In 2015, the Financial Times joked that RadioShack, a struggling brick and mortar electronics chain, should consider selling fruit baskets or turning its stores into Zumba studios to survive. The retailer had ignored the e-commerce threat for so long that few believed it could survive. Two years later, RadioShack was virtually gone.
Source: TY Lim / Shutterstock.com
Today, GameStop (NYSE:GME) the stock is in a similar situation. Since the early 2010s, GME bosses have treated the retailer like drunks in an open bar – distributing princely dividends to shareholders (and stock options for themselves) while cutting back on reinvesting in old stores.
But then something happened: a group of retail investors, driven by Reddit / WallStreetBets hedge funds, decided to reduce GME’s stock from $ 10 to $ 480 in a matter of weeks. People still love GameStop!
This love for GameStop and disdain for Wall Street is an unusual combination. This means that, unlike RadioShack in 2015, the video game retailer still has a chance to fight. For the sake of GameStop and its shareholders, Reddit investors need to end the revolution they started. And if they do, Redditors and Chewy (NYSE:CHWY) founder Ryan Cohen can still send GME shares back to $ 500.
GME stock: Intentionally directed to a ditch
Anyone who has recently visited a GameStop store will say the same thing: they look old. And this is by design. For more than a decade, GameStop’s management has enriched shareholders at the company’s expense. GameStop’s capital expenditures, the budget used to maintain its stores, peaked in 2011 at nearly $ 200 million before being cut in favor of higher dividends and share buybacks. Meanwhile, the company’s stores continued to age and the layoffs continued unabated.
Even so, shareholders allowed then CEO J. Paul Raines to stay on course. Why? This earned them money. Customers, employees and other stakeholders were not a priority. And after several failed acquisitions, including game developer Kongregate, GameStop management decided that making money from the company was a better bet.
The company’s blind commitment to mediocrity peaked at the April 2020 strategy meeting. There, GameStop management outlined a plan to “optimize the core” and “become the social / cultural hub for games” through construction of “experimental laboratories”.
In other words, they wanted to drive more traffic to the store. During a year of pandemic. (How the hell did management make $ 35 million between them?)
Change in progress? Redditors think so.
All of that began to change in August 2020, when Chewy founder Ryan Cohen bought 9 million shares in the retailer. He and two associates would later join the board in January 2021.
“GameStop needs to evolve into a technology company that delights gamers and offers exceptional digital experiences – not to remain a video game retailer that prioritizes its physical presence and stumbles into the online ecosystem,” said Cohen in a public letter to the board.
Investors were delighted, sending stocks in an initial $ 4 to $ 40 run. Mr. Cohen was not just talking about improving e-commerce (a strategy that could have worked 15 years ago). Instead, he talked about fundamental changes in the GameStop business that could create a new player revitalized in the $ 180 billion gaming industry.
The change, however, will not come promptly. And that’s where Reddit investors come in.
So far, Mr. Cohen owns only 13% of the company. This is not enough to dislodge the existing GameStop card; just last year, the board fought another activist investor with big plans for change.
To be clear, there is nothing particularly damaging about the current CEO George Sherman or his team. (Redditors, please don’t send pizzas to his place at 1 am) Managing a declining business is difficult during the good times and almost impossible during crises.
But to become an agent of change, Cohen needs more than his vote for the video game retailer. He needs the support of another investor.
Reddit investors, unite!
So far, Reddit investors have boosted GME’s shares using a financial peculiarity known as delta-gamma coverage. It happens when many investors buy deeply out-of-the-money calls – the lottery tickets preferred by the r / WallStreetBets crowd. And in one of Wall Street’s least understood processes, as prices rise, market makers will buy more shares of GME to protect their positions. This creates a feedback loop that pushes prices even higher.
But for GameStop to reach a price of $ 500 (and stay there), Redditors will need more than the peculiarities of Wall Street.
To do more, they will need the four tools of activist investors: invest, strategize, rock and vote.
Activist Investment 101
This is the obvious first step with activist investment: investors need to buy GameStop shares and insure themselves. The options can make you fabulously rich, but only ordinary shareholders can vote at shareholders’ meetings.
Next, investors need to strategize what is best for GameStop. Sucking out the vital blood of a dying company may generate some money for shareholders, but it will not transform GME into a $ 35 billion company. Nor try to beat established players like Twitch or Valve in their own game. Instead, winning strategies will involve identifying technologies a decade from now and investing before others do. (A virtual reality universe, anyone?)
Third, shareholders need to make their voices heard – something that Redditors already seem very good at doing. With a single well-crafted public letter to the board (plus a few backstage negotiations), Cohen managed to win three seats on the board. Smaller investors may not have the same platform, but they can undoubtedly start putting pressure on GME’s board to move faster.
And finally, shareholders must vote. Most investors typically outsource voting to their brokerage firms, making annual meetings a stamp test. But unless the shareholders come to Cohen’s aid, the change will not come quickly enough.
Time is running out for GME stock
Reddit and Mr. Cohen will have to work fast. Thanks to the years of excessive corporate debt, GameStop now has a debt / equity ratio of 3.5x. The retailer spends more than $ 300 million in interest, maintenance and leasing costs, which will burn his $ 446 million treasure faster than most people expect.
Mr. Cohen probably saw the writing on the wall. Without drastic changes, GameStop’s chances will melt faster than Mr. Cohen’s ice cream cone mysteriously posted on Twitter this week.
That’s what makes CFO Jim Bell’s resignation on Wednesday so remarkable. Clearing the ranks of janitors is an essential first step towards a turnaround, and Cohen seems to have taken the advice from his downfall. But more still needs to happen. And Mr. Cohen needs your help, Reddit.
For GameStop to reach $ 500, the company would need a market capitalization of $ 35 billion, or more than the combined value of Twitch and Steam.
A secondary offer of $ 150 per share would be a start. A dilution of around 10% would raise $ 1 billion, something AMC Entertainment (NYSE:AMC) did during the inventory increase in January.
But money alone will not solve GameStop’s decline. The company desperately needs a new vision among its management staff. Rehiring a COO would be a good first step – the company hasn’t bothered with one since 2019. Drawing a long-term strategy (and finding the right person for the job) would be even better.
In short, GameStop needs a change of strategy that it must make even From Netflix (NASDAQ:NFLX) co-founder Reed Hastings nods in approval.
Mr. Cohen has worked his magic on Chewy.com before. And perhaps he is even the right person to take on the most important role at GameStop. But before starting on this path, the 35-year-old founder will need all the help he can get. And with a megaphone powered by Reddit, retail investors finally have a chance to make that happen.
Good luck, Redditors. I will see you on the moon.
As of the date of publication, Tom Yeung had (directly or indirectly) no positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment consultant with a mission to bring simplicity to the investment world.