Why Shares of GameStop Popped Today

What happened

Shares of video game retailer GameStop (NYSE: GME) jumped today after The Wall Street Journal reported that the struggling company could reach a deal to sell itself by mid-February. Interest from private equity firms in acquiring the company was first reported last June. The stock was up about 12.7% at 11:25 a.m. EST on Friday.

So what

Private equity firms Sycamore Partners and Apollo Global Management are reportedly interested in buying GameStop, according to the Journal's sources. Shares of the retailer have plummeted 75% since peaking in late 2013, and they've lost more than 25% of their value over the past year, even after Friday's surge.

GameStop is facing an existential crisis as video games increasingly go digital. The company's used-games business, long a cash cow, is in irreversible decline. The company tried to diversify by building an empire of smartphone retail stores via its Spring Mobile brand, but that strategy hit a wall as the market for smartphones became saturated. GameStop disclosed a massive write-off related to that business early last year, and it jumped ship entirely last November when it agreed to sell Spring Mobile for $700 million.

GameStop's new strategy is to focus on games and collectibles, which is guaranteed not to work as the age of physical game discs comes to an end. The stock appears to be very cheap, trading for just 5.5 times the midpoint of the company's adjusted earnings guidance for 2018. But that rock-bottom valuation reflects the fact that GameStop's core business is doomed.

Now what

A buyout is the best option for GameStop, especially now that its diversification strategy has been revealed to be a blunder. There may be no saving the company, but a private equity firm could certainly earn a solid return as long as the price paid was low enough.

If GameStop doesn't manage to sell itself, it's hard to see a path forward that doesn't end badly for investors.

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Timothy Green has no position in any of the stocks mentioned. The Motley Fool owns shares of GameStop and has the following options: short January 2019 $16 calls on GameStop. The Motley Fool has a disclosure policy.