This meme stock phenomenon fascinates me not only because of the sheer monster returns that they are generating but also the fact that much elevated stock prices seem to be staying! GameStop was at ~$15/share in Dec 2020. By end of Jan 2021, it rallied to almost $350/share. That’s 20+x return. Though it dropped back to below $50 for a brief period of time, it has actually been trading in the range of $150-250/share. Bravo to anyone who stuck it out! It’s easy to just dismiss this kind of moves as irrational. I feel compelled to at least understand it a bit more, especially with GameStop being the original meme stock.
Fundamentals, if any
Like last post on AMC Entertainment, GameStop’s current fundamentals hardly justify the stock valuation. Nonetheless let’s take a look. As of writing, the stock is trading at ~low-$200s, giving an enterprise value of $16bn. Before the pandemic in 2020, the company did ~$170mm EBITDA in 2019, down from $470mm in 2018 due to 20+% decline in revenue while SG&A remained around the same. That being said, the company does experience year over year fluctuations due to product launch cycles, e.g. the Nintendo Switch in 2017, PlayStation 5 and Xbox Series X in 2020.
Let’s say in the best case scenario they can overhaul their store base and re-align the SG&A. Perhaps they can do 5-10% EBITDA margin on the current $5bn revenue (assuming no growth for conservatism). That would be $250-500mm EBITDA. Current valuation would imply 30-60x multiple. To state the obvious, it is not pricing in turnaround of the existing business model, but a complete transformation based on prospects proposed by the activist investor and Chewy founder, Ryan Cohen.
Transformation Plan
Only thing that we can have a glimpse of his transformation plan is his letter to the board dated Nov 2020 (link here). Generally I agree with the assessment. Two biggest assets of the company are its brand name and its loyalty program. As of latest fiscal year end (1/30/2021), the company had 47mm PowerUp loyalty members in the US, of which 15mm are active customers (those who have purchased or traded at GameStop in the past year). The membership total included 4.4mm paying members. Internationally, the company had another 23mm members. In comparison, Chewy had a total of 19mm active customers at the same period end, although it also had a lot more subscribing customers.
To still leverage this customer base that GameStop has, it makes total sense to become a gaming technology company. Focus on e-commerce than physical retail. As he laid out in the letter, I can see that, by putting in Chewy type of high-touch customer experience, GameStop can become one of the online and mobile destinations for gamers. An online marketplace where it provides a wide selection of gaming products, digital content, online community experience, online trade-ins, streaming, Esports and related offerings. Meanwhile, streamline and enhance the physical store experience for gaming. Obviously easier said than done but it makes sense conceptually.
Chewy as Comparison
So how might someone value this? One way is to look at Chewy as a “comp” (see the separate Chewy post here, if interested). Ryan Cohen was successful in building Chewy into the Amazon of pet products. Perhaps he can indeed turn GameStop into Amazon of gaming. The good thing about the gaming industry is that, similar to the pet industry, it continues to enjoy a healthy growth rate of say 5-10% a year. Moreover, gaming industry is close to 3 times bigger than the pet industry.
However, competition in gaming is a lot more intense. When Chewy started in 2011, it was disrupting a relatively sleepy industry, with PetSmart physical stores dominating the space. The only legitimate online competitor was Amazon Pet. Chewy was able to differentiate itself through better customer experience.
In gaming, the dramatically improved internet infrastructure and cloud computing have truly changed nearly every aspect of the gaming world. Every major game publisher, game console manufacturer, cloud gaming platform, live streaming service provider, and mobile app store now all tries to take a piece of the pie with constant innovation, direct to consumer offerings and excellent customer experience. To simply build a foothold in such an industry is no easy feat.
Conclusion
For argument sake, lets say GameStop succeeds in transforming itself. On a very high level, gaming industry is much bigger than pet but competition can be significantly more intense. Balancing the two factors, perhaps one day GameStop can achieve Chewy today’s valuation of roughly $30bn. Given GameStop’s existing brand name and customer base, maybe it will take half the time, or say 5 years. With today’s valuation at $16bn, buying GameStop stock today would be ~2x in 5 years. But of course there is real execution risk, without even knowing what the final e-commerce product would look like and how customers would react to it. I look forward to the product launch and progress going forward.
