales, down 20.3%.
  • Trading conditions in the UK retail market have been challenging with total sales for the video games market2 down 13.5% year on year (“YoY”).
  • UK GTV of £353.5 million, down 11.4% YoY, with Black Friday weekend trading stronger than overall performance.
  • UK sales and overall margins impacted by a faster than expected decline in the market for old format content as well as a slower than anticipated switch to new format content (Xbox One and PlayStation 4).

Technological Change in the Console Gaming Industry

When Microsoft Initially announced the Xbox One, they gave gamers the option to download new titles digitally, directly to their consoles on release date or buy the actual disk from a retailer. It didn’t end there. They then added some other restrictive policies:

Give your games to friends: Xbox One is designed so game publishers can enable you to give your disc-based games to your friends. There are no fees charged as part of these transfers. There are two requirements: you can only give them to people who have been on your friends list for at least 30 days and each game can only be given once.

Trade-in and resell your disc-based games: Today, some gamers choose to sell their old disc-based games back for cash and credit. We designed Xbox One so game publishers can enable you to trade in your games at participating retailers.  Microsoft does not charge a platform fee to retailers, publishers, or consumers for enabling transfer of these games.

Connectivity: With Xbox One you can game offline for up to 24 hours on your primary console, or one hour if you are logged on to a separate console accessing your library. Offline gaming is not possible after these prescribed times until you re-establish a connection, but you can still watch live TV and enjoy Blu-ray and DVD movies

Gamers could only lend out video games once, and also have the person on their friends list for 30 days to do so. Also, in terms of trading in and reselling the game, Microsoft gave the publishers all the leverage on this end. Meaning that Publishers like Electronic Arts (EA) and Activision, could simply decide to disable trade-ins for its popular titles like FIFA and Call of Duty, which will force everyone to pay full price for them. This also completely eradicates the used game market, which is Game Digital’s (GMD) and Game Stop’s (GME) most profitable segment (See Image 1 meme from google below) and will most likely strain their business models. GME and GMD both accept used games from customers as trade-ins and resell them at an higher markup.

Gamestop be like
Image 1 (Source: Google ‘Gamestop be like’)

The gaming community revolted. Sony subsequently announced the PS4 and said that there will be no used game restrictions at all, a shot at the Xbox. The gaming community cheered, and Microsoft quickly reversed its Xbox policies. Microsoft also made Kinect required for the Xbox and bundled them and added $100 to the price, pricing it at $499. Play Station camera was not required and was priced at $399. Microsoft quickly reversed this after PS4 sales took off and Xbox lagged, the Microsoft Xbox Chief, Don Mattrick, abruptly ‘left’ the firm. So, what have we learned from this? Well, the gaming community is powerful.

Risks

The largest risk facing GMD and GameStop as well is the decline in Physical game sales. The decline in new Physical Games also kills the used game market. While I do agree that the decline is inevitable, the more important metric is the pace of the decline.

Catalysts

Low Enterprise Value to Free Cash Flow (EV/FCF) yield and slow rate of decline

GMD currently trades at 5x last year’s EV/FCF ratio, a 20% yield. This means that assuming FCF stays stable, it will take 5 years to recoup my investment. This is extremely low and provides a decent margin of safety. Also, as sales of physical games decline, this will stretch out the recoupment years. I will be willing to hold on to my shares as long as the decay rate does not exceed 10%. A 10% Decay rate on my DCF model places GMD’s intrinsic Enterprise Value at £152 million, which approximates today’s price. The decline in Revenues that was announced was driven by Console sales, the console segment (Hardware) accounted for 29% of 2015 Sales (Image 2).

Revenues
Image 2. Segment Revenues (Source: Full Year Results)

The Hardware segment, however, commands a 4% gross margin (Image 3) and only accounted for 5% of the total 2015 gross profits. So, while the decline in Hardware revenues should be noted, investors have grossly overreacted, as the effect on the bottom line is trivial. The other segments also contributed to a portion of the revenue drop. By my estimates, they declined by 6%. As I noted earlier, I will be willing to hold on to this stock if that rate does not exceed 10%. Investors have been on the edge of their seats with GameStop and Game Digital since the Microsoft incident. GameStop

Margins
Image 3. Segment Gross Margins (Source: Full Year Results)

(GME) is down 40% in December alone (Image 4) and is one highly shorted stocks on the NYSE, with a short interest of 54% as of December 15th (Image 5). I don’t have access to Short Interest data for GMD, but any negative news sends these two stocks into free fall.

Gamestop Chart
Image 4. GameStop 1 year Price Chart (Source: Yahoo Finance)
GME Short Interest
Image 5. GameStop Short Interest (Source: GuruFocus)

Cash Balance and Dividends

Ex-Dividend Date is on 12/31/2015, but will be voted on in the Shareholder meeting in January and paid thereafter. Management has said that the dividend will most likely be paid, because the two largest shareholders have agreed to vote in favor of it. Cash Balance also sits at £63.1 million as of 7/31/2015. Last year, Management paid out £22 million in dividends, which at these prices, represents an 18% dividend. Management is also shareholder friendly, and plans to return cash from operations to shareholders on a regular basis.

I purchased this at at average price of £1.26 on 12/29/2015, it trades at £1.22 now (12/31/2015).