Most companies that trade on the stock market today are usually legacy firms in search of growth, or newer business models in search of profits. But Gamestop (NYSE:GME) unfortunately is a combination of both. The company is desperately scrambling to find a business model that justifies the irrationally high market cap of $14 billion for GME stock.
Well they did have an interesting business model for a while, even as digital game downloads were growing rapidly. This model produced roughly 3% or 4% net margins and could generate at least $3.00 per share in EPS. However, that was on $8 billion in revenues. Revenues are now in the $5 billion range.
The Q2 Transcript Was Telling
The transcript for the quarterly conference call was under eight minutes long with no Q&A from wall street analysts or institutional shareholders. More importantly, no discussion was held regarding the company’s long-term strategy and transformation into a technology company. But they did state, “We believe net sales is the primary metric by which stockholders should assess the Company’s execution.”
Well I’m sure day trader type shareholders may like that opinion on how to assess the company, but most investors eventually require a return on capital for the company they’re investing in.
In many ways, GME stock has become a SPAC. It’s now essentially a blank-check company where investors have no knowledge of its future business plan, particularly one that can support it’s excessive market cap.
ATM Proceeds and Debt Levels
During the quarter, the company shored up its balance sheet by taking advantage of its grossly inflated share price in a $1.1 billion ATM (at-the-market) offering. They intend to use the proceeds for general corporate purposes (meaning absorb the operating losses) as well as for growth initiatives.
All traditional debt was eliminated with the proceeds from these offerings. The only debt remaining was a French government loan related to the Covid-19 pandemic. GME now has $1.7 billion in cash on the balance sheet as of July 31, 2021.
However the company still has a massive retail base of 4,642 physical stores which means their operating lease liabilities represent large company obligations. At the end of the last fiscal year ending Jan. 31, 2021, total non-capitalized lease obligations were $673 million. The present value of the obligations were $480 million. These are contractual obligations, so many analysts treat this as debt.
GME Stock Valuation is Unreasonable
There is of course still no reasonable or sensible justification for GME’s current stock price. If GME returns to historical operating margins next year (it won’t even come close), then they would earn approximately $3.00 per share. This would give them a 60x P/E ratio for a company that is secularly challenged, faces tough competition, and whose high margin business may eventually be completely disintermediated. That’s a higher price-to-earnings than Amazon (NASDAQ:AMZN)!
Since positive earnings are years away, we can utilize a Discounted Cash Flow model. If we project a generous 15% EBITDA growth rate over the next 10 years, GME stock is worth somewhere in the $35-$45 range.
Operating losses and negative free cash flow are expected in 2021 and will likely bleed into 2022. There is an enormous amount of uncertainty in the GameStop business model and path to historical margins. If they can achieve positive operating margins and return to the 6% level over the next five years, then the company at best may be in $40-$50 range.
Business miracles have happened before and it will be interesting to see what rabbit the new Gamestop management team will pull out of the hat. Perhaps they should copy the late stage bull market corporate theme of projecting massive losses for the next five years, and then the stock should skyrocket and follow the lead of other money losing companies.
There is no scenario that GME stock makes a reasonable investment at these levels, and it remains a speculative trading stock only fit for the meme/Reddit day-trading crowd.
On the date of publication, Tom Kerr did not hold a position in any security mentioned in the article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Tom Kerr has worked in the financial services industry for over 25 years. Currently he is a Senior Portfolio Manager at Rocky Peak Capital Management. Prior to that he was Chief Investment Officer and Director of Research of SGL Investment Advisors, and has served in a number of positions at other finance-related organizations. Mr. Kerr has also been a contributing writer to TheStreet.com, RagingBull.com and InvestorPlace.com. He’s a CFA charterholder and obtained a B.B.A in Finance from Texas Tech University.