Shares of video game retailer Game Digital (LSE: GMD) climbed by more 10% this morning after the company announced plans that could reshape the business into an esports powerhouse.
Mike Ashley bets on esports
To complement its popular Insomnia live gaming event, Game Digital has been rolling out an in-store gaming arena format, branded BELONG. The pace of this rollout has been cautious so far, with just 19 arenas in the UK out of nearly 300 UK stores.
That's about to change. Sports Direct -- which has a 25.75% shareholding in the business -- is going to provide up to £55m of debt funding for an accelerated rollout of BELONG in Game stores and Sports Direct locations.
Alongside this, Sports Direct has paid £3.2m to acquire a 50% share in the BELONG brand and a 50% share of future profits from this business.
A changing business
Game Digital shares have lost around 75% of their value since the group re-joined the stock exchange in 2014. The group's core retail business is only marginally profitable.
But value investors -- including me -- have recently been drawn to the stock's big cash pile and flexible, short-leased store estate. Net cash reached a seasonal peak of £67m at the end of December, almost matching the current market cap of £70m.
The combination of net cash and minimal lease liabilities has given management the opportunity to shift focus towards esports. Early signs seem encouraging. Revenue from esports and related activities rose by 116% to £13.2m last year. Although losses rose to £6m due to investment, the company says that results have been good enough to support further investment. Sports Direct appears to share this view.
Buy, sell or hold?
At face value, Sports Direct seems to have acquired its 50% share in BELONG quite cheaply. But this deal will mean that gaming arenas can be rolled out much more quickly than expected. If successful, this could give Game a head start over rivals in a growing market.
I think there's scope for the group to transform itself into a successful esports business with a profitable retail sideline. I plan to continue holding.
One transformation I won't buy
FTSE 250 waste recycling group Renewi (LSE: RWI) is another work-in-progress. Formerly known as Shanks Group, the company changed its name last year after an ambitious merger with a Belgian firm.
The main attraction of this deal appears to be economies of scale. Management expects to report EUR12m of committed savings for the year ending 31 March. A total of EUR40m of synergies are expected by 2019/20.
Will it work?
Although trading has been strong so far this year, I believe these cost savings are much needed. Looking back at previous years' financials, this doesn't seem to be a very profitable business. The group's underlying operating margin was only 4.6% last year, while underlying return on capital employed was only 2.8%.
Another area of concern is debt. Adjusted net debt was £435.9m at the end of September. This represents more than nine times next year's forecast net profit, which seems uncomfortably high to me.
Renewi shares trade on a 2018/19 forecast P/E of 15. I don't think that's cheap enough to be attractive. This is one corporate transformation I'll be avoiding for now.
Today's top growth buy could climb 200%
I'm bullish about Game Digital. But it's not without risk. I'd only buy these shares as part of a diversified portfolio. One retail stock which may offer bigger and better growth prospects is the company featured in A Top Growth Share From The Motley Fool.
This company has an impressive growth record, but our analysts believe the shares are still too cheap. They reckon this stock could still rise by up to 200%.
If you'd like to know more, download our free, no-obligation report today. To get your copy, just click here now.
Roland Head owns shares of Game Digital. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.