Justin Sullivan
GameStop (NYSE:GME) has been one of my longest ever short positions, which I’ve held on and off in some form since late 2015 when the company was being subjected to the realities of people moving away from in-store purchasing of various gaming devices and services. Since then, they’ve enjoyed a surge in share price on behalf of meme trading frenzies and the subsequent decline back to a more realistic range.
While all of that was happening, the company did take advantage of the higher share price to purge themselves of a chunk of their debt, but have not managed to make a dent in other parts of its business segments to alter the course of declining revenues or higher costs of those revenues in order to justify any continued higher share price.
Let’s explore this 1 positive to 99 negatives to see where we stand.
The 1 Positive: Debt & Interest Expense
In 2018, the company held a record amount of long-term debt, with just over $818 million, on which it was paying nearly $57 million annually in interest expense. In 2020, when interest rates went down to near zero, the company’s share price went through the meme stock trading frenzy and alongside refinancing some of their high interest rate debt – they issued a whole bunch of equity to pay down their existing debt.
They continued to pay off their debt in the following years, as follows:
| 2018 | 2019 | 2020 | 2021 | 2022 | Now | |
| LT Debt | $818M | $472M | $420M | $216M | $41M | $32M |
(Source: Company Balance Sheet – Seeking Alpha)
Not only does this help their valuation by deleveraging the company, it also acts as a cash preserver due to the lower interest expense they’ll pay in the long run, especially as interest rates skyrocket due to the Federal Reserve trying to combat global inflation after the COVID-19 pandemic.
As a result of their debt reduction, the company has been saving millions of dollars each year from interest expense, which they’ll be able to use to try and jumpstart parts of their business.
| 2018 | 2019 | 2020 | 2021 | 2022 | Now | |
| IE | $57M | $57M | $27M | $32M | $27M | $2.1M |
(Source: Company Income Statement) (IE = Interest Expense)
Comparing these two charts shows just how sensitive to interest rate rises the company is. Even while they lowered their long-term debt by half, from $420 million to $216 million, they saw their interest expense rise from $27 million to $32 million. This means that if they would not have paid off their long-term debt, they would likely be paying tens of millions more annually in interest expense, crippling any chance of growth they may have in the future by not allowing for any material investments.
But even with this somewhat rosy development, there are still negatives.
The Many Negatives
There are negatives factors which, I believe, greatly outweigh the positive one.
Number 1: Revenues
The company’s revenues continue to decline as they see less demand for their devices and services, which are facing stiff competitive pressures from other online e-commerce outlets like Amazon (AMZN) and others. After seeing a little bump in sales here and there in any given quarter which they used heavy promotions to get merchandise out the door, they mostly continued with their downwards trend.
| 2018 | 2019 | 2020 | 2021 | 2022 | TTM | |
| Sales | $8.5B | $8.3B | $6.5B | $5.1B | $6.0B | $6.1B |
(Source: Company Income Statement – Seeking Alpha)
The pandemic saw their in-person sales plummet, as many other retail outlets have seen as well, and as they’ve regained some of those sales, it’s still hard to see them returning to their former, 2019-level glory days as consumer behavior is likely to have shifted to online purchasing, which GameStop has little advantage over almost any other player in the industry. This is mostly due to the higher price of these devices and services, which prompts current and potential users to look for the best deals, meaning they frequently look elsewhere and have very little brand loyalty with GameStop.
As a result, revenue growth from this point forward calls for low single digit growth, which is expected to decline. I do continue to believe that the company will most likely miss or report in-line with these expectations given the market dynamics that are going on within the gaming industry.
| 2023 | 2024 | |
| Sales | $6.27 billion | $6.48 billion |
| Growth | +4.27% | +3.41% |
(Source: GME Sales – Analyst Projections – Seeking Alpha Aggregator)
Number 2: Gross Profit Margins
It’s not only that I believe that the company is likely to just meet or potentially miss their sales projections, it’s that the cost of goods is quite high, and rising. This means that with the company not being able to adequately compete with other online retailers and simply raise prices to combat these rising costs – they’re likely to see their gross profit margins decrease in the coming years.
Although with the shift online the company is seeing some expansion in margins, the fact that their merchants and suppliers are raising prices on them while they have very little opportunities to raise prices is concerning.
Furthermore, after some decline in their operating costs for a few years, they’re back on the rise again as the company has more or less done what they can to close down underperforming store locations and at the same time needs to deal with the rising cost of labor for minimum wage workers in their stores and other investment they need to make in order to attract people to their online sales platforms.
Both of these problems are causing very limited growth potential for the company’s bottom line, even if they do end up growing their sales by the aforementioned rates. What this means is, I believe, that even if they grow sales by low single digits, the odds are that their net income won’t grow much at all, if any.
Valuation Assessment
After a few years of reporting a loss per share based on significantly higher expenses and other factors, the company is projected to report a nearly 21% decline in earnings per share to a loss of $(1.37) per share. This implies a net loss of more than $415 million, which I believe is a conservative projection.
While this may not be the best comparison due to the company’s profitability and earnings per share growth, a company like Big Lots (BIG) has a similar brick and mortar presence as GameStop and is projected to grow sales at roughly a third of the rate GameStop is but trades at a multiple of 0.1x forward revenues. Projecting an extremely optimistic 0.5x sales multiple for GameStop means their fair value is around a $4 billion market capitalization.
GameStop’s current market capitalization is just shy of $8 billion.
Risk Assessment Presents A Worry
The main risk associated with a short position in GameStop is that if they once took part in being the target of meme stock traders which drove the company’s share price so high, it can certainly happen again. This means that if you hold a short position, you can wake up one day, as happened before, and the company’s stock can be up several hundreds of percent, and you’d owe that much.
One of the ways around this is using longer term CALL options which can capture this move and provide a nice cushion for any movement against you. I’ll expand on which options I hold at the end of the article, but since I’m not a financial adviser and everyone has a different risk tolerance, you should consult with a financial expert prior to any short positions in general, and GameStop in particular.
The other risk associated with owning the company’s shares short is that they are somewhat susceptible to a buyout from any e-commerce company. Their brand recognition and sales avenues can potentially be a big boom for a company who wants to get into the gaming hardware and software business or expand their footprint in it. I won’t speculate on who that may be, but it’s certainly not outside the realm of possibilities since integrating the company into an e-commerce platform and closing down 90% of its physical locations can become a net positive, or a sum-of-all-parts profit.
There are other smaller risks associated with GameStop, like them catching an unforeseen tailwind from an increased interest in gaming or a sudden introduction of a best selling game which can push their sales up. Even so, I don’t think that any of these are enough to overcome their natural decline, but investors or potential investors in GameStop can make their own points.
Thesis Conclusion
With these aforementioned factors, even a reduction in debt and interest expense to near zero, the company is facing too tough of headwinds to justify any type of position in its current state. Furthermore, the fact that they are trading at around 1.3x forward sales multiple with current expectations means that I believe they are overvalued by as much as 50%, even if they maintain their current sales growth trajectory.
Given the fact that I believe they will likely miss these expectations, there’s little reason for me not to double down on my current short position and build it back up to its previously held size.
I am holding, and will subsequently increase, a short position through equity. I hold some long dated CALL options to mitigate any potential risks if GameStop catches any second wind from meme traders. I currently hold June 2023 CALLS with a $50 and $60 strike, just in case so I don’t blow up my account.
I remain highly bearish on the company’s long-term prospects.
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