Why 'Big Short' investor Michael Burry is going long on GameStop, the video game retail titan that's been crashing all year (GME)

Phil Spencer Microsoft E3 2019

  • GameStop’s stock value has been crashing all year as the company struggles to adapt to a changing market.
  • But legendary investor Michael Burry is going long on GameStop, and there’s a simple reason why: Discs.
  • In 2020, both Sony and Microsoft plan to release their next-generation game consoles — and both consoles will still have disc drives for consumers who want to buy games on physical media instead of through digital storefronts.
  • Visit Business Insider’s homepage for more stories.

Last week on August 22, the world’s biggest video game retailer had its best day at the stock market since 2018. 

GameStop’s stock price, which has been in steady decline since late January, leapt for the first time in months — from $3.55 per unit on Wednesday afternoon to $4.12 by mid-Thursday. (It’s since given up some of those games, trading at $3.70 at the closing bell on Tuesday.) 

It was the first major upward move in months, and it was largely attirbuted to a single person: Famed “Big Short” investor Michael Burry, who predicted (and profited from) the subprime mortgage crisis of 2008. 

But why?

Michael Burry Big Short

Burry is going long on GameStop — his investment firm, Scion Asset Management, and affiliates own 3,000,000 shares of GameStop, per a press release.

His reasoning is solid: The beleagured video game retailer is getting an extension of life thanks to Sony and Microsoft. He believes that both console makers are putting disc drives in their respective next-generation game consoles.

Indeed, this is a confirmable fact: Both Sony and Microsoft have said that their respective next-generation game consoles, the successors to the PlayStation 4 and Xbox One, will still have disc drives. Sony told Wired as much in an exclusive interview with the console’s lead system architect, Mark Cerny, back in April. And Microsoft Xbox chief Phil Spencer said as much about the next Xbox, codenamed Project Scarlett, in an interview with GamesIndustry.biz in June.

That’s an important piece of information if you’re looking at GameStop’s stock right now, and here’s why: GameStop’s primary form of revenue is buying and selling used games — games on discs.

GameStop NYC

Customers bring in their game discs, which GameStop purchases in store credit or cash. Those game discs are then re-sold at a markup. GameStop also sells new and used consoles, and new games, and gaming accesories, and all manner of geek culture memorabilia. But its foundational business model is built on buying and selling used games — games that are, again, on discs. 

That business model has deteriorated as digital storefronts on Xbox Live and PlayStation Network began offering new subscription models and increasingly better sales. Why go to the store and buy a physical game if you can get the same thing from your couch right now, and maybe for less?

Moreover, digital games cannot be traded in and re-sold. As people purchase digital copies of games, they also trade in fewer used games. 

Thus, if the next PlayStation and Xbox were to go entirely digital, with no ability to read physical media (read: discs), GameStop would be in much more serious trouble.

GameStop

But both of the new consoles will read discs, which Burry believes “is going to extend GameStop’s life significantly.” In an interview with Barron’s, Burry said the position GameStop is in “looks worse than it really is.” He also pointed to some crucial context: The way that game console cycles work.

In summer 2019, we are at the tail end of the PlayStation 4 and Xbox One life cycle — both are expected to get replaced in 2020 with new PlayStation and Xbox consoles from Sony and Microsoft. Such was the case in summer 2012, as the end of the PlayStation 3 and Xbox 360 cycle was in sight and new consoles similarly close. 

In the summer of 2012, GameStop’s stock price as at its lowest in years. By November 2013, when the Xbox One and PlayStation 4 launched, the stock’s price had nearly tripled.

GameStop stock (maximum, as of August 2019)

At some point in the not-so-distant future, the vast majority of video games will be purchased digitally or, even more likely, never puchased in the first place — instead, you’ll just pay for a Netflix-esque streaming service or two and they’ll give you access to an instant library of games. Heck, Microsoft’s already offering as much with the very successful Xbox Game Pass service.

But when that future comes, GameStop is in a very dangerous position — the same position that record stores and DVD sellers found themselves in not so long ago. For now, GameStop will likely live on for a few more years. 

“I definitely think it’s a melting ice cube,” Wedbush analyst Michael Pachter said of GameStop’s disc-based business model in an interview with Business Insider earlier this year. “For sure it’s going to go away eventually. And for sure their future will be truncated and eliminated the day that discs stop being manufactured.”

But that doesn’t mean the disc-based business model is leaving just yet — with new consoles from Microsoft and Sony coming in 2020 that play discs, “they just got a seven-more-year reprieve starting in 2020,” Pachter said. “GameStop’s got about 10 years before that ice cube is fully melted.”

And, most importantly for investors, the company’s stock value is likely to regain much of the ground it lost in 2019.

SEE ALSO: GameStop soars after ‘Big Short’ investor Michael Burry says it still has big upside

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