Nine months ago, GameStop stock bottomed out at $2.80 a share, a reflection of the myriad problems facing the retailer specifically and brick-and-mortar game retail as a whole. As of Tuesday morning, though, that stock price is hovering around $40 a share (peaking at $44.74 as of this writing), with the vast majority of those gains coming in the last couple of weeks.
Is GameStop really worth up to 16 times as much as it was back in April? Is the company’s ambitious turnaround plan finally (and suddenly) turning things around? Is GameStop roaring its way back to the nearly $10 billion market cap it enjoyed at the height of the Wii phenomenon?
Probably not. Analysts suggest the recent surge in GameStop’s stock price is the result of a massive short squeeze bubble that will pop eventually. But beyond the sky-high valuations of recent weeks, analysts also suggest there’s some reason to believe GameStop’s long-term health is more robust than last year’s stock doldrums suggest.
Here comes Cohen
To understand GameStop’s current stock market run, you have to go back to August, when investor Ryan Cohen bought in to a roughly 10 percent ownership stake in the retailer. Cohen is best known as the founder of pet food superstore Chewy.com, which sold to PetSmart for $3.35 billion in 2017. Since that sale, Cohen has tended to invest his billions in big, safe stocks like Apple and Wells Fargo, so his major investment in the much riskier GameStop attracted notice.
Since August, Cohen has bought even more GameStop shares, and he and two former Chewy executives have been named to the company’s board of directors. That gives Cohen, along with fellow activist investors from Hestia, the potential capability to steer the company in a new direction.
And Cohen hasn’t been shy about identifying what he sees as the problems for the company. “GameStop’s challenges stem from internal intransigence and an unwillingness to rapidly embrace the digital economy,” Cohen wrote in a bold, italicized, underlined, and all-caps portion of a November SEC filing.
“GameStop’s challenges stem from internal intransigence and an unwillingness to rapidly embrace the digital economy”
The company has to “promptly pivot from a brick-and-mortar mindset to a technology-driven vision,” he continued. “If GameStop takes practical steps to cut its excessive real estate costs and hire the right talent, it will have the resources to begin building a powerful e-commerce platform that provides competitive pricing, broad gaming selection, fast shipping, and a truly high-touch experience that excites and delights customers.”
Even as GameStop’s earnings reports continue to be uninspiring, Cohen’s bold talk about a new, less physical path forward for GameStop got some investors excited. “[Cohen’s involvement] has given the market confidence that this profit will be spent wisely to grow the company into an e-commerce competitor, similar to Chewy, instead of doubling down on the brick and mortar strategy,” DOMO Capital Management President Justin Dopierala told Ars. “GameStop’s most valuable asset is their database of tens of millions of PowerUp Rewards members that no other competitor has the ability to replicate. GameStop will be able to leverage this data to become a fierce e-commerce competitor over time and has many unexplored avenues to monetize the data.”
“[Cohen] seems to have a vision of what the company should be in the future,” Telsey Advisory Group analyst Joseph Feldman told Ars. “It’s more experiential, it makes sense given the changes in the market, so maybe it’ll help speed that along. It’s certainly something worth watching.”
“Because you’re buying a month’s worth of pet food every month, you just keep going back like groceries. The game business isn’t like that.”
Others are more skeptical that applying a strategy for selling dog food will be so simple to apply to selling video games. “[Cohen]’s real-world experience is selling commodity products like pet food and toys into a market that has recurring demand for that,” Wedbush Morgan analyst Michael Pachter told Ars. “Because you’re buying a month’s worth of pet food every month, you just keep going back like groceries. The game business isn’t like that. In the pet food/toys business, there is no virtual download, [whereas with] GameStop, all the games they sell, you can buy digitally at the same time.”
The big squeeze
Whether Cohen can turn GameStop around or not, the investor excitement around his new strategy presented a problem for the many investors who had shorted the stock (i.e. borrowed shares that they expected to go down in value). As their short positions came due, those short sellers found themselves having to buy shares at the new, higher price to cover that earlier borrowing.
“Demand started with some Robinhood-type retail investors, but once it started going up, then you had shorts that were like ‘Oh shoot,'” Pachter said. “And the shorts were getting killed, so they started covering. And that was a feeding frenzy. Light supply, heavy demand… so the stock’s just getting ripped up… I’ve never seen anything like this in my life.”
Meanwhile, investors who continue to think the stock price is overinflated are continuing to borrow more short positions, confident that the price will come down to earth eventually. Interest has gotten so hot that Thursday saw a trading volume of 144 million shares of GameStop stock, even though there are only about 45 million actively traded shares available.
“I would not be chasing the name here. The smart money already got in and probably got out.”
It’s this kind of feeding frenzy that has led GameStop stock to more than double in the last week, analysts agree, rather than anything fundamental about the real value of the company changing in that time. But that cycle has to end eventually as short sellers run out of capital and available shares to buy. And that peak could be coming relatively soon, according to some analysts.
“There was a massive short position in [GameStop] and I would be very interested to see what happens to the share price when things calm down and the short sellers have to cut their losses on this,” Standpoint analyst Ronnie Moas told Ars. “It could be another new wave of short sellers could come in, but I haven’t closely analyzed the situation… I would not be chasing the name here. The smart money already got in and probably got out.”
Others think this short cycle could keep going for a while, though. “If a short squeeze does occur… the shares could certainly rise over $100 per share in the short-term as the number of shares short currently exceed shares outstanding,” DOMO Capital’s Dopierala said. “So far, the short sellers have proven resilient, which leads us to believe that they are very well capitalized and will not exit until the moment that GameStop is able to show tangible results that prove they can successfully transform.”
While Dopierala was heavily invested in GameStop very recently, he told Ars he cashed out of his position on Thursday. That brings up the issue of when other investors might start to look at GameStop’s quickly inflating stock price and see an opportunity to cash out (which would help bring the price down to more reasonable levels).
Pachter notes that an insider Hestia investor sold 812,000 shares of GameStop last week, according to SEC filings, and suggests more investors might take their profits and run soon. “What’s [Cohen]’s strategy?” Pachter asked rhetorically. “Get the stock to $300 or get the stock to $32 and make 300 percent profit? You have to ask, does he actually think he can take it higher than this by remaining a shareholder?”
While Dopierala continues to be bullish on GameStop as a whole, even he admits that the company’s transformation “may not happen as quickly as suggested by the current stock price.” Analyst consensus suggests GameStop could settle at a price of around $10 a share based on the fundamental health of the business.
“There’s nothing wrong with GameStop,” said Pachter, who has a target price of $16 for GameStop stock. “I’m absolutely convinced they’re going to thrive and survive. They don’t have net debt, so they’re not going bankrupt or anything. And with the new console launch, they’re probably going to sell a lot of consoles and be fine.”
“There’s nothing wrong with GameStop. I’m absolutely convinced they’re going to thrive and survive.”
“You would think next holiday season should be another very good year for the video game space, just considering the installed base, and people want the new consoles,” Feldman added. “[GameStop] continues to reduce its store base, increase profitability, and they’ve been doing a better job consolidating.”
There are still plenty of headwinds for a business like GameStop, of course. “The problems GameStop has—many of these problems are not going away any time soon,” Moas said. “The world has changed in the last few years as you can see with all of the shopping mall closures and the disruption Amazon and others have caused GameStop and others in the industry.”
But as long as there’s demand for new and used physical games, there will be demand for GameStop, Pachter suggested. “The people that value trade-ins value don’t want to buy digital. If you do trade games in, you look at every game you purchase as a $20 bill on trade in. People think that way. So they’re going to keep buying physical—those who care to trade them in—because there is value there. They’re not going to give away that value.”