GameStop’s infamous short squeeze has sent its stock price soaring, but how does it make money, and should you invest?
As of March 17, GameStop (NYSE: GME) has seen its stock price surge nearly 1,200% year-to-date (YTD), thanks to a short squeeze initiated by the ‘wallstreetbets’ subreddit. We will dive into how the company makes its money and if you should purchase shares.
What is GameStop?
GameStop (NYSE: GME) is the world’s largest retailer of video games that operates more than 5,000 stores in the U.S., Europe, New Zealand, Canada, and Australia. First coming to life as Babbage’s in 1984, the company went through a series of mergers and acquisitions to itself being acquired by Barnes & Noble in 1999. In 2004, Barnes and Noble sold off its controlling stake and GameStop continued to purchase smaller companies to expand its global physical footprint.
GameStop’s business model
In an effort to avoid the fate of companies like Blockbuster Video and Tower Records, GameStop is making a strong effort to pivot online. It started by assigning Chewy founder Ryan Cohen to its board and giving him the e-commerce reins. The company also got rid of 11% of its underperforming brick-and-mortar locations and reduced selling, general, and administrative (SG&A) costs by over $315 million in the first three quarters of 2020. As of Q3 2020, GameStop’s e-commerce sales are up 257%, so it certainly seems like the company is making the right moves.
It has over $580 million cash on hand and $417 million in debt which makes its net debt virtually zero. GameStop’s real estate portfolio is valued between $85-$100, million which it can utilize as an ambidextrous business model much like Target has, offering in-store pickup and fast delivery of merchandise. George Sherman, who was appointed CEO in 2019, has a three-point plan for the company which includes further reducing SG&A costs, optimizing the current business by reducing prices on used games, and finding new revenue streams like selling retro video games and consoles. Although its stock price surge is driven by spiteful investors out to punish short-sellers, the company can use this temporary windfall to invest in such ventures.
How does GameStop make money?
GameStop’s main profit generator is in used games as the company can control the spread and the margins. Also, last year saw a new console cycle with the release of new video game units from both Sony and Microsoft, and as a retailer, GameStop is sure to benefit (results of Q4 are pending). The company was doing just fine until online services like Xbox Live and Steam started growing in popularity by offering users entire libraries of games easily downloadable at home.
Then it expanded into the loot (or licensed merchandise) business by studying the most popular products at Comic-Cons and devoting a portion of its stores to these products. Additionally, GameStop acquired ThinkGeek in 2015, which already had a slew of licenses, to further magnify its market share. The company also made acquisitions of Kongregate in 2010 to enter social gaming, Spring Mobile in 2013 to get into the wireless market, and Simply Mac in the same year to sell Apple Products.
The short squeeze
The company will continue to expand its digital presence and lower overhead and expenses but the fallout from the short squeeze was felt throughout the entire investing community. Hedge fund Melvin Capital Management, a leading GameStop short-seller, lost over $3.5 billion. Retail trading platform Robinhood suspended buying but not selling of GME stock temporarily, blaming clearance and settlement protocols. This caused many investors to criticize the app and question the T+2 settlement altogether; a change to the settlement window would require a great deal of effort as the last change from three days to two took roughly 6 years to implement.
Is GameStop a good investment?
Not yet as nearly all experts agree that the stock price will almost certainly crash. I would wait for the short squeeze to end and for prices to return to more sane levels before investing. I feel the company is making a very strong effort to enhance its digital presence and is expected to be profitable by 2023. Further, with Cohen behind the wheel, it certainly has the potential to be an online market leader, like Chewy.
A MyWallSt subscription gives you access to over 100 market-beating stock picks and the research to back them up. Our analyst team post daily insights, subscriber-only podcasts and the headlines that move the market. Get your free trial now!
MyWallSt operates a full disclosure policy. MyWallSt staff currently holds long positions in companies mentioned above. Read our full disclosure policy here.