Betting against GameStop Corp. is getting risky.
The prediction that downloadable video games would soon do to GameStop what digital music did to CD stores isn’t coming true as quickly as bearish traders expected. They have short-sale positions tied to $2.1 billion worth of the $5 billion retailer’s stock. That’s 16 times the average short interest ratio for the Standard & Poor’s 500 Index, according to data compiled by Markit and Bloomberg.
Yet the stock price keeps rising, a reflection of how well GameStop has continued to do in the face of the industry’s shift to digital. GameStop shares are up 39 percent this year, one of the best returns in the S&P 500, and have further to go, according to most analysts’ estimates tracked by Bloomberg.
“The shorts think the sell-side analysts are looking through rose-colored glasses,” said David Magee, an analyst for SunTrust Banks Inc. who has a buy rating on the stock.
Perhaps the biggest threat to GameStop short sellers, though, is the increased merger talk involving Best Buy Co. As the $12 billion electronics retailer grapples with a lack of growth, it may make sense to acquire GameStop, according to analysts such as Magee.
“What Best Buy doesn’t have is top-line growth, and they’ve never been able to crack this category,” he said in a phone interview.
The merger math works. While Best Buy’s stock may not be the most attractive takeover currency, the company does have $2.1 billion of net cash.
If Best Buy could fund a deal with cash and debt, the transaction could be very accretive, data compiled by Bloomberg show. A 30 percent premium for GameStop -- or about $60 a share -- would boost Best Buy’s earnings next year by about 31 percent, the data show.
Jackie Smith, a spokeswoman for Grapevine, Texas-based GameStop, didn’t respond to a phone call or e-mail seeking comment. Amy von Walter, a spokeswoman for Richfield, Minnesota-based Best Buy, declined to comment on whether the company has considered a deal with GameStop.
For Best Buy, there’s much to envy at GameStop. Its same-store sales grew 8.6 percent in the quarter ended May 2 and almost 4 percent on average for the past 10 quarters. Best Buy’s average same-store sales over that stretch are flat to down.
One major way GameStop keeps customers loyal is a trade-in program for used games. Video-game file sizes are so huge that it can take hours -- and the rare powerful Internet connection - - to download them to a console. GameStop is benefiting from that issue, as well as the hesitancy of some customers -- or their parents -- to use credit cards over the Internet.
Separately, it also offers AT&T Inc. prepaid wireless plans and buys, repairs and then resells old iPhones and iPads.
GameStop is also trying to become a relevant player in digital, a part of its business which it says expanded about 17 percent in the last quarter. Digital offerings include what’s called additional downloadable content that comes out following the release of a new game. For example, someone playing “NBA 2K15” can pay about $50 to download virtual currency to spend within the game on new uniforms and equipment for the characters.
“The company says, ‘Look, we’re acknowledging that the shift to digital is happening, but the chronology of how this is happening is different than most people perceive it,’” said Arvind Bhatia, an analyst for Sterne Agee Group Inc. “GameStop is going to participate in it. They’re also diversifying.” Bhatia has a buy rating on GameStop’s shares.
On July 8, Oppenheimer & Co.’s Brian Nagel raised his GameStop share-price estimate to $51 from $45. The stock ended last week at $46.96.
On Monday, GameStop shares rose 0.8 percent in New York to $47.35, their highest price since January 2014.
It’s still relatively cheap at about 6 times the average forecast for this year’s earnings before interest, taxes, depreciation and amortization. Even Staples Inc. -- another chain some believe is facing extinction -- has a higher valuation, as does 95 percent of the S&P 500.
For years, some have argued that GameStop should just sell to a private equity firm, giving it more leeway to work on its diversification plan without the pressure of public quarterly results. The $466 million of free cash flow that the company generated in the past 12 months no doubt checks the box for buyout feasibility.
Bhatia says GameStop essentially has been taking itself private, buying back lots of shares on the open market and shrinking its store base.
It remains to be seen if any sort of acquisition or buyout involving GameStop will happen. But for now, the bulls are winning as the shorts hang around at their peril.