Today’s post is going to be looking at the stock GME or GameStop. I will be going over the business model, risks in investing, GME in the future, what type of position to take, and what type of return you can expect.
Our previous research post went over the upcoming giant in the EV industry, ASPN.
For now buy Iron Condors. Once GME has settle down buy shares. Read below for explanation and how to.
Let’s jump right in.
GameStop Corp (GME) was established in 1996 and over the years has become a leading specialty retailer for video games and video games accessories.
GME operates its business in the United States, Australia, Canada, and Europe. These areas are serviced by both the physical stores of GME and their e-commerce sales.
As of January 30, 2021 GameStop had a total of 4,800 stores spread out across the U.S, Canada, Austria, and Europe. Further, GameStop also carries inventory and sells pop culture figurines along with owning the worlds largest gaming magazine, Game Informer.
GameStop sells three types of products.
- Collectibles: These are licensed merchandise that revolve around pup-culture and video game themes.
- Software: Software consists of video game currency and select pre-owned video game downloads through GameStop’s online e-commerce platform.
- Hardware and Accessories: This is the largest of GameStop’s product lines. Hardware consists of physical video game consoles along with manufactured PC’s. The accessories consist of controllers, VR sets, memory cards, and headsets.
Select Financial Data
As we can see GameStop’s net sales have decreased year over year. Whenever you see this happening its either the company failing in their business model or the market as a whole shifting.
In this case it’s the market as a whole shifting. More and more retailers are buying their video games through e-commerce mediums such as Steam, the Microsoft Store, and the PlayStation Store.
This has resulted in GME having to rethink their entire business model as they are slowly being ‘boxed’ out of business by large e-commerce video game giants.
The following is an image that breaks down the net sales by category.
As we can see software sales have decreased over the past three years (2018-end of 2020) by a total of 7.6%. At the same time GME’s Hardware section increased from 44.9% up to 49.7%. Finally, the collectable market has improved to 11.4%.
This combination of shrinkage of net-sales and a stronger reliance upon hardware and accessories puts GME in a bad spot. This is because GME does not manufacture any hardware products. Not controlling their largest revenue section, hardware, means that GME is liable to outside businesses for operation.
As a result of this market change GME has started to shut down physical stores and instead double down on their e-commerce platform. This is a great move for GameStop as it means that they can reduce overhead and build up larger amounts of capital to weather market conditions.
Risks to investing
GME has a lot of risks right now. Primarily in the form of a declining business model along with an extremely overvalued stock.
First, the business model. It is no secret that the market for physical video game retailers has declined. GME’s executive leadership failed to properly see and position the company for this change.
Right now GameStop is catching up to something that it should of done a decade ago when distributors such as Steam and Xbox live started offering direct online sales to consumers. Had GME saw this coming they could of either doubled down in e-commerce then and boxed these newcomers out or diversified into another industry.
GME is a prime candidate for liquidation by an activist firm. As such we need to be wary for any long position until we see positive year over year revenue growth.
Second, in January of 2021 GME’s stock price shot through the roof. This was caused by several funds shorting nearly 100% of the stock (due to above mentioned reason) and retailers performing a short squeeze.
Before the squeeze happened GME was valued around $20-$40 a share. This itself is overvalued but still within reason. Right now if you invest for the long term you expose yourself to massive losses if you listen to fundamentals.
The smart answer would be to short GME but due to recent events I would highly suggest against this. Retailers have flooded the market and at any second this position could explode upwards.
GME in the future
GameStop on June 9th, 2021 announced to the SEC that the company had decided to sell up to 5,000,000 shares of its common stock. When fully completed this could conservatively raise around $750,000,000 worth of capital (assuming everything is sold above $150.)
This massive influx of ‘free’ capital could drastically change the course of the company going forward. Further, on May 3rd 2021 GME announced that it leased out a 700,000 square foot fulfillment center in York, PA.
This speaks volumes to GME’s new strategy of becoming the leading company in video game and pop-culture merchandise. We will see GME in the coming years shift from a brick and mortar establishment to another Amazon.
We can see evidence of this already when in March GameStop appointed Jenna Owens to be the vice president/chief operating officer. Ms. Owens comes from non other than the e-commerce giant Amazon. At Amazon her duties included building out distribution channels.
The York PA center will distribute to the east coast of the United States while another center in Reno, Nevada will handle the west coast. These are the top two dominant areas for population in the U.S.
This will effectively allow GameStop to have next day shipping to all gamers across the United States. This is the Amazon tactic, to have impulse buyers get their goods in next day shipping before they can cancel them. If this is properly done then we can expect to see sales all three segments of GameStop (merchandize, software, and hardware) go through the roof.
What type of position to take
As we can see GME is highly overvalued currently at $180 but can jump up at any moment to well above $300. That being said I don’t think that holding shares is a good idea here.
This is because by holding shares you are exposing yourself to significant downside. The stock could plummet down to $50 and you effective lost 66% of your investment.
Further, shorting I think is a very bad idea as well. This is because GME has a habit of running and there is to much upside risk here as well. If you shorted when the stock was $40 and then it ran up to $500 you would be out 1,250%. We cant have that type of risk in this position.
As such we need to invest in a position where you will make money if the stock goes up or down. The best way to do this is with the Iron Condor.
Setting up the trade to make money
GameStop for investors must be approached by a two phase investment. First is the short term, which I will demonstrate how Iron Condors will make you money. Second, is the growth of the video game market along with e-commerce.
Short term trades: Iron Condor
The above image is the Iron Condor trade. You will be both buying and selling a vertical call and put that are OTM. You will be putting up $4400 worth of capital to secure this trade but your return is around 15-17% and has around a 94% of making money (in the current market.)
By doing this you can make money if the stock goes either up or down. In this case you will make a 15% return on investment if GME ever trades outside the range of $175-$190 in the next 100 days (expiration is October,2021).
A 15% return on a trade that profits from either up or down movement is perfect for this type of stock that has consistently high volatility. That is until the GME starts to post a profit.
Long term trade on GME
In the long term I think that GME will be a good investment. The massive investment in e-commerce along with hiring the right talent will allow GME to weather the storm and adapt to the changing retail video game market.
That being said I wouldn’t invest until I see a rising net-sales on their 10-q or 10-k filing. Until then I recommend that you be careful approaching the stock and play Iron Condors so that you make money if the stock goes either up or down.
Once GameStop starts to return a positive profit from their e-commerce development we should start to see a snowball effect for the company. This is because e-commerce is becoming the medium in which most retail buyers prefer to buy their products.
As we can see from the above image over the past decade the United States alone has seen a massive increase in e-commerce sales. From 2012 to 2021 e-commerce has exploded from a meager 5% of total retail sales to now resting in 2021 at 14%. That is at total growth of almost 300%!
Further, the video game market is expected to explode in growth as well along with the population. Currently in the United States there are around 180 million people within the age demographic of video gamers (15-55). This age demographic is going to grow in both range, older people playing, and population as time goes on.
Those figures mean that in the U.S alone, GameStop’s market, there is massive potential for expansion. The fact that GameStop is going after the e-commerce section is amazing for the company. It really is the best opportunity for them to capture the expanding market.
Setting up the long term investment.
Right now is not the time for anyone to invest in GME for the long-term. We need to wait volatility to drop. This will happen as retailers begin to shift away from the stock as they go after the next ‘big thing.’ The best way to gauge this shift is by watching the sizzle index on the GME option chain.
The sizzle index watches the volume of options bought and sold on an asset over time. If the amount is higher then the normal amount then the sizzle index goes up, if the volume is down then the index goes down.
By watching the sizzle index we can see if retailers and those who bet upon their sporadic movements are leaving GME. Once we see a negative number on that sizzle index we can then begin to think about taking a long position.
At this point GME should have been down trending and consolidating at either the low $100’s or the high $90’s. Then the proper investment is to buy shares and immediately buy a put just below your entry price. You will have to do this in 100 shares allotments to 1 put.
By doing this you will guarantee your downside because if GME falls below the strike price on the put your shares will be sold for that value. This will limit the downside if your position should fall and will allow you to capitalize upon the upside potential of a now e-commerce giant GameStop dominating the North American market in late 2022 and beyond.
We will wait, and watch the stock for the proper time. I expect this part of the trade to work in late 2022.
“The big money is not in the buying or selling, but in the waiting.”Charlie Munger
What type of return can you expect.
So we have two investments going on. First, is the Iron Condor. Second, is the longing or buying of shares.
Return #1: 17% on Iron Condor
Well for the short term Iron Condors we can reliably expect around 17% return on investment every 100 days or so. This is assuming that volatility remains high and GME will have a high likelihood to swing past our ‘wings’ or ends of the condor.
Return #2: Around 42% over 2 years.
GME if it does everything perfectly could position itself to be valued around $130-$150 after falling down to the low $100’s or high $90’s where we will take our position.
The reason for this massive upwards growth is because of brand recognition, growing ‘gamer’ demographic, and GameStop’s shift to becoming an e-commerce giant.
Amazon started with Books and expanded. GameStop will start with games and expand. The only difference is that GameStop has a proven brand along with the potential to raise between $750,000,000 to $1.1 billion worth of capital through selling class A common shares.
I have to be clear, this is an incredibly ambitious task that requires the right leadership and excessive capital investment. Fortunately for GameStop they now have both. In March they brought on Jenna Owens, a former Amazon executive in charge of building e-commerce. Further, have been raising capital through selling of class A common shares.
It remains to be seen if this can happen properly. I am bullish on GME in the long term but I wont invest until the company has proven to me that they have what it takes, as largest shareholder Ryan Cohen calls the “Amazon of Gaming.”
GameStop is an interesting love story between a failing company and the younger retailer investor. Had retailers not gotten ahold and drove the companies price through the roof earlier this year I am positive that GameStop would of faded into obscurity like Blockbuster did.
The flow of capital into the stock has given management a second chance at doing what they should have done a decade ago, innovate. I am excited to see if they have what it takes. My investment stands by eagerly waiting.
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Until next time, I wish you the best in your investments.
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