With shares down just 4% (to $147) in 2022, GameStop (GME 0.10%) has outperformed the S&P 500, which has dipped 13% year to date (YTD). The company is enjoying modest revenue growth as it pivots away from its traditional brick-and-mortar business into opportunities in e-commerce and cryptocurrency. But with losses spiraling and no guidance, GameStop investors may face more risk than they bargained for.
What is GameStop?
GameStop operates a chain of stores selling new and used games in North America, Europe, and Australia. This business model has come under pressure as gamers increasingly download games instead of dealing with physical software. As a result, hedge funds and other mainstream investment groups have heavily shorted GameStop shares over the last few years.
But in January 2021, a group of retail investors decided to pile into GameStop in the "meme stock" movement. This trend led to a rapid increase in GameStop's stock price and gave management a lifeline to turn the business around by issuing new shares to raise capital. Now the company is executing a transition to technology -- focusing on e-commerce and trendy industries like blockchain and digital collectibles.
What is the long-term strategy?
First-quarter results highlight GameStop's transition. Revenue increased by 8% YTD to $1.4 billion as growth in collectibles and software offset a dip in hardware sales. GameStop's hardware business, which includes sales of new and used gaming consoles, now represents only roughly 49% of sales (down from 55% in the prior-year period). Expect this trend to continue as management pivots to new growth drivers.
GameStop is reducing its store count, which stood at 4,573 locations at the start of 2022, down 243 from the prior year. The company is also positioning itself for e-commerce by leasing several large fulfillment centers in North America -- such as a 530,000-square-foot facility in Reno, Nevada, expected to be operational this year.
As with its fellow meme stock AMC Entertainment, GameStop's management is also pivoting to blockchain technology, even though this industry has a limited correlation to its core business. In May, the company launched a digital asset wallet to allow users to store, send, and receive cryptocurrencies and non-fungible tokens (NFTs), digital records of ownership stored on the blockchain. In the second quarter, the company plans to launch an NFT marketplace for these assets in the form of digital art and collectibles.
Losses are mounting
GameStop's new businesses are helping boost its top line, but the bottom line is deteriorating. First-quarter operating losses ballooned from $40.8 million to $153.7 million (a 277% year-over-year increase). And this was due to both lower gross margins and an increase in selling general and administrative expenses as the company hires new talent to help execute its transition to e-commerce and cryptocurrency.
To be fair, a company doesn't reinvent itself overnight. But GameStop investors should ask themselves how long they are willing to wait. With single-digit top-line growth and spiraling losses, profitability looks to be nowhere in sight. Management isn't providing guidance during this early stage of its "transformation," leaving investors in the dark about how long it will take for the company to actually create value. With all of this in mind, I avoid GameStop until these issues are resolved.
