Being traded as a meme has significantly improved GameStop’s cash position, giving the company a stronger foundation to pursue larger initiatives.
- GameStop’s stock skyrocketed in 2021 due to retail investors on Reddit, causing massive short squeezes and heavy losses for institutional investors.
- Activist investor Ryan Cohen’s 2020 stake acquisition led to major management changes, raising $1.1 billion and achieving profitability in 2023 through cost-cutting.
- GameStop’s inflated valuation is driven by market sentiment, not business performance, with ongoing revenue declines making it unsuitable for value investors.
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GameStop’s Meme Story
Video game retailer GameStop (NYSE:GME) had its stock emerge as a sort of “poster child” of the meme stock phenomenon where massive short squeezes occurred in 2021. This increase in trading activity led to huge losses for several institutional investors who were betting against the company.
These short squeezes were made, however, by a special coalition of retail investors who, with social media platforms like Reddit as a stage, all rallied together to buy the stock in extremely high volumes, putting pressure on short sellers to cover their positions.
Going back five years, GameStop was going through very different circumstances to today, as in 2019 the company’s shares plummeted as the market was already sniffing out a potential banrkuptcy ahead.
The dire situation prompted a significant shakeup in the company’s management, as conflicting interests among executives added insult to the injury that was a rapid depletion of cash reserves and declining sales.
Challenges stemmed from intensified competition from digital media in gaming, as well as the encroachment of e-commerce behemoths eroding the company’s market share.
But the meme frenzy that followed ultimately proved highly profitable for GameStop. As the company’s shares soared to unprecedented heights in early 2021 amidst the short squeezes and peak stock popularity, GameStop seized the opportunity to issue additional equity, thereby diluting its stock.
This strategic move enabled GameStop to raise approximately $1.1 billion in cash in that time, which was then utilized to bolster the company’s balance sheet and alleviate its debt burden.
The “Ryan Cohen” Era
Still in the early stages of the meme frenzy, Chewy (NYSE:CHWY) co-founder and former CEO Ryan Cohen emerged on the scene. As an activist investor, Cohen acquired a significant stake in GameStop shares in 2020, contending that the company’s shares were undervalued.
“I invested in GameStop because I thought it was cheap and the intrinsic value of the business was worth more than the price that I paid,” Cohen stated. “There was a tremendous amount of skepticism around GameStop, and those are the things that I like… looking at things while no one is looking at them.”
Ryan Cohen’s decision to amass a substantial stake in GameStop at that juncture is often credited as one of the catalysts behind the subsequent massive short squeezes in the stock. Most of Cohen’s stake in GameStop was acquired when the share price ranged from $3 to $4 (post-split). This represented an upside of approximately 280% at present, with his gains having surpassed 2,000% at one point.
Remarkably, Ryan “Diamond Hands” Cohen opted not to sell a single share. Instead, he continued to acquire more shares sporadically, albeit in smaller quantities.
Despite GameStop’s share price experiencing significant volatility, Cohen remained bullish on the stock. He also leveraged his profile as an activist investor to orchestrate what could be seen as a “hostile takeover” of the company.
As he owned over 10% of the company’s total shares, Cohen ascended to the position of Chairman of the Board, orchestrating a significant overhaul of the company’s executive board, including the appointment of a new CEO of his choosing.
Maintaining a discreet demeanor and employing a mysterious tone, GameStop under Cohen’s stewardship divulges minimal information regarding its business fundamentals. The company refrains from issuing formal guidance, preparing presentations for investors, or hosting earnings calls.
In September last year, Ryan Cohen unexpectedly took over as CEO of GameStop. With GameStop’s filings since 2022 indicating the company’s primary objective of achieving profitability, in 2023 the company reported its first profitable year since 2018 marking a significant turnaround. GameStop reveresed a net loss of $331.1 million in 2022 to a profit of $6.3 million in 2023.
However, it’s important to note that these results were primarily achieved through extensive cost containment, staff reductions, inventory management, and store closures. GameStop continued to report declining revenues in 2023, signaling a clear downward trend in its core business.
Latest Moves and Recent Meme Rally
In Q3 2023, Ryan Cohen’s latest move at the helm of GameStop came to light when the company disclosed a revision to its investment policy. Previously, the policy restricted GameStop’s cash balance to fixed-income assets; however, it now allows for investments in equities at Cohen’s discretion.
But then, unexpectedly, Ryan Cohen and co. received a big positive surprise: another meme rally around GameStop stock.
This time, the rally was made possible by super buying pressure surrounding Keith “Roaring Kitty” Gill’s return to social media, posting memes on the X platform (formerly Twitter) after being inactive since 2021.
For those unfamiliar with the events from about four years ago, Keith Gill, known on YouTube as “Roaring Kitty,” was a key player in GameStop’s big share-price surge between 2020 and 2021. Gill initially bought his position in the video game retailer in June 2019 via call options and expanded his GME holdings over the following year.
So GameStop acted fast. As in the trading session on May 14, shares in the video game retailer reached $64 per share, reaching a market cap of almost $15 billion (remembering that in mid-April, the company had a market value of $3.2 billion), the company’s management acted quickly in a market open sale agreement where they could sell 45 million common shares.
Since 2021, GameStop has not diluted its shareholders, but if GameStop manages to sell these shares at a share price close to $20, that would mean an extra cash infusion of almost $900 million.
Thus, with a much stronger balance sheet under the new investment policy, it is likely that GameStop will allocate investments in other equities this year or next. Likely because nothing is clear about the way the company is going with Ryan Cohen at the helm. But so far, this is the main evidence that there is a strategy behind making GameStop more profitable.
A Meme Stock Valuation
GameStop’s valuation is far from sensible based on its fundamentals. Although the company has now reached profitability, it trades at an EV/EBITDA of 294x, versus an industry average of 10x.
BestBuy, for example, is a brick-and-mortar electronics retailer that has suffered from the same industry woes with falling revenues. It trades at an EV/EBITDA of 6.95x.
But clearly, GameStop is a company that, for the last three years, has not traded on the basis of its fundamentals but on the basis of fluctuations in market sentiment dictated by retail investors and traders. So why look at valuations at this point, right?
The Bottom Line
GameStop’s core business is in pure decline. Revenues decrease every year, and the company is forced to cut costs to stay minimally profitable and operational.
It’s undisputable that the company has cash, mostly thanks to equity offerings (thanks to meme stock investors) and unorthodox management. However, any turnaround, no matter how gigantic, is unlikely to justify such a stretched valuation for at least a few good years to come.
On top of all this, there is an ultra-volatility that has probably never been seen on the stock market because of the company’s “meme stock” label for the last few years. This makes it practically impossible to predict where the stock might go, at least in the short term.
That said, although I believe the thesis around the stock can be seen as trade material, value investors should avoid the stock at all costs.
(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content)
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