Summary

• GameStop has shifted from a legacy video game retailer to a market-defining company, but fundamentals are increasingly misaligned with reality.

• Declining revenues, competitive pressures, and an ambiguous strategy cast doubt on GameStop's future viability in a rapidly evolving digital sector.

• The company faces an identity crisis, with significant store closures planned in Europe and a need to either diversify or face further declines.

• Despite some improvements in SG&A expenses and margins, I'm hesitant to maintain a bullish thesis for GameStop in the near term.

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Like it or not, GameStop (NYSE:GME) is one of the companies which has defined the market over the last decade, captivating and inspiring a new wave of investors and traders as it transformed from a legacy video game retailer to the firm that became the ultimate 'meme stock'. Investing in the company has not been about analysing the fundamentals for quite a while, but at some point, the reality needs to align with the numbers. With declining revenues, competitive pressures, and a fairly ambiguous strategy in a rapidly evolving sector, I'm not too sure the magic can continue for too much longer. I'm hesitant to put a Sell rating on the company, since we know what it can do, but I'm running out of reasons to support a bullish thesis in the near term.

GME Share Price (Seeking Alpha)

The Company Behind the Stock

GameStop seems to be facing an identity crisis of sorts in recent times, following years of dominance in the physical retail sector for video games, consoles and accessories. With over 4,100 stores globally, it has been a trusted platform for gaming enthusiasts since founding in 1996, but whether this model has a place in an increasingly digital world is up for debate.

The leading indicator for this is a 20% annual decline in net sales, now down at $860 million. As a result, management is anticipated to close down a substantial number of stores, with operations in Germany, Italy, Ireland and several other European countries to end soon. As much as there are some improving signs in SG&A expenses, sending margins up to 29.9%, it represents the crossroads the company sits at; either to diversify and move away from the original business model, or to stick with it and face further declines.

Fortunately for management, there is plenty of cash available to go from here. Strategic equity offerings have built up over $669 million in cash, giving a wide range of options for acquisitions and investments. However, there have been no announcements or indications of any particular plans. This lack of clarity raises a few concerns from me on the company's long-term direction, and ability to deploy resources to expand and reinvent itself in a challenging environment.

Navigating a Complex Environment

Clearly, the market is moving quickly, and as much as the strategic direction of the company is unclear, there is plenty going on to improve the customer experience. Microsoft (MSFT) Dynamics 365 is being used now to unify the physical and digital stores, and management is doubling down on digital marketing to build out capabilities in reaching new customers.

This may be a challenging time for expansion, however, with the gaming sector highly sensitive to macroeconomic conditions. The last few years of volatile inflation and interest rates have impacted the discretionary income of key customers, leading to decreased revenues on gaming products. Management has attempted to diversify somewhat, with new offerings in collectibles and merchandise, but these again fall into an area which customers are unlikely to prioritise when the cost of living becomes increasingly challenging. Cost-cutting measures have helped to offset this challenge, but are unlikely to be a long-term solution.

GME Revenue (Seeking Alpha)

While many companies would choose to address these challenges in earnings calls, management continue to avoid these, leading to speculation and scepticism from institutional investors.

Tackling the Valuation

GameStop has long been a target for traditional value investors, with claims made that the valuation has soared far beyond realistic metrics, and is supported by speculation and retail investors. Looking at the full range of valuation metrics, there isn't much to suggest the company is a bargain at present. Comparing these to the wider sector suggests the degree of elevation for some of the metrics, but as I noted before, this is not a company which necessarily trades based on the normal rules of the market.

GME Valuation (Seeking Alpha)

Infamous short squeezes have sent the share price far higher than current levels, with fundamentals going out the window. I'm not too clear on whether this scenario has played out though, with the short interest now only at 7%.

I'm an investor who cares too much about the fundamentals to take a chance on such an event happening again. Looking at the numbers themselves in a discounted cash flow (DCF) calculation, there are still plenty of reasons to worry about further downside if investor enthusiasm fades. Considering a discount rate of 8%, and declining revenue growth in line with forecasts, shares could still be over 70% higher than fair value. With this estimated at $9.41, I'd be very nervous about the coming years if the company's fundamentals and lack of strategy lead investors elsewhere.

GME DCF Calculation (ValueInvesting.io)

Reasons for Optimism

Of course, certain events sent the stock surging, such as the 'ringleader' of the meme stock frenzy, Keith Gill, tweeting about the company, but this can quickly reverse as investors take profits or reflect on unchanged fundamentals.

Looking at the positives, the company has virtually no debt, and plenty of potential if management can develop a plan, but without any details of this, investors are more or less playing a guessing game. Following the events of the last few years, it's not a company I'd feel comfortable betting against, with the potential for enormous surges ever-present, but definitely don't think it falls into the 'easy' bucket for investors.

If CEO Ryan Cohen instead looks to reinvent the company in the style of Berkshire Hathaway (BRK.A), with a holding company enabling investments across a series of other areas, then there could be an interesting future ahead. However, this is largely speculation for now, and simply being able to invest in stocks and a wider range of assets is unlikely to excite investors unless a genuine edge can be offered.

There's also a decent progression in the quant grades for the company, with strong momentum over the last few months, and some positive revisions.

GME Quant Ratings (Seeking Alpha)

Unclear Future Ahead

GameStop has been a genuinely interesting company to watch over the last few years, but as an investor, it still feels too dangerous to touch. With tremendous volatility in both directions, I feel it's more of a gamble than a traditional investment. Of course, some will do very well with speculating on the future of the firm, but with the strategy unclear for now, I won't be anything more than an observer.