If anyone ever asks you what a stock is worth, the answer should be as simple as pulling up a current quote. The price point that intersects where the most ambitious buyer is willing to buy and the most impatient seller is willing to sell a certain security is a logical answer for the value of an investment. When it comes to a highly volatile stock, however, the answer changes rapidly, and typically not rationally.
It's hard to find a wilder stock than GameStop (NYSE:GME) these days. The video game retailer has traded from as low as $2.57 to as high as $483 over the past year. On Thursday alone, when it hit that all-time high of $483, it also traded as low as $112.50. On the surface, this is just a number, and the valuation itself is incomplete without knowing how much of a particular company you are getting with the per-share price.
Cap and gown
With 69.7 million shares outstanding, we can flesh out GameStop's wild run with a little more granularity. Over the past year, investors have figured that GameStop was worthy of a market capitalization ranging from as low as $72 million to as high as $33.7 billion. On Thursday alone, the range was $7.8 billion to $33.7 billion. Factor in GameStop's net debt position to arrive at enterprise value -- how much it would set back a company wanting to buy all of GameStop -- and you be adding roughly $0.7 billion to all of those market-cap price points mentioned earlier.
If breaking down what this means in trying to value a company bores you, then you are approaching GameStop more as a speculator than an investor. You're not alone these days, obviously. There's a colorful narrative here in which individual investors are sticking it to hedge fund boo birds, but sooner or later, GameStop's price tag will reflect what the underlying business is worth. In the end, someone has to clean up after the party. Someone has to own GameStop as either a $772 million or a $34.4 billion business on an enterprise value basis. The actual worth is typically found somewhere in that range, so let's kick down some of the bearish and bullish points.
The bearish argument is widely known, and it's why there were so many investors betting against the retailer heading into the mother of all short squeezes. We're not buying physical games the way we used to, and that's a bigger problem than you might think for GameStop. The chain doesn't mark up all of its products the same way. Big-ticket consoles command the lowest profit margin, with most of the money collected going back to the manufacturers. There is more pricing wiggle room with new games and accessories, but even those items are no match for GameStop's resale business. The chain pays a pittance for the games and consoles that you no longer need. It spruces them up and sells them as preowned merchandise for a lot more than it paid.
The gaming industry's shift to digital delivery stings the GameStop model where it hurts the most. You can't trade in a download. You can't barter a stream. The trend is seemingly unmistakable. This will be the third fiscal year in a row with sharply declining sales for GameStop. Trailing sales are 46% below where they were when the business peaked eight years ago.
Even when the news is positive -- as it was earlier this month, when GameStop announced that store-level comps actually rose 4.8% during the nine-week holiday shopping season -- it's not that great when you dig into the performance. Total sales actually declined over the holidays because there are 11% fewer stores than there were a year earlier. The positive comps were solely the one-time handiwork of expensive but ultimately low-margin PS5 sales, and this is a shift away from high-margin sales that will continue to erode the bottom line. GameStop used to be a bastion of free cash flow, but operating profits have now fallen sharply for five consecutive fiscal years.
On the bright side
Some naysayers have compared GameStop to Blockbuster, but here's where it's a good time to pivot and reflect on the positives. GameStop's business is in a state of decline, but it will be a much longer tail than what we saw at Blockbuster. Keep in mind that Blockbuster's rental model was initially undercut by price -- through Redbox kiosks dotting the high-traffic retail landscape and Netflix offering mail delivery of DVDs and Blu-rays -- and then by the obsolescence of the medium itself.
No one is undercutting GameStop on price. Consoles have pretty standard pricing across online and offline retailers. There's a little more promotional flexibility for new games for online retailers that command leaner overhead, but ultimately, this boils down to GameStop's differentiator: its preowned-merchandise business. GameStop has the scale and customer base to pull off what even the world's largest e-tailer has struggled to duplicate. GameStop is safe on that front, but it's no match for the digital migration.
GameStop isn't stuck in the past. It saw the future of gaming years ago, acquiring digital platforms and making a retail store push into collectibles and other non-video game categories. It hasn't been enough. A market-celebrated deal last year that will help GameStop capture some downstream revenue in the Xbox ecosystem is encouraging. The Xbox partnership buys the chain time but not a marketable future.
The model that was once a no-brainer -- with high sales per employee in typically affordable small-box suburban strip-mall locations -- is now losing money. Analysts see profitability potentially returning by fiscal 2023, but that also assumes that sales will start turning the corner.
A silver lining here for GameStop is that all of the media attention and millions of Reddit and Robinhood users now cheering on the chain they remember nostalgically could lead to a near-term blip in store activity. There are a lot more people paying attention to GameStop as a business than there were a few weeks ago, but it's not sustainable in the long term. There's no turning back the digital migration, in which GameStop will be an outsider looking in. There is no reasonable acquirer that would pay $34 billion -- or even $10 billion -- for a company with GameStop's decaying fundamentals.
Trailing sales of $5.2 billion isn't a bad number. But when the top line is going the wrong way, with its footprint shrinking, and there's no earnings multiple, with the operating profit turning negative, the near-term gyrations in price are fleeting theatrics. Be careful on both ends of this investment.