Motiwala Capital LLC has released the quarterly letter to clients for the period January – March 2013. Please contact me if you have any questions or comments.

thanks
Adib Motiwala
Portfolio Manager

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.

We have just released our performance of managed accounts in 2011 and 2012. You can read it here along with the notes

Here is the video.

Here are the slides

Debt Ceiling Crisis (2011)

Fiscal Cliff  (2012/2013)

Sequestration (2013) — live on your favorite outlets right now

Debt Ceiling (2013) —releasing May on CNBC

The biggest one was the debt ceiling crisis in 2011, which was followed by S&P downgrading the US ratings from AAA. The equity markets sold off quite a bit.  However within a few weeks, the markets recovered strongly and ended higher than the levels before the ‘ceiling’ discussions.

Next after that was the Fiscal cliff post the US Presidential elections in 2012. Nothing much happened there and the US stock market ran up about 6% in January 2013.

Now, ‘Sequestration’ is playing out in media outlets. Let’s see how this one ends.

And the debt ceiling talks will make another appearance around May 2013. Those would be good excuses for a sell off as the markets are near all time highs. Smart investors should have their watch list of stocks ready to capitalize on any bargains.

Kohls Research Report

Disclaimer: Accounts managed by Motiwala Capital had a long position in KSS at the time of this blog post.

Watch it here