Rational Investors Should Stay Away From GameStop Stock

The GameStop (NYSE:GME) farce is among the biggest stories emerging from the stock market in recent memory. The Reddit-induced short squeeze helped propel GME stock over 2,000% this year. The company has posted losses in the past couple of years, and the pandemic has only added to its existing woes. Despite the minimal growth in its top and bottom line, the stock is trading so high, its average price point can’t pay for a tenth of a share.

GameStop’s CFO Jim Bell recently resigned, as reports suggest that the company was dissatisfied with his work in transforming its business. The company plans to operate a more tech-oriented business going forward due to the apparent paradigm shift in the video game industry.

Digital game sales exceeded physical game sales for the first time during the pandemic, a trend that will likely stick beyond the crisis. Only time will tell how it fares in transforming its business, but for now, GME stock is a definite no-no for rational investors.

Restructuring The Business

It’s not the first time GameStop has worked on a turnaround plan. Back in 2018, it made serious efforts to turn things around with its business. It started at the top, with hiring a new executive team and a new CEO. Moreover, the company sold-off its excess assets and used the proceeds to settle debts. 1,000 underperforming stores were closed off along with other operational expenses.

It did whatever it could to streamline the business, but naturally, it couldn’t turn a blind eye towards its stagnating sales growth. Hence, in kick-starting the recovery in its sales, the company introduced a couple of unique initiatives. First, it built its stores around the try-before-you-buy concept, thereby presenting them as social gaming hubs. The second was being more involved in the digital ecosystem of the vendors.

With all these efforts, it is natural to assume that the company would be in a relatively stable financial position. It had $600 million in cash and $485 million of debt as of October last year. However, the absence of a workable and relevant sales model will only burn through its cash like in the past. Its relatively strong financial positioning and the new console cycle have helped it attract investor attention, but it will need to seriously think about a sales strategy that works in today’s changing market in the long-term.

The Problem With GameStop’s Business Model

Due to the pandemic-induced restrictions, gamers have turned to online platforms to purchase video games. The development raises the alarm for brick-and-mortar retailers such as GameStop.

GameStop has a tall order ahead of it. You’d imagine that it would be able to ride the next-gen console wave for the next 5-7 years. However, with a multitude of e-commerce vendors out there, its revenue share will continue to shrink over time.

It has, however, struck a deal with Microsoft (NASDAQ:MSFT) in getting a cut from the Xbox’s digital sales. The revenue-sharing deal gives it a percentage of any digital sales, including full games, downloadable content, subscriptions and micro-transactions.

I doubt other game or console developers would want to be part of such deals in the future. It allows them to cut-out the middle-man and avoid taking a hit in revenues. Video game developer Electronic Arts (NASDAQ:EA) has launched its subscription service, which provides access to a whole library of games. Others will likely follow suit once there’s clarity about the model’s success.

Bottom-Line on GME Stock

GameStop has arguably been the most talked-about security this year for all the wrong reasons. The reality is that rational investors could find little or no value in investing in the stock at this time. It doesn’t even remotely have the top and bottom-line to back up its lofty stock price. Moreover, with the paradigm shift in the video game industry, it will be incredibly hard for the company to stay relevant with its current business model. Avoid GME stock at all costs.

On the date of publication, Muslim Farooque did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Muslim Farooque is a keen investor and an optimist at heart. A life-long gamer and tech enthusiast, he has a particular affinity for analyzing technology stocks. Muslim holds a bachelor’s of science degree in applied accounting from Oxford Brookes University.