When I was learning about serious investing a few years back, I heard and read about many things. Cash Flow, Free Cash Flow, Management, Business, Valuation, Price, Margin of Safety, strong balance sheet, ROIC and so on. One of my friends/mentors, an excellent investor himself, Henry Schacht (who runs Schacht Value Investors – http://schachtvalue.com/) kept mentioning about Capital allocation. Initially, I did not know what he meant and why that was important. Over time and after many emails/ discussions and examples, I began to understand the importance of this aspect when considering investments.
Capital allocation is what management does with the capital generated by the business. Management can choose among a few things
(1) Invest in the business – Capital expenditures and organic growth
(2) Acquire companies
(3) Pay dividends to share holders
(4) Buyback shares
(5) Pay down debt
I am sure we all have our own examples of companies that exhibit good capital allocation. IBM comes to mind compared to MSFT. Their regular buybacks and dividends with the use of some leverage have produced good returns for their shareholders. The outcome is also seen in a much higher P/E ratio than MSFT.
So, let me come to the company mentioned in the title of this article. ie. GameStop (GME). We have owned GME since our inception in early 2011.
First a line from today’s GME Q4 2012 earning press release.
Rob Lloyd, chief financial officer, said, “Using a combination of stock buybacks and dividends, GameStop returned more than 100% of its record free cash flow to shareholders in 2012. Going forward, we expect to maintain our commitment to use cash flow to increase shareholder value.”
During fiscal 2012, GameStop generated $632.4 million in operating cash flow and spent $151.2 million in capital expenditures and other investments generating free cash flow of $481.2 million. The company repurchased $409.4 million of GameStop stock during fiscal 2012, including 3.2 million shares, or $74.7 million worth of stock, during the fourth quarter. In February 2012, the company initiated a dividend payout to its shareholders and paid out $102 million in dividends during 2012.”
Oh and btw, GME ended with $635 million in cash and no debt on its balance sheet in a market cap that is now $3.4 billion.
So, lets look back and see what GME has done in terms of Capital allocation.
2010
Shares bought back : $381 million
Debt paid down : $200 million (from cash on hand)
Acquisitions : $ 38 million
Capex : $198 million
Cash from Ops : $590 million
FCF : $392 million (defined as cash from ops – purchase of PPE or capex)
2011
Capex : $165 million
Acquisitions : $ 30 million
Debt paid down : $250 million. ( debt free balance sheet)
Shares bought : $262 million
cash from ops : $625 million
FCF : $460 million
2012
Capex : $151 million
Acquisitions : neglible
Shares bought : $409 million
Dividends : $102 million (can pay dividends now, no debt to service)
Debt paid : $0 (paid off in 2011)
Cash from Ops : $632 million
FCF : $481 million
As can be seen from the last 3 years, GME capital allocation is pretty clear. We talked about the five points at the start. GME has checked off all of them.
(1) Pay down debt aggressively and achieve debt free balance sheet. Check. Reduce risk. Very few retailers can boast of that.
(2) Buy back shares aggressively. Check. (as shares were undervalued and helps improve shareholder return in the long run.)
(3) Initiate and raise the dividend. Check.
(4) Keep acquisitions small and tactical v/s spend in desperation. Check.
(5) Capex to open new stores/ Invest in the business. Check.
At Motiwala Capital, We pay a lot of attention to capital allocation along with strong balance sheets, free cash flow, ROIC and valuation. At today’s closing price of ~$28, GME has a market cap of $3.4 billion, EV stands at $2.8 billion, EV/FCF = 6.6x (using $425m low end of 2013 guidance).
Here is a link to a previous blog post on GME in response to an article. GME was trading at $18 then.
Happy investing. And once again thanks to Henry Schacht for teaching me a valuable investing concept (among many)
Adib Motiwala
Portfolio Manager
Motiwala Capital
Disclosure: Long GME and MSFT.
