Is the GameStop (GME) share price a ticking-time bomb?

The GameStop (GME) share price continues to soar, but is it about to come crashing down? Zaven Boyrazian takes a closer look.

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The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

2021 has been a fascinating year for the GameStop (NYSE:GME) share price. The company saw its stock rise from $17.25 to nearly $350, only to then crash. But despite all the volatility caused by the short-squeeze, it’s now trading at around $220. That’s a 5,000% increase in 12 months! But is this valuation justified or a ticking time bomb? Let’s take a look.

The bull case for the GameStop (GME) share price

2020 has been a challenging time for most retailers. After all, lockdown restrictions made footfall in physical stores drop significantly. But GameStop has been struggling for many years due to the rising popularity of downloading digital copies of video games instead of buying a physical disk. This transition by gamers effectively made the company an unnecessary middleman, which saw its revenues slashed and earnings drop into the red.  

But is that about to change? Following the recent events, activist investor Ryan Cohen bought a 13% stake in the business and will become chairman of the board in June. He previously co-founded the online pet food business Chewy and intends to use his knowledge to transform GameStop into a “digital-first, omnichannel retailer”. Beyond this, the firm has also replaced its CEO and CFO, resulting in a brand new management team.

This move towards higher-margin e-commerce appears to have given investors hope for the future potential of this business. And if successful, could enable the business to make a comeback. It’s also worth noting that the new management team recently signed a partnership with Microsoft. While there is limited information about this deal, it does include a royalty-like structure in which GameStop will receive a cut for each Xbox game sold on its website. But as promising as this may be, I remain quite sceptical about the GME share price.

Troubling financials

Whether new management can achieve its goals remains to be seen. As it stands, there’s limited information available on what a digital-first GameStop will look like as no guidance has been issued.

Looking at its recent financial statements, there appear to be some misleading signs of recovery that may be inflating the GME share price. While revenues declined by a further 22%, net losses were almost halved from $400m in 2019 to $238m in 2020. The lack of advertising, receiving, and distribution costs last year due to the pandemic substantially reduced the costs of sales. And this led to a seemingly improved bottom line. But looking at the gross profit margin, the firm’s profitability actually declined from 29.5% in 2019 to 24.7%.

On the balance sheet, long-term debt was reduced from $420m to $216m. This is an encouraging sign for me. Yet the money didn’t come from sustainable sources such as operating profits, but rather from closing and selling 462 stores.

The GameStop GME share price has its risks

The bottom line

To keep the lights on, the management team turned to shareholders to raise additional capital. And in April this year, it successfully issued 3.5m additional shares, raising $551m.

These new funds certainly give the business some breathing space. But, the online transformation of GameStop has only just started. And beyond the brand’s nostalgia factor, I can’t identify any discernible competitive advantages this business has in the online space.

As far as I can tell, the valuation of the GME share price is being driven entirely from speculation rather than fundamentals. I’m not interested in adding it to my portfolio.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

Zaven Boyrazian does not own shares in GameStop. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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