The wild ride GameStop (NYSE:GME) has been on this year could be coming to an end. The stock is down over 50% from levels it hit just one month ago and it has lost two-thirds of its value from the all-time high it struck back in January.
Because the video game retailer is one of the few so-called meme stocks that actually does still have a future, does the haircut GameStop’s shares received mean it’s time to buy? Not yet, and here’s why.
Going online for the win
GameStop is just beginning its turnaround adventure. It has a new management team and board of directors that are like-minded in their vision for the retailer.
They want GameStop to shed its vast physical retail footprint, keeping only the most profitable ones, and instead transition to an online-heavy focus. Or, as chairman Ryan Cohen termed it, GameStop needs to become “the Amazon of gaming.”
The pandemic last year showed it’s certainly possible. With people forced to stay at home with retail stores closed, and e-commerce channels the only avenue to purchase games and equipment, gamers flooded its website, sending visits over 1,000% higher.
What it proved is that the GameStop brand still has considerable value. Amazon.com and other retailers and manufacturers sell games, equipment, and accessories, but GameStop is the go-to retailer, even online.
A war chest to back its plans
The video game outlet also used the investor frenzy over the stock to its benefit. A year ago, GameStop posted adjusted losses of $79.1 million, had $417 million in debt, and almost another $500 million in operating leases. Even with the $570 million in cash it possessed, it was a heavy drag on its business if it hoped to survive even after the video game console upgrade cycle passed.
However, using the mania surrounding its stock this year, GameStop was able to raise substantial amounts of new capital, which was used to pay off all of its debt while still leaving it with $771 million in cash to finance its turnaround strategy (it does still have $445 million in operating lease obligations).
Fellow meme stock AMC Entertainment (NYSE:AMC) attempted to follow a similar playbook, proposing a 500 million-share offering earlier this year and, more recently, a 25 million-share offering. Both were resisted by its shareholders, causing the theater operator to shelve both plans. As a result, AMC’s financial situation is far more dire than GameStop’s.
This all speaks to why GameStop is a meme stock that can still be standing years from now when the craziness of the meme stock tumult is a distant memory. But that doesn’t make the stock a buy.
Time to put up or shut up
At this moment, GameStop is more like a penny stock with a good story. Think back to when everyone seemed to be a lithium miner because of the high demand for electric vehicle car batteries. Or when rare earth minerals were all the craze. The same happened with solar panels and even gold mining.
They all had a good story to sell but nothing to back up their bluster. Instead, they were classic pump-and-dump schemes, where boosters churned up interest in the stock to get the price to jump so they could bail out and reap a windfall while you’re left holding essentially worthless paper.
A good case can be made that those yelling loudest about AMC are engaging in much of the same activity.
Right now, GameStop’s turnaround is all talk. It has yet to show that Cohen’s plan to remake the retailer into an e-commerce powerhouse for gamers can actually work. I do believe GameStop has the potential to pull through, but not at any price.
Putting a price on a rebound
For all the pummeling its stock has taken recently, GameStop’s shares are still trading 4,000% above the level they were at one year ago. The true penny stock status it held back then was arguably just as unjustified as its current sky-high valuation, but it’s not yet offering investors any discount. In fact, it’s all premium and then some.
First-quarter sales of $1.2 billion are 25% higher than last year, but still 18% below 2019. Yes, GameStop has closed many stores over the last two years, but that’s just it: It needs to prove it can still grow sales being a mostly online retailer.
That $445 million in operating leases tells the heavy tale of its physical footprint. Cohen is smart to want to get rid of that anchor, but that’s an issue to be tackled in the future.
GameStop’s valuation metrics — price to sales, to earnings estimates, to free cash flow — are all vastly inflated. I can’t tell you the right buy-in price for the stock, but I know that $165 a share is well above it.
I like GameStop’s chances for a turnaround, but the video game retailer is not a stock I’d invest in anytime soon, not even after a 50% haircut.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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