- Before GME became the original “meme stock,” it was a deep value play
- The stock’s adherents — including two now-famous bulls — saw upside from a turnaround
- Q2 earnings show little progress; without another short squeeze, GME should keep falling
What’s often forgotten amid the January 2021 meme-stock frenzy is that GameStop Corp (NYSE:GME) was already on the move before becoming a worldwide story. During the second half of 2020, the video-game retailer soared an incredible 324%.
One might think covering by short sellers drove that rally. But that doesn’t appear to be the case. Short interest in the stock readily increased along with the rally. Some shorts covered, certainly. But more entered the trade.
Instead, investors—many of them on Reddit forums—were buying GameStop as a long-term investment. The short interest was a potential catalyst but, in their eyes, not the core reason for owning GME.
What’s interesting now in 2022 is that while GME has soared nearly 2,500% since Jul. 1, 2020, that original bull case hasn’t played out. Indeed, it seems increasingly unlikely to do so. Another short squeeze now appears to be the core reason for owning the stock—and that’s probably not enough.
The 2020 Case For GameStop
In the middle of 2020, GameStop was in trouble. The rise of digitally-downloaded video games threatened the company’s brick-and-mortar business. After failed attempts to move into mobile plans and Apple (NASDAQ:AAPL) products, the company tried to pivot into collectibles, but that revenue stream couldn’t support a footprint of over 5,500 stores.
In fiscal 2019 (ending Feb. 1, 2020), GameStop’s same-store sales declined 19%. Adjusted operating profit plunged almost 80%. Amid the novel coronavirus pandemic, it seemed certain that profits would soon turn negative, likely for good.
The business performance is precisely why GME was the most shorted stock in the market. But some deep value investors saw a different story. GameStop had a hugely valuable brand. The balance sheet was in decent shape, with cash nearly covering the debt.
There was potential for the company to turn itself around by pivoting into digital sales, shrinking the in-store footprint, and other moves. And there was another potential catalyst at play: new consoles were coming from Microsoft (NASDAQ:MSFT) and Sony (NYSE:SONY).
The bullish interpretation was that just as had happened during previous iterations of the “console cycle,” GameStop’s business wasn’t in permanent decline. Rather, consumers bought fewer games and consoles while waiting for the new models to arrive.
In some versions of the story, the short interest was highlighted as part of the bull case. But, generally speaking, it was in the context of short covering driving the stock higher once the fundamentals improved.
Two Famous Bulls
Indeed, two now-famous GME bulls detailed their respective cases at the time. Chewy (NYSE:CHWY) founder Ryan Cohen took a stake in GameStop in August 2020. In November, Cohen wrote a long letter to the GameStop board arguing that the company had:
“the ability to pivot toward becoming a technology-driven business that excels in the gaming and digital experience worlds.”
Short sellers are only mentioned as evidence of the market’s lack of confidence in the company’s management.
Before he testified in front of Congress, Keith Gill, better known as Roaring Kitty, was arguing in favor of the stock on YouTube and Reddit. On the latter platform, he cited “asymmetric upside.”
The thesis was simple. If GameStop won in digital, the stock would roar. If it didn’t, cash flows from sales of new consoles would cushion the blow. Gill, in fact, would write elsewhere on Reddit that he was “not sure” about a short squeeze being on the way.
The Story Isn’t Working
In terms of GME stock going up, both investors were right. In terms of the GameStop business improving, they were wrong.
The console cycle hasn’t helped GameStop much. Wall Street expects revenue of about $6.3 billion this year, against $8.3 billion four years earlier. Even on an adjusted basis, GameStop is running losses, despite paying off all of its debt (and thus removing interest expense) thanks to equity sales last year.
The digital initiatives haven’t shown much, either. GameStop has rebuilt its systems. In July, the company launched an NFT (non-fungible token) marketplace. But NFT prices have collapsed; the optimism toward and potential of that marketplace are not what they were 18 months ago.
GME did get a bounce after earnings thanks to a partnership with cryptocurrency exchange FTX. But the partnership details so far are limited to one single initiative: selling FTX gift cards in GameStop stores.
This is a company with an enterprise value near $7 billion. Gift cards and operating losses can’t support that kind of valuation.
The 2020 bull case needs to start playing out. Otherwise, at some point, the 2020 valuation is going to return.
Disclosure: As of this writing, Vince Martin has no positions in any securities mentioned.