GameStop BUY/SELL/HOLD? One-Pager

GameStop could either be the ultimate value stock, or a total old economy dud. This is the one-pager to understand the company and how to trade the stock.

GameStop (ticker: GME) is a video game retailer operating more than 5,000 brick-and-mortar stores worldwide. GameStop sells gaming consoles, accessories, and new and used video games. They also run GameInformer.com, an online gaming magazine.

GME's price declined drastically over the last decade from over $50 in 2013 to just under $3 in April 2020. This was driven by the gaming industry's shift from brick-and-mortar retail to online retail and GameStop not being able to keep up. However, in the last 6 months, GME's price has recovered by almost 10x. Is GameStop turning a new leaf or is this euphoria misguided and temporary?

Bull Case

• STRONG FINANCIAL POSITION - Despite declining financials over the last few years, GameStop still has a strong financial position to execute a large business transformation. The company has non-trivial cash flow ($8B revenue and $232M free cash flow in 2019), $500 million in cash, and manageable debt. In addition, GME's recent price increase opens up the option to raise more cash through equity offerings.

• ACTIVIST INVESTOR RYAN COHEN - Activist investor Ryan Cohen is campaigning to focus the company on ecommerce instead of brick-and-mortar retail. Stocks tend to do well if a company is targetted by activist investors and Cohen is the perfect activist investor to drive change at GameStop given his experience running Chewy, an online retailer for pet products. Cohen and two former Chewy execs were recently appointed to GameStop's board.

• LEVERAGE EXISTING ONLINE FOOTPRINT - GameStop can leverage its existing online footprint (GameStop.com and GameInformer.com) as a low cost starting point to grow its ecommerce business.

• 5,000 BRICK-AND-MORTAR STORES FOR OMNICHANNEL RETAIL - GameStop's 5,000 brick-and-mortar stores is unintuitively an asset for its ecommerce pivot. Market research shows that omnichannel retail strategies perform better than purely-online strategies (e.g. Apple and its iconic Apple Stores). The real-life experience of physical stores increases customer spending and brand loyalty. GameStop's focus on gaming and its many physical stores give it an omnichannel edge over other gaming ecommerce retailers. For example, its stores can be optimized for gaming experiences while Walmart and Best Buy don't have room to be specific.

• OPPORTUNITY TO CUT FAT - GameStop's stores have short term leases (24 months average lease duration) which gives it opportunities to cut fat by closing underperforming stores. This improves the company's short term financial situation and is crucial for executing the large business transformation that Cohen is advocating for.

• LARGE LOYALTY PROGRAM - GameStop's PowerUp loyalty program has 55 million members that are, or can be converted, to dedicated ecommerce customers.

• LOW PRICE TO SALES RATIO - Even with a $2.5 billion market cap ($35.5 per share), GameStop has a relatively low price-to-sales (PS) ratio of 0.4. The SP500's median PS ratio is 1.5. Chewy, the company co-founded by Ryan Cohen, trades at over 6 times sales. Even with just a PS ratio of 1, GME's price would be around $90.

• GAMING INDUSTRY GROWING RAPIDLY - The gaming industry has been growing rapidly over the last few years and GameStop is in a great position to capitalize on this growth if management can successfully pivot the company.

• INVESTOR MINDSHARE - GME's recent meteoric price rise and the WallStreetBets subreddit's obsession with the stock has attracted a lot of investor attention. Even CNBC's Jim Cramer is talking about it. With so many people watching GME, expect any modicum of good news to propel the stock upwards.

• SHORT SQUEEZE - GME is a heavily shorted stock with many believing that the company can't successfully pivot. Last week's run from $20 to almost $40 has definitely enticed many more traders to short the stock. If price continues to increase, a short squeeze can happen when many short positions are forced to close at once, creating a temporary spike in buying pressure. Keep in mind that short squeezes are only good for a stock's price in the short term.

Bear Case

• FAILURE TO PIVOT - GameStop's biggest risk is a failure to pivot to an omnichannel ecommerce business. To reach this goal, the company has significant hurdles to clear. For one, there are many competitors in the gaming ecommerce space. Walmart, Amazon, and Best Buy compete with GameStop in selling physical gaming products like consoles and accessories. If GameStop starts to sell digital goods like downloadable games, it'll face intense competition from Steam, EA's Origin, and Microsoft's Xbox Game pass, as examples. To succeed in this hyper competitive space, GameStop needs to find a niche and grow from there. This is a difficult journey requiring business acumen, finesse, and dedication from its executive team.

• UNFAVORABLE BROADER MARKET CONDITIONS - GME is a speculative stock and speculative stocks are the hardest-hit during a market downturn. Economic conditions remain uncertain with the slow rollout of the vaccines, the fact that we don't know how practically effective the vaccines are, the apperance of multiple COVID-19 strains around the world, and the likely resumption of debt payments this year (e.g. end of the student loan moratorium in May and the end of the eviction moratorium in February). The chances of a market downturn in 2021 is non-trivial. In addition, even if the pandemic does end and North America and Europe opens up again, expect a short term decline in gaming interest as everyone rushes to go back outside. This can negatively impact GameStop's earnings for a couple of quarters.

Trade Plan

GME is a red hot stock driven by retail fervor. I don't recommend shorting the stock. Although it's generally ill-advised to chase a high gaining stock, especially after a recent 100% move, an exception can be made for GME given the chance that this is the start of a gigantic move upwards with shorts covering and retail pushing the price up. A long position in GME from here on out is a high risk and high reward play.