The Curious Case of Game Digital (LON:GMD)

One of the more notable survivors of the High Street is Game Digital, although its existence belies a turbulent past. As recently as 2012 the company was in administration. OpCapita purchased a selection of assets from the administrators and floated it back on the markets 2 years after it left. In some aspects though, the same problems have continued to dog the company, namely stagnant demand, increased competition and rising costs. 

It used to be the case that computer game shops had it all their own way before the turn of the century. Mail order was slow and unwieldy, whereas a shop allowed you to purchase a game instantly. Nowadays though, purchasing off the internet is about as seamless as going into store, and in many cases more convenient. 

GAME haven’t been knocked out and are trying a range of new initiatives. But that hasn’t stopped the share price from taking an almighty tumble in the past few years:

To put this into context, in December 2014 a share was worth 325p – today you can pick one up for a tenth of the price or perhaps even less. But then quite a few things have changed since those days. For a start, there were profits! By contrast, the last year has seen Game slip into loss, and it seems that this year those losses will increase.

There were other factors that fed the pessimism around the share price. One problem was the collaboration agreement between itself and Sports Direct. With Sports Direct owning approximately a quarter of the company, it would wield quite some power and so it showed. GAME’s new digital play on the growing popularity of esports (called Belong) was sold. Or at least part of it – a 50% cut up front for £3.2m. GAME also benefit from a rather vague agreement to site their stores inside of existing Sports Direct stores, as well as access to funding. 

From the share price, people obviously thought this was too cheap and the markets remained unimpressed.

What is quite anomalous about GAME is their balance sheet. Often, you’d expect companies whose share price to have taken a 90% hammering to be either short of cash, or high on debt – perhaps both, as Conviviality showed. But the converse is true at the company. Their overdraft facilities remain undrawn as the most recent interim report states:

Continued strong liquidity with Group cash of £84.9 million as at 27 January 2018 (2017: £73.0 million) and access to aggregated facilities of up to £130 million across the UK and Spain (2017: c.£80 million) following the signing of the Sports Direct financing facilities agreement on 12 February 2018

£85m is a remarkable number, because this dwarfs the current market cap of £54.1m. Effectively, this puts no value on the operations. In theory you could acquire the company, close it down and take the cash (in practice, share prices rise and there would be exit costs).

But this is probably about as good as it will get for now. Last years comparable results showed that profit before tax in the 26 weeks to January 2017 was £22.1m, and this turned into a £12.1m net loss at the end of the year. The explanations for this are quite easy: winter is an absolute bumper time for games, as many are bought as presents and outdoor activities lose their popularity. Given that profits are down this year, the best case scenario will be another net loss.

Structurally, it seems that little has changed in the industry and short of really significant discounts on leases, there will be continued losses. Stores have branched out in the years and stores retail mobile phones as well as used software and hardware but extending the product mix seems difficult.

Despite having a large amount of money, the board have been careful not to share it with shareholders at this point:

Reflecting the decision to increase investment in the Group’s new BELONG concept and optimise the UK estate in light of the significant number of lease events planned for over the next nine months, the Board has taken the decision not to declare an interim dividend (2017: 1.0 pence per share). 

The Board will continue to evaluate future dividends and remains committed to returning surplus cash to shareholders after retaining sufficient capital to fund the required investment to support future business growth.

This dividend wouldn’t have cost an awful much; there are 170m shares outstanding. The capital expenditure was £6.5m in the last year, so there is plenty of room to fund new Belong arenas. In my opinion, it would be extremely efficient for the board to simply buy back a significant percentage of shares whilst they are so cheap, but perhaps holding on to the cash is a reflection on their future prospects. If there were to be a general slump in the markets a company like GAME would be quite vulnerable if it was funded by debt. The money on the balance sheet is an indication they won’t be going bust any time soon, although it seems to me that in order to prosper they will need to fit a way to monetise their core retail operations.

So it GAME worth a play? It seems to me to hinge on how their esports operation pans out. Potentially if it does catch on, they will be ideally placed. Most of the sites are situated in good areas, and the Sports Direct tie up makes sense in terms of customer demographic. The big question is whether sufficient profitability will ever arise from it. The comments from the report suggest this isn’t the case at the moment:

Our Events, Esports and Digital division includes BELONG, Game Esports and Events, Ads Reality, Game Esports Spain and Multiplay (UK) Limited prior to its disposal.

In aggregate, these areas grew sales by 15.6%, or £1.2 million, to £8.9 million in the half (2017: £7.7 million), with the majority of these sales attributable to BELONG and Game Esports and Events.

Gross profit margin improved by 15.7 percentage points in the period to 32.6%, predominantly reflecting the higher margins achieved on events such as Insomnia and Minecon in the period.

Underlying operating costs (before depreciation, amortisation, adjusting and exceptional items) across these areas decreased to £4.0 million (2017: £4.1 million), resulting in an Adjusted EBITDA loss of £1.1 million (2017: EBITDA loss of £2.8 million).

For a rapidly expanding segment, growth hasn’t been that impressive, although understandable. Many stores simply won’t have the space to fit the new facilities in and others may just be unsuitable. It also requires investment in staffing and equipment.

There are certain risks that the whole esports thing may either be a fad, or remain as a niche. For instance, will there still be a Minecon in 10 years time? Or will something else have arrived on the scene by then? The other risk is that Sports Direct have little loyalty to the venture and would be indifferent to the performance and would be more interested in footfall and reducing the effective rent for their own stores, as they would be subletting some space. 

Given the current malaise in retail, I haven’t purchased, but potentially this is a share that could multiply pretty quickly. Time will tell if I’ve missed the boat.

Pure Passive Investor. Always looking for ways to make money (but not myself) work harder.

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