GameStop (GME)

GameStop (GME)

Summary:  Overpriced

Score:  6/20

MOS:  1%

Share Price:  $189

Sticker Price:  $192

Is GameStop stock a good buy?

GameStop is an American video game, consumer electronics, and gaming retailer founded in 1984 and headquartered in Grapevine, TX. As of January,2021, the company operates 4,816 stores including 3,192 in the United States, 253 in Canada, 417 in Australia and New Zealand and 954 in Europe.

In 2021, the company’s stock price skyrocketed from $40 to $347 due to a short squeeze orchestrated by users of the Internet forum wallstreetbets.

A short squeeze is when you have a large amount of short-sellers betting a stock will go down. But the problem is, as the stock rises, the short-sellers are “squeezed” to the point where they can’t take it any longer and are forced to sell for a major loss. In other words, the higher the stock goes, the greater the loss. 

In January of 2021, numerous hedge funds were short-selling GameStop but a large number of retail investors on wallstreetbets rallied together to buy more of the stock, causing these hedge funds to lose money. On January 28, 2021, some brokerages including Robinhood, halted the buying of GameStop and other securities. This decision attracted criticism and accusations of market manipulation from politicians and businesspeople. Dozens of class action lawsuits have been filed against Robinhood since.

So let’s break down this situation a little more and dive into the GameStop business model.

In this situation, the hedge funds were right in their analysis of the stock. The financials were terrible in January (and still are today) and the business model itself, which we’ll break down shortly, is a dying breed. This stock was indeed poised to fall further. The rally caused by the investors on wallstreetbets is a rare occurrence but it showed us that retail investors can play the game correctly and beat hedge funds. Unfortunately, brokerages like Robinhood changed the rules (halted buying) which relieved the pain for the hedge funds. That halt on buying caused an emotional domino effect which quickly triggered a selloff. The stock went from $325 down to $90 in one trading day.

GameStop generates revenue by selling video game consoles and video games through retail stores as well as online. They do not manufacture their own gaming system such as Microsoft manufacturing Xbox and Sony manufacturing PlayStation. They also do not develop their own games such as Activision Blizzard and Take-Two Interactive.

Video games have been moving to an online distribution format where consumers can download and play as many games as they want. Consumers no longer want to walk or drive to a store to buy video games.

Think of it like Blockbuster vs Netflix. Blockbusters was a retail store, founded in 1985, where you could rent physical VHS tapes. In the 1990s they transitioned to DVDs and they reached their peak in 2004 where they had over 9,000 stores around the world. In fact, at their peak, they were opening a new store every 17 hours. Unfortunately, a series of bad business decisions and circumstances led to the demise of Blockbuster. Here is that list:

  • Viacom bought 81% of Blockbuster in 1994 and treated the business as an ATM. It was essentially a cash cow that provided funding for one of Viacom’s other brands, Paramount. When that cash cow started to slow down, it decided to cut ties with it in 2004.
  • Netflix was founded in 1997 and introduced mail-order DVDs which disrupted the retail store rental business model. Netflix also introduced a subscription model with unlimited DVD’s which was a game changer. Blockbuster had the option to buy Netflix in 2000 for $50M but Blockbuster laughed Netflix’s founder, Reed Hastings, out the door. Today, Netlix has a market cap of $253B. 
  • Walmart was becoming a threat by offering DVDs for a retail purchase price of approximately $5, which was just a dollar or two more than a rental at Blockbuster.
  • Redbox introduced DVD rental kiosks which did not require employees or physical stores to operate. This means they could generate similar revenue with significantly less overhead. This created a higher profit business model.

Overall, the storm was closing in from all sides and blockbuster filed for bankruptcy in 2010. As of today, only one store remains in Bend, OR.

Now circling back to GameStock, let’s break down the red flags on the business model. Remember, an investor should never invest in a stock, they should invest in a business. This means you need to look past the numbers as well as the emotions found on Youtube, Reddit, Twitter, and any other social platform.

  • Retail Stores: GameStop has 4,816 retail stores. This means they have significant overhead with physical office locations and the employee payroll to operate those locations. 
  • Video Game Developers: All major video game developers such as Electronic Arts, Activision Blizzard, and Take-Two Interactive are moving, or have already moved, to online purchase and download. If a customer wants to play another game, they don’t go to a store, they simply purchase the game online. This is similar to the Netflix business model. When a company goes completely digital, they no longer have supply chain costs, warehousing costs, material costs (plastic and aluminum), etc. Digital is the future and Netflix proved this with the movie rental industry.
  • Video Game Manufactures: GameStop does not manufacture their own gaming systems. This means they buy physical consoles wholesale and sell retail. Buying wholesale and selling retail means smaller profit margins. Companies like Microsoft, Sony, and Nintendo manufacture their systems which means they generate larger margins. They also have the high ground and can control the costs to produce and prices to charge. GameStop does not have this power.
  • Leadership is fighting an up-hill battle: GameStop brought on Chewy founder, Ryan Cohen to the board of directors to help with ecommerce strategy. GameStop also hired Matt Furlong and Mike Recupero, two ex-Amazon Executives to serve as CEO and CFO and transform the company into a ecommerce model, that play still won’t make a significant difference. The video game consoles GameStop sells online can still be purchased from Amazon and Target for the exact same prices. As of September 2021, I confirmed the Oculus Quest 2 (256GB) VR headset is $399 on GameStop, Amazon, and Target. This confirms there is no moat especially on pricing power.

Here is what the news has to say.

This article from mywallst.com states that most experienced investors are avoiding this stock. 

This article from fool.com states that GameStop may still have a chance. Some of the key points include the company trimming stores to reduce overhead and are experimenting with the idea of selling new products such as gaming tables, gaming televisions, and e-sports training centers. 

My comments on this are adding gaming tables, gaming televisions, and e-sports training feels like a great business model for a few high school students who want to make a few extra bucks over the summer. I’ll be surprised if any of these options increase the share price of a publicly traded company. They are definitely reaching.

This article from nbcboston.com states that MassMutual will be fined $4M by the state of Massachusetts due to the activities of YouTuber, Roaring Kitty, AKA Keith Gill. Gill, who was a MassMutual Investors Services Agent, was involved with discussions on Reddit around the GameStop’s stock. Gill made two trades in GameStop worth more than $700,000 undetected, and he facilitated transactions of nearly twice MassMutual’s $250,000 limit. Nearly 1,700 trades that he made for three other people went undetected or monitored by MassMutual, as well, officials said. As stated by Gill, “I believed the company was dramatically undervalued by the market. The prevailing analysis about GameStop’s impending doom was simply wrong,” he said in prepared testimony. “My investment skills had reached a level where I felt sharing them publicly could help others.”

My comments on this is Gill definitely did not look at the business model. It’s easy to see where GameStop stands against other companies and thinking this was a wise investment is beyond crazy. Also, the undetected trades of $700,000 are a bit alarming. This raises an integrity issue. This is a reminder that trusting analysts or advisors in the financial industry can sometimes work and of course, sometimes not work. Be careful who you take advice from. Personally, I like to look at analysts, wealth managers, and financial advisors through a different lens. I ask the question, if this person were put in the position of CEO, could they lead the company? In most cases, that answer is a resounding no. But please keep in mind, I’m sure there are a few analysts, wealth managers, and financial planners that have incredible business acumen as well as the integrity that make them fit to lead a publicly traded company.

Let’s take a look at a few companies in the video game industry. These are not direct competitors but they have the opportunity to take market share away from GameStop.

GameStop (GME)

Summary:  Overpriced

Score:  6/20

MOS:  1%

Share Price:  $189

Sticker Price:  $192

 

Video Game Manufactures

Microsoft (MSFT)

Summary:  On Sale

Score:  19/20

MOS:  80%

Share Price:  $294

Sticker Price:  $1,481

 

Sony (SONY)

Summary:  Watch

Score:  12/20

MOS:  48%

Share Price:  $112

Sticker Price:  $215

 

Video Game Developers

Activision Blizzard (ATVI)

Summary:  On Sale

Score:  17/20

MOS:  80%

Share Price:  $73

Sticker Price:  $367

 

Take-Two Interactive (TTWO)

Summary:  On Sale

Score:  15/20

MOS:  80%

Share Price:  $145

Sticker Price:  $732

 

Electronic Arts (EA)

Summary:  Watch

Score:  10/20

MOS:  1%

Share Price:  $126

Sticker Price:  $128

 

Now let’s take a look at the 4 M’s.

MOS: With a score of 6/20 and a MOS of 1%, the financials are awful. When you take a closer look at the Financials tab within Tykr, you can see the declining year over year revenues and the negative net income and EPS. The weak financials are not surprising given the business model.

Meaning: We all saw what happened to Blockbuster. The video game industry is heading the same direction as the video rental industry. Knowing that video games may be purchased and downloaded online shows us that physical video games are no longer the future. If GameStop wants to keep stores, perhaps they should consider going private and operating like a small business. 

Moat: There is no moat with this business model. With console manufacturing, they buy wholesale and sell retail. In other words, they have no pricing power when manufacturing companies do. With video games themselves, developers have moved to the online format which GameStop can’t compete with.

Management: I give GameStop credit for bringing in an experienced board member such as Cohen, and experienced leaders such as Furlong and Recupero, but a lot needs to change with the business model to position the company as a wise investment.

 

Now let’s take a look at the financials. A good value investor should be able to read the income statement, cash flow statement, and balance sheet and within 60 seconds have a pretty good idea of how the business is performing.

 

Revenue (Found on the Income Statement)

2018:  $8.5B

2019:  $8.2B

2020:  $6.4B

2021:  $5B

Revenue is declining. This is a red flag.

 

Net Income (Found on the Income Statement)

2018:  $34M

2019:  -$673M

2020:  -$470M

2021:  -$215M

Net Income has fallen well into the negatives. The removal of some office locations is most likely why the net income has increased in 2021. The profits are improving but still negative.

 

EPS (Found on the Income Statement)

2018:  .34

2019:  -6.59

2020:  -5.38

2021:  -3.31

EPS is still well into the negatives.

 

Free Cash Flow (Found on the Cash Flow Statement)

2018:  $321M

2019:  $231M

2020:  -$493M

2021:  $63M

Free Cash Flow has improved slightly which is impressive. Still, the score of the company is 6/20. This is one reason why GameStop is not 1/20.

 

Total Assets (Found on the Balance Sheet)

2018:  $4B

2019:  $2.8B

2020:  $2.4B

2021:  $3.5B

Total Assets have increased since 2020. This is also a reason why the score is not 1/20.

 

Total Liabilities (Found on the Balance Sheet)

2018:  $2.7B

2019:  $2.2B

2020:  $2B

2021:  $1.6B

Total Liabilities have decreased which is good. The obvious reason here is the removal of office locations.

 

Total Debt (Found on the Balance Sheet)

2018:  $820M

2019:  $659M

2020:  $1B

2021:  $921

Total Debt has declined. Again, this relates to the removal of office locations.

 

Total Equity (Found on the Balance Sheet)

2018:  $1.3B

2019:  $611M

2020:  $436M

2021:  $1.8B

Total Equity has increased which is a good sign. This is another reason why the score is not 1/20.

 

Most of the stock reviews here on Tykr are focused on potential buying opportunities. Of course, as an investor, you should always make your own buying and selling decisions based on your own financial goals. But this review on GameStop is a good example of looking at a business, not just the numbers. Be careful when following advice from guru’s on Youtube, Reddit, Twitter, TikTok, and any other social platform. Try to research and understand the integrity of these individuals and try to determine if they could indeed run the company if they were placed in the position of CEO. Also make sure you manually look at the financial statements or if you want to save time, look in Tykr to see the overall financial health of the company. Then, move past the numbers and look at the business. If you can understand the business model and where it’s going, you will increase the probability of making a positive return on your investment.

The Summary, Score, and MOS of this stock may have changed since the posting of this review. Please login to Tykr to see up-to-date information.