Video game retailer GameStop (GME 1.50%) is planning to split its stock, probably later this year. Investors love the idea, sending GameStop shares as much as 22.5% higher in Thursday's after-hours trading.
Normally, I don't pay much attention to stock splits. They don't make a difference to the value of your shares, and the option to pick up a smaller slice of the company for a lower cost per share is nearly pointless, now that most brokerages will let you buy and sell fractions of a full share anyhow.
But GameStop's stock split is something worse than a pointless exercise in pure mathematics. I think the company and its investors may regret this move in a couple of years.
Image source: Getty Images.
What is GameStop doing?
GameStop is asking shareholders to boost the number of authorized shares from 300 million to 1 billion. The active count was just 76 million shares in late January, so the company already had room to execute a 3-for-1 stock split without boosting the authorized share base. Assuming that the proposed authorization passes muster in shareholder votes and other regulatory steps, GameStop will be able to split each share 12-fold.
The company has other plans in mind for the lifted share ceiling, such as issuing more stock as part of executive compensation and incentive plans. Selling more shares on the open market is another option, in case GameStop needs to raise some extra cash. And those extra shares could also come in handy for a stock-based acquisition or two, putting the stock's historically high market value to work.
Why is the stock split a bad idea?
GameStop's planned split reminds me of a few mistakes from years long past.
You're probably familiar with Nokia (NOK -0.27%) and LM Ericsson Telephone (ERIC 1.90%). The two Scandinavian telecom infrastructure veterans used to be important names in the area of consumer electronics, and particularly in the early development of the cellphone sector. Nokia was the king of mobile phones before the smartphone revolution took place, and Ericsson was a serious contender.
Times were good, business was booming, and the two stocks skyrocketed in the late 1990s. From early 1995 to the end of 1999, Ericsson's share price gained 511% while Nokia delivered a return of 1,970%.
Nokia and Ericsson wanted to keep their stock prices in reach of ordinary investors, so they split their shares a few times in that period. Nokia doubled its share count in 1995, again in 1998, and once again in the spring of 2000. Ericsson ran through a 4-for-1 split in 1995 and another 4-for-1 in early 2000, sandwiching a 2-for-1 split between those actions in 1998. In both cases, a share bought in early 1995 turned into 32 by the spring of 2000, reducing stock prices by the same ratio.
The final splits brought Nokia's price down to roughly $50 per share and Ericsson settled in at approximately $100. Without the splits, investors would have faced share prices of $1,600 for Nokia and $3,200 for Ericsson. So everything made sense, and the telecom experts were managing their share bases with reasonable stock prices in mind.
But this was the year 2000, and you know what happened next. The dot-com crash came first, followed by the 9/11 attacks. And as the cellphone market recovered from these calamities, the market meltdown of 2008 coincided with the arrival of modern smartphones. The resulting stock chart isn't pretty:
Ericsson took some action along the way, doing a reverse stock split at a ratio of 1-for-10 in 2002. Another tweak followed in 2008, splitting the underlying stock on the Stockholm market in half while performing a reverse 1-for-5 split on the American Depositary Shares. These moves were required in order to meet the minimum stock price requirements of the New York Stock Exchange (NYSE, a subsidiary of Intercontinental Exchange) and avoid a delisting.
These stocks have been skimming the borderlands of the penny-stock market for two decades now. Mind you, we're still talking about experienced leaders in the telecom sector with multibillion-dollar market caps and massive revenue -- but the stock splits of the golden age dropped their share prices into the low single digits. Even now, the companies are worth more than $30 billion each, but their stocks remain in the range of $5 to $10 per share.
This is the future I see for GameStop. Its stock surged to historic highs thanks to the "meme stock" phenomenon, in which a large number of small investors organized market-moving trades via social media channels. GameStop is now searching for a long-term strategy, but its management team and board of directors have been tight-lipped about the details of this strategy shift.
The old business model isn't working, and GameStop needs to overcome its high capital costs in a hurry. The company is burning cash at an alarming rate, and investors will eventually run out of patience with raising debt and selling more shares in order to keep the lights on.
And that's GameStop's version of the dot-com crash. The stock traded for less than $5 per share in the summer of 2000, when the market cap was less than $300 million. But since that low point, financial results have not improved by any meaningful degree.
Let's imagine that GameStop splits its stock by a ratio of, say, 5-for-1...and then the market gets back to its senses. Once the market cap drops back from $12.7 billion to $300 million, the split-adjusted share price will plunge below $1. And then we'll be talking about reverse stock splits instead, assuming that GameStop still wants to trade on the NYSE.
I don't think I'm expecting a massive disaster here. All I'm saying is that GameStop hasn't earned its massively inflated market cap, and I wouldn't be surprised to see it pop fairly soon. And that's where the upcoming stock split starts to look like a big mistake.
