Jun 28 2020 - GameStop: Zero Near-Term Bankruptcy Risk

Summary

GameStop trades at a remarkably low valuation despite the upcoming console refresh.

Off-loading key properties within its portfolio will provide GameStop with a tremendous cash infusion in the very near term.

Exchanging 50-75% of its debt for 2023 bonds will provide the necessary breathing room to weather the next two quarters before the new console launch.

Before I begin with my investment thesis, I'd like to encourage readers to gloss through the articles that have appeared prior to this one. Justin, Courage & Conviction, and Dmitriy have done a phenomenal job depicting the long-term bull case and appeal of investing in GameStop. This article should be viewed as a supplemental argument highlighting tremendous near-term catalysts to go hand-in-hand with their respective well-stated points. If you have arguments regarding console units or the short squeeze, I'd recommend you view the thousands of aggregate comments written on their respective articles.

Having said that, for this particular article, my main three points are the following:

1. Share price manipulation and strong short-selling have presented the market with a false perception of GameStop's near to mid-term ability to operate as a going concern.

2. GameStop's real estate provides equity investors with a strong base-line value that will be unlocked in the very near term.

3. The debt exchange will provide GameStop with the necessary financial freedom to operate and adapt its business model to a post Covid-19 world.

Share Price Manipulation

Over the past 5 years, GameStop's stock has steadily declined from to .45.37477696-159309436267161.png

(Source: Google Search)

A large part of this decline has been due to a combination of deteriorating financials, a large digital shift in gaming, poor M&A activity, and severe short-selling. Due to GameStop's poor capital allocation decisions, a steep decline in price from the highs of 2015 was warranted. If you were amongst the many short sellers that anticipated this significant decline, I tip my hat to you and congratulate you on your successful trade. However, at today's price of .45, shorting the stock appears to be a completely saturated trade.

As you can see from the image below from Hestia's SEC filing - despite GameStop's severe share price decline, short interest has nearly tripled to 100% of float.

37477696-15930951281859293.png

(Source: Hestia SEC Filing)

This type of share price manipulation is practically unheard of. Despite a net cash position, a

Real Estate

GameStop currently owns 1,128,000 square feet of real estate.

37477696-15930972008450484.png

(Source: 10-K)

As management has mentioned on the earnings call, it is actively seeking buyers for most, if not all, of its properties. These sale-leaseback transactions will be tremendously accretive to shareholders in the very near term. I believe, due to Covid-19, these properties have actually become more valuable assets. Due to the increasing number of cases, limited consumer exposure to in-person shopping, and the uncertainty of the market as a whole, lenders are increasing commercial vacancy rates and requiring property owners to hold principal and interest reserves on new purchases and refinances of traditional retail properties. This will only make sale-leaseback transactions more favorable.

GameStop, a tenant with a strong cash position, will provide the new owner with a locked-in lease agreement with a corporate guarantee. This will further alleviate some of the market uncertainty and make these properties more attractive to a buyer, providing GameStop with significant bargaining power to negotiate favorable lease terms. Additionally, even if GameStop were to negotiate short-term leases and inevitably leave the space, due to rock-bottom interests rates, an owner can purchase these properties either with cash or using bridge financing at rates as low as 6.5% to transfer over to 4-4.5% permanent financing as the properties stabilize.

Based on my own valuation, it's possible GameStop will fetch north of mm for its properties - representing roughly 30% of its current market capitalization.

Debt Exchange

Just a few weeks ago, GameStop announced a debt exchange. Essentially, bondholders have the option to exchange 6.75% bonds maturing in March 2021 for 10% bonds maturing in 2023. On the surface, it's puzzling why GameStop elected to exchange all of the outstanding debt for higher interest rate bonds rather than purchasing a large sum in the open market at a discount to par. After all, GameStop could have retired millions of outstanding debt by purchasing bonds for 75 cents on the dollar. However, as Justin stated in one of the comments in his most recent article, it's quite possible GameStop garnered just enough support to prevent short sellers from putting GameStop in technical default. If that is the case, GameStop might have actually executed the debt exchange flawlessly. However, I'd like to take the exchange one step further as it relates to the sale-leaseback.

As stated in the press release regarding the exchange, if successful, many material covenants will be removed from the new and existing bonds.

In conjunction with the Exchange Offer, GameStop is soliciting consents (the “Consent Solicitation”) to eliminate substantially all of the restrictive covenants, certain affirmative covenants and certain events of default contained in the indenture governing the Existing Notes. The Exchange Offer is conditioned upon the consummation of the Consent Solicitation and certain other conditions. Holders who tender their Existing Notes in the Exchange Offer must also, and will be deemed to, deliver their consents with respect to such Existing Notes pursuant to the Consent Solicitation.

(Source: GameStop Press Release)

See below for the existing restriction imposed by the current 2021 bonds:

37477696-15931001139826388.png

(Source: 10-K)

As we know, with a 50% interest in the exchange, the debt swap was successful. That leaves GameStop with roughly 0mm in outstanding debt the company has to tend to before March of 2021. However, now that both new and existing debt will have many covenants removed (which include the right to engage in sale-leaseback transactions), I believe we could potentially see another 15-25% more bonds tendered and exchanged by July 1st. That would leave just between 0mm and 0mm outstanding in March 2021 bonds. With a cash balance of approximately 0mm-0mm and a sale-leaseback transaction that will bring in mm, I truly believe there is absolutely no way GameStop can't service its debt requirements.

Although bears and bulls will continue to dispute GameStop's relevance in a digital gaming world, the bulls have a much stronger argument for GameStop's near-term likelihood of strong price appreciation. With the completion of the debt exchange and sale-leaseback transaction, I believe we could see a stark change in narrative. I will not instigate that a short squeeze will happen as a result of the news, but I do believe by the end of July as insolvency becomes a distant dream for bears, we could see a hefty change in price.

Disclosure: I am/we are long GME. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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