Considering Our Options – $GME Long Stock & Protective Put

by Enis August 22, 2014 9:44 am • Commentary

GME reported a strong quarter yesterday evening, and the stock is up 8% this morning. I entered a new trade on Monday in GME ahead of the earnings event:

TRADE – Buying to Open GME for $40.10
TRADE:  GME ($40.10) Buy the Aug22nd 37.50 Put for $0.54

– Buy 1 Aug22nd 37.50 Put for $0.54

Rationale:  The weekly put purchase is merely a cheap way to take away the downside tail risk on the earnings event.  We would be happy for it to expire worthless and GME to move higher this week.  If GME does move below 37.50 this week and the earnings report does not reveal any significant long-term fundamental changes, then we would sell the long put position to close and keep our long stock position after the event.

With the event past, and GME up 8% this morning as I type, my long weekly $37.50 put position is worthless, but I am long the stock from a cost basis of $40.64.

My impression from reading the Q2 earnings release and the conference call transcript is that GameStop continues to maintain or increase market share in almost all selling channels even as gaming becomes more digital.  The company sold more than 50% of all PS4 or XBox units sold in the second quarter.  Granted, the second quarter is the least important from a seasonal perspective, but it’s still encouraging to see that market share strength.

President Tony Bartels repeatedly acknowledged the gradual shift to digital gaming, but was quite confident that GameStop would continue to be an important retail middleman in that process. One analyst asked about the recent headlines that Microsoft was going to start selling digital subscriptions for XBox games.  This was Bartels’ response:

I think what you’re going to see is publishers and platform holders are constantly going to be looking for new ways to reach the gamers. I think what we’re showing is, especially with our DLC performance, what we’re showing is that we’re market makers, not only on the physical side, but also on the digital side.

So we always say that we’re for the gamer. So if the gamer wants an online subscription service, then we’ll sell them an online subscription service. If the customer wants to buy a physical game, we’ll obviously do that. If they want to buy a digital download, we’ll sell them that. So when it comes to the customer, we’re agnostic in terms of what they’re going to buy, and we just want to give them the best service.

So as these roll out, we haven’t heard of others that are getting into this business, but you know, if this rolls out, we’ll make it available and we’ll be a part of the value chain as well.

While the 27.5% short interest in GME is a reflection of some traders’ skepticism that GameStop can adjust to an increasingly digital marketplace, up to this point, GME’s continued expansion and increased revenues do suggest a place for GameStop in the gaming delivery value chain.  In other words, I don’t think GME management is spewing a bunch of management cliches to hide a weakening business.  The numbers support their view.

The one disappointment (also voiced by an analyst on the call) from the report is that GME did not raise guidance for the year, especially since 80% of 2014 EPS will be in the next 2 quarters.  However, GME had a strong second half of 2013 as a result of Take Two’s release of Grand Theft Auto V, so the comparables are tougher than usual for the second half of 2014.  In addition, there have been some releases pushed to 2015 from 2014, so GME management is taking a conservative approach to guidance, particularly after the disappointment in last year’s holiday sales.

I like this long position heading into the crucial holiday season based on the results of the past 2 quarters, and the overall trends in the industry.  Gaming is a secular growth market across many different channels (traditional console, digital, and mobile), and GME is well placed to benefit from that trend, with a distressed valuation to boot.