Pros And Cons Of Investing In GameStop Stock

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GameStop Corp.’s (NYSE:GME) business had been on a decline for the last several years with sales of gaming software and consoles shifting online. Decreasing sales coupled with operating deleverage resulted in the company’s net income turning negative. This was further exacerbated by lockdowns and the e-commerce boom in 2020. Many short-sellers started targeting the company at that time betting on eventual bankruptcy. However, things started turning around with Ryan Cohen taking control of the company and the stock catching the attention of “Reddit” or “Meme” investors. Not only did the ensuing rally in early 2021 obliterated short-sellers, but it also helped strengthen the company’s balance sheet as GME was able to issue shares at higher prices.

GME has now corrected significantly from the highs made in early 2021 but it is still trading much higher than the levels before the short squeeze. Many investors and traders are trying to figure out if they should consider taking a position in GME stock at these levels. In this article, I am going to discuss the pros and cons of investing in GameStop which one should consider before putting money on the long or short side. But before discussing it, let’s take a look at the key metrics for the company.

GME Stock Key Metrics

Revenues

Even before the pandemic hit its business, GME’s revenue had been declining, owing to the industry’s shift to e-commerce. GameStop Corp.’s revenue was ~$8.5 billion for FY2017, which dropped to ~$5 billion for FY2020. GME’s revenue witnessed growth in FY2021, but the increase was attributed to the relaxation of lockdown restrictions and increased popularity of GME among retail investors, who helped to boost GME’s sales by purchasing products from the company.

GME’s store count has also been on a decline for the last several years with a decrease across all operating geographies. The company’s sales per store followed a similar trend and fell from $1.45 million in FY2017 to $1.05 million by FY2020. However, in 2021, GME’s sales per store increased, owing to higher collectables and hardware & accessories sales as a result of increased popularity.

GME’s Total Revenue and Store Count (Company Data, GS Analytics Research)

GME’s Sales Per Store in (USD thousands) (Company Data, GS Analytics Research)

Margins

Due to increased competition from e-commerce, GME’s gross margin has declined from 31.4% in FY2016 to 22.4% in FY2021, whereas SG&A as a % of revenue increased from 23.4% to 28.4% in the same period. GME has been posting operating losses since FY2019.

GME’s Gross margin and SG&A expense as a % of revenue (Company Data, GS Analytics Research)

Pros of investing in GME

If we look at the company’s past performance there is not much which can be deemed as positive. However, a lot has changed in the past year and there are a few bright spots if we look at the future.

Ryan Cohen led transformation

With a lot of cash (thanks to the short squeeze) and Ryan Cohen at the helm, GME is attempting to transform itself into an e-commerce marketplace for gamers. GameStop’s newly appointed management includes technology veterans such as Matthew Furlong (CEO) and Mike Recupero (CFO) and the company is taking steps to reinvent its business. The company is likely to close the bleeding offline segment and will focus on creating an e-commerce company focused on gaming and related products. Furthermore, the company plans to enter the $40 billion NFT market with a blockchain-based NFT marketplace, which could be another opportunity for the company in the long term.

GME has gained some traction in these efforts. GameStop’s new brand relationship with PC gaming companies such as Alienware, Corsair, and Lenovo has allowed them to increase their PC sales by ~150% last year.

In early 2022, GME announced a partnership with Immutable X. The partnership will establish grants to creators of NFT content and technology. Immutable X will also become a layer 2 partner and platform for GME and the company’s NFT marketplace which is expected to be launched this year.

Cash-rich balance sheet

GameStop Corp. was able to raise a good amount of cash at an inflated valuation following last year’s short squeeze. The company’s balance sheet is strong, with only ~$40 mn debt and over $1.27 billion in cash and cash equivalents. The healthy amount of cash on hand has not only removed the near and medium-term bankruptcy risks but also enabled the company to fund its new ventures.

While these efforts are still in the initial stages and there is a lot of uncertainty associated with the final outcome, there are scenarios where GME’s success in any of these initiatives may result in higher stock prices.

In addition to these fundamental factors, there is also a potential for a short squeeze. In the past also “Reddit investors” have caused unexpected short squeezes in the stock. There is a chance of a similar short squeeze in the future, which can drive the stock higher. Short interest as a % of the float was 21% as of April 13, 2022. It is not very high compared to previous levels but if the short sellers continue to target the stock, they may be in for a nasty surprise.

Cons of investing in GameStop

Not an easy path ahead

While management’s long-term turnaround story does look good, transforming a company from a traditional brick-and-mortar retail store to a full-fledged online e-commerce cum NFT marketplace will take a significant amount of time, effort and investments. As previously stated, the company has sufficient cash to sustain its operations, but it is still a loss-making company. So, this transition needs to be completed in a timely manner. How GameStop would be able to compete with well-established e-commerce companies still needs to be seen.

Poor historical performance

GameStop’s poor historical performance gives little confidence in the business’s intrinsic strength. GameStop’s gross margins have been continuously declining since the pandemic. SG&A expenses had exceeded gross margin since 2019 (i.e. even before the pandemic). There was some improvement in the company’s revenue last year but I believe a good portion of it was due to all the hype surrounding GME stock. This benefit might go away this year putting some pressure on its core business.

The company’s valuation has increased meaningfully without much improvement in underlying business performance. So, if the company is not able to deliver on its new growth initiatives, there is a significant downside possible.

Investors turning away from risk-assets

The low-interest-rate environment increased the risk-taking appetite of many investors post-pandemic. This led to a rally in various risk assets, be it technology stocks, cryptocurrencies or meme stocks. However, this trend seems to be reversing with interest rates rising. So, GME’s stock may continue its downward journey as investors move away from risky assets.

Is GME Buy, Sell or Hold?

GME’s revenues should continue to remain under pressure until management’s e-commerce initiative gains significant traction. The offline segment generates the majority of GME’s revenue, and while management is taking efforts to improve its e-commerce presence, there is a lot of competition in the e-commerce business, and it’s unclear how successfully will GME be able to compete. GME’s revenue increased in 2021 as a result of its increased popularity among retail investors, but the trend is fading with decreased GME website visits. GME’s entry into the NFT market, as well as its partnership with immutable X, are still in its inception and will take time to bear fruit. All of this indicates a lot of uncertainty for GME’s future.

I would like to see some traction in management’s turnaround efforts before becoming more positive. I would not recommend going short either. Meme investors are known for orchestrating short squeezes and, if the past is any indication, it is best to remain on the sidelines on these stocks even if you are not too optimistic about their long term prospects. There is also a potential fundamental case for the company if management’s turnaround efforts are successful. Hence, I have a Neutral or Hold rating on the stock.