GameStop’s soaring stocks don’t hide the reality

Behind GameStop’s soaring inventory lies the grim reality of its outlook: The video game retailer is floundering even as the industry around it is booming.

GameStop has been caught up in a battle between the high-income hedge funds betting against it and the smaller investors trying to back it up. This caused the GameStop share price to soar despite the fragile financial situation below.

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Flailing companies like AMC Entertainment and American Airlines also saw a big increase in shares, but GameStop was the main battleground between the Davids and the Goliaths. Shares have climbed 1,600% in the past three weeks, closing at $ 325 a share on Friday and giving GameStop a market cap of nearly $ 17 billion. The shares have since cratered. On Tuesday, they fell 60% to close at $ 90.

Many investors fully understand the contradiction between GameStop’s stock price and its trading fundamentals. But for those who imagine it will be the next Tesla or Amazon, the truth is, it probably isn’t. The company’s quarterly report released in September showed another sharp drop in quarterly sales as it struggled to adjust to the rise of mobile games and digital downloads that have made its more than 5,000 stores obsolete, again. more during the pandemic.

And the attention-grabbing media coverage hasn’t brought shoppers back to stores in recent weeks. The decline in customer traffic accelerated in January, according to a new study from analytics firm Placer.ai. For the week ended Jan. 18, the number was down 20.3% from a year ago.

Analysts polled by FactSet have a “sell” rating on the stock and a target price of $ 13.44 per share. Some analysts believe a reasonable valuation could be between $ 20 and $ 30 per share at best.

While new GameStop board member Ryan Cohen, founder of online pet store Chewy, has raised hopes of a turnaround, the battle will always be uphill.

“It’s fascinating to watch. But at the end of the day, you can’t escape gravity, “said Scott Rostan, CEO of Training The Street, which teaches financial modeling and valuation to students and MBAs.” Ultimately, reality will set in and ultimately the fundamentals are going to have to come into play. “

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The Grapevine, Texas-based company was founded in 1984 as Babbage’s and resumed the GameStop name in 2000. It was the destination to grab the latest video games when they were released. But it has also become the place to exchange old games and consoles to get money or credit to buy new ones.

Sales have declined over the past decade due to the rapid transition to downloading games. Annual sales have grown from their peak of $ 9.5 billion in fiscal 2012 to $ 5.15 billion expected for the fiscal year ended Jan. 30, according to FactSet.

At a GameStop location in Brooklyn, there were illuminated wind up notices stuck to the front windows. Inside, the shelves were for sale with a meager mishmash of salvaged power cords, animated key chains, and t-shirts.

Most of the games went quickly with a huge cut. Stacks of games for the Xbox 360 – the Microsoft gaming console that went out of production about six years ago – could be bought for a quarter instead of the $ 50 they once commanded.

Carlos Cruz, 33, from New York, used to visit GameStop once a week to buy new games and trade in old ones. But that stopped a few years ago when he started downloading games. Now he’s going to GameStop every two months, specifically to get some exclusives.

“It’s easier for me to download the games around the house and not go anywhere,” said Cruz, noting that 90% of his games are digital.

Xbox Live, PlayStation Network, Nintendo eShop, and the Steam online gaming platform allow players to download games. And Amazon is testing the cloud gaming arena with a new streaming service called Luna. Discounters like Walmart, Best Buy, and Target have also increased their offerings.

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Meanwhile, the global video game market has exploded, a trend accelerated by the pandemic as Americans stay at home. The global gaming industry is expected to reach $ 174.9 billion last year and $ 217.9 billion by 2023, according to analytics firm Newzoo. That’s up from Newzoo’s forecast released at the start of the pandemic last year of $ 200.8 billion.

There have been some recent positives for GameStop. The company posted total sales down 3.1% for the nine-week period ended Jan. 2, but managed to offset store closings with strong demand for game consoles. Online sales, which accounted for about 30% of the company’s overall sales, more than tripled. And GameStop has reduced its overall debt on its balance sheet by nearly $ 600 million since early 2019.

In mid-January, GameStop added Cohen and two of his former Chewy colleagues to its board after Cohen urged the company to focus on its online operations.

“GameStop must evolve to be a tech company that thrills gamers and delivers exceptional digital experiences – don’t remain a video game retailer that over-prioritizes its physical footprint and stumbles into the online ecosystem,” Cohen said in a commentary. letter to the board of directors last november.

By the end of last fiscal year, GameStop will have closed more than 1,000 stores since mid-2019. It also added PC games, computers, monitors, table games, and gaming TVs to its mix. But analysts believe any turnaround will take time, and some believe Cohen’s experience running an online pet store is not applicable to the gaming industry.

“I think he’s a good merchant and a good retailer,” Wedbush analyst Michael Pachter said. “But can you digitally download pet food or toys? I don’t think so.”

Cohen, whose investment firm has acquired a 12.9% stake in GameStop in recent months, declined to comment. GameStop could not be reached for comment.

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Analysts say GameStop could take advantage of the high stock price and come up with its own stock offering like American Airlines. The chain could use this money to reinvest in the business.

But given so much uncertainty, the question is: at what cost?

“No one knows what the real valuation is,” said Alon Y. Kapen, corporate transactions lawyer at Farrell Fritz. “And you don’t know when that window is going to close.”