GameStop Investors Are Getting Burned Again

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GameStop GME announced its fiscal first quarter results on Wednesday along with a new CEO and CFO from Amazon AMZN and a 5 million share offering where the company can sell shares anytime. From a short-term stock perspective the stock offering is the most important as it cratered the shares $82.17 or 27% from $302.56 to $220.39 on Thursday. While this knocked off almost $6 billion in market cap, the company is still worth almost $16 billion.

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This is the third time this year investors have lost billions in a few days. Anyone who bought the shares and held them in the past 10 trading sessions are now underwater, some of them by over $100 per share.

Colin Sebastian, Senior Research Analyst at Baird, has a Neutral (equivalent to Hold), Speculative Risk rating with a $25 price target. He wrote in his earnings recap note, “As GameStop’s Board continues to shuffle the management deck, the goal to transform into a “technology” company that delights gamers remains mostly a mystery, particularly as the video game industry accelerates the shift toward downloads, streaming and cloud services. No doubt the console transition period is providing a lifeline, but games are not dog food, and investors deserve more than memes to value a company’s fundamental, long-term prospects.”

This is a smart move by the company, for the company

In April GameStop sold 3.5 million shares raising $551.7 million for an average of about $158 per share. This allowed it to redeem $216.4 million in 10% debt, which resulted in the company having no long-term debt.

If the company can sell 5 million shares at the current price of $220 it will raise approximately $1.1 billion. Combining that with the $771 million in cash the company currently has will allow it the financial flexibility to pursue new initiatives over a multi-year timeframe. However, it will take years, not months or quarters, to fundamentally change the company and its financial results.

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The results for the first quarter were better than expected

Even though it was an easy compare from last year’s Covid-19 impacted fiscal first quarter, the company did even better than expected.

  • Revenue of $1.28 billion, up 25% year-over-year and above the $1.16 billion consensus estimate
  • Hardware grew 37% year-over-year and was 55% of sales
  • Collectibles grew 93% year-over-year
  • Gross margin of 25.9% was a bit ahead of consensus of 25.7%
  • Pro-forma EPS loss of $0.45 vs. an expected loss of $0.82

While the company did not provide guidance, analysts are probably increasing their estimates for the remainder of this year and next. However, the stock’s valuation is still very extended.

Selling stock won’t create much dilution

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GameStop’s shares are up 1,070% year-to-date at $220.39. If the company were to sell all 5 million shares and raise $1.1 billion at the current price it would only dilute existing shareholders by 7%.

But valuation numbers don’t make sense

Before Covid-19 derailed the U.S. and worldwide economies GameStop was slowly losing revenue from fiscal 2016 to 2018 then had a sharp drop-off in fiscal 2019 (ended in January 2020). GameStop may be able to shake up its business enough to recover at least some of downturn but it won’t happen overnight.

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  • Fiscal 2016 revenue: $8.6 billion
  • Fiscal 2017 revenue: $8.5 billion
  • Fiscal 2018 revenue: $8.3 billion
  • Fiscal 2019 revenue: $6.5 billion
  • Fiscal 2020 revenue: $5.1 billion
  • Fiscal 2021 revenue: $5.45 billion estimate
  • Fiscal 2022 revenue: $5.31 billion estimate

Note that while GameStop’s fiscal year ended on January 30, 2021, and would normally be labeled fiscal 2021, GameStop calls it fiscal 2020.

When calculating the company’s valuation metrics these results use fiscal 2018’s $8.3 billion in revenue so as to be as generous as possible.

  • At Thursday’s close of $220.39
  • Market cap of $15.8 billion
  • 12.4 times greater than December 31, 2020’s market cap of $1.3 billion
  • 1.9x market cap to fiscal 2018’s revenue
  • vs. 0.15x at December 31, 2020

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Using fiscal 2023’s revenue of $5.31 billion makes the valuation numbers even worse. It comes in at 2.9x market cap to revenue or 52% higher.

Due to the huge spike in GameStop’s shares and the resulting bubble valuation metrics, it makes perfect sense for the company to sell shares at inflated prices and put itself on stronger financial footing.

Surprisingly, analysts are bullish on the shares

Yahoo! Finance has 12 sell-side analyst ratings on the shares with an average price target of $62.25 even though they have the company losing $1.02 per share in fiscal 2022 (ending February next year) and losing $0.59 per share in fiscal 2023.

  • 2 Strong Buys
  • 2 Buys
  • 7 Holds
  • 1 Underperform

It feels like the Strong Buys and probably the Buy ratings are “stale.”. I find it hard to believe that given the price and valuation levels the shares are at that a sell-side analyst has a Buy, much less a Strong Buy, rating on them.

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Shares have been extremely volatile

From GameStop’s SEC filing for its shares offering one of the Risk Factors included, “For example, on January 28, 2021, our common stock experienced an intra-day trading high of $483.00 per share and a low of $112.25 per share. In addition, from January 11, 2021 to June 8, 2021, the closing price of our common stock on the NYSE ranged from as low as $19.94 to as high as $347.51 and daily trading volume ranged from approximately 1,790,000 to 197,200,000 shares. During this time, we have not experienced any material changes in our financial condition or results of operations that would explain such price volatility or trading volume. These broad market fluctuations may adversely affect the trading price of our common stock.”

Note how the company pointed out that there have not been any material changes to the company’s finances or operations over these time periods.