- GameStop's shares are significantly overvalued at this point in time.
- However, management is finally taking advantage of this fact by issuing new shares.
- This is a great first step that was accompanied by strong sales data, but it's not aggressive enough to preserve the firm's value.
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For better or worse, GameStop (NYSE:GME) never ceases to surprise. All year, the business has been through a rollercoaster of a ride as speculators, aiming to punish hedge funds and other institutional investors for shorting the stock, have sent shares soaring higher only to crash back down again. Right now, shares of the business are higher again, though they are far away from where they were at their peak. In truth, GameStop is not worth anywhere near what it is trading for today. With a market cap of $13.1 billion, the company is trading probably close to 10 times what it is actually worth. Having said that, though, recent financial performance, combined with an excellent but overdue strategy for management, could be starting to change what the company is worth fundamentally. I do still believe that shares deserve to be trading far lower than where they are at today, but if management follows recent developments up with another major stock issuance, the firm might be able to justify some of the upside it has seen since the year began.
The headline development regarding GameStop that investors are likely paying attention to revolves around the company's decision to issue an ATM, or at-the-market, program. Simply put, this is an initiative where the company will opportunistically sell shares on the open market in order to raise capital for itself. The rationale here cannot be overlooked. Pretty much nobody will deny that shares of the video game retailer are tremendously overvalued. However, the fact that shares are trading at such a lofty level can work in management's, and investor’s, favor. Since the demand for shares is so high, management can sell stock in order to raise cash. If enough cash is raised, then the company's valuation, or at least some of it, may very well be justified. In essence, it would become a self-fulfilling prophecy.
This is a strategy that I alluded to in both of my recent articles on the business. You can read them here and here. Yes, management would be diluting shareholders, but that is a small price to pay for the cash that would come in. With that cash, the company could do anything. Ideally, they would use it to continue transforming the firm and pave its way for the future. There are many avenues GameStop could take in order to create shareholder value as its retail stores continue to close down. In the fourth quarter of last year, for instance, the company saw 34% of its net revenue come from e-commerce activities. Year over year, this figure grew by 175%, and compared favorably to the 12% of sales they accounted for in the fourth quarter of 2019. The company could explore making its own video games. It could also focus on other related activities as well.
According to the terms of its ATM, the company plans to issue up to 3.5 million shares. At present pricing, this would work out to gross proceeds of $654.3 million. Based on my estimates, net proceeds would come in at around $643.9 million. Management is not, however, blind as to how volatile shares have been. After starting out 2021 at under $20 apiece, shares eventually rose to more than $400. As of April 5th, they are at $186.95. because of this volatility, the company also decided to place a limit of $1 billion worth of gross proceeds that it could take in for now. On a net basis, I estimate this would come out to about $984.4 million. No matter how you stack it, the cash raised would be well worth the 4.8% dilution the company would incur.
Another, though less advertised, headline came out on April 5th related to the company's financial performance so far in 2021. For the first nine weeks of the fiscal year, GameStop saw its revenue surge 11% compared to the same period a year earlier. The bulk of this increase came from an 18% increase, year over year, in the sales the company generated in the five weeks ending in early April. This came despite weakness associated with the COVID-19 pandemic. And it comes despite the firm’s store base being 13% smaller this year than it was last year.
Frankly, this financial performance is phenomenal. Unfortunately, we don't know what the entire picture looks like right now, but it is likely that a good portion of this game is coming from the company's online sales. If management can continue to generate this kind of performance, and if it can raise a significant amount of cash, then the case could be made that shares could be worth more than the $20 apiece I indicated in one of my aforementioned prior articles.
One critique that I have regarding what GameStop is doing today is that I believe the firm is not being aggressive enough. Very possibly, management used this recent ATM to gauge the appetite of the market and to see how much shares might fall in response to this development. For the day (April 5th), shares dropped only 2.4%. So long as we don't see any significant decline near-term, it would appear that the company has proven an appetite in the market for additional shares. And with a 10-day average volume of nearly 21 million shares traded, the business could exhaust this ATM rather quickly.
It should be mentioned that GameStop does not need this cash. Based on my estimates, as of the end of last year, the business had $635 million in cash on hand. With debt of around $363 million, this left no net debt, but a net cash balance of $272 million. Rather, this strategy is about cashing in overpriced stock for the guarantee of cash they can fill its coffers. Because of all of the events surrounding this, and especially after seeing the market’s reaction to the initial ATM, I would argue that management needs to be issuing more shares than these. As an example, if the firm were to dilute shareholders by 20%, that would result in 17.5 million shares being sold. Gross proceeds would be nearly $3.3 billion. That probably still would not be enough to justify the company's valuation as it stands today, but it would certainly establish a floor. The more that it dilutes shareholders, at least at elevated prices, the more the retailer can grow into its valuation.
Right now, the situation with GameStop is fascinating. It is a clear and extreme example of an irrational market. As I had stated in prior works, if management does nothing, then shares will eventually come down to earth. But this current step is a great step forward. It shows that management is willing to take that lunge, and it gives shareholders the opportunity to create what I would consider a miracle. Namely, it would revitalize an otherwise slowly unwinding firm. Or at least it would give it the opportunity to. I still maintain that true investors should not touch GameStop with a 50-foot pole. But, for speculators, or if management does issue a great deal more shares, then for anybody, it may not be a horrible prospect.
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This article was written by
Daniel is an avid and active professional investor.He runs Crude Value Insights, a value-oriented newsletter aimed at analyzing the cash flows and assessing the value of companies in the oil and gas space. His primary focus is on finding businesses that are trading at a significant discount to their intrinsic value by employing a combination of Benjamin Graham's investment philosophy and a contrarian approach to the market and the securities therein. Learn more.
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