Browse through your feed of LinkedIn and you’ll probably see some content related to the recent run-up in GameStop Corp.’s stock price (ticker: GME). All of the arguments against GameStop have alluded to doubts as to the company’s ability to survive in an industry that is continually moving away from the traditional distribution channels (analogies to Blockbuster are frequently used here). Is the company overvalued given the massive increase in stock price? I have not seen any quantitative analysis out there on this, so figured that a “quick and dirty” comparative analysis — business valuation style — might provide a different perspective. Note that, in this article, I will try to avoid the qualitative “explanations” around the company’s valuation as you can read plenty of that on your own 😊. I will focus on the quantitative data.
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One challenge associated with determining whether GameStop is overvalued is answering the question: as compared to what? There are not a lot of companies out there that focus solely on brick-and-mortar video game retail and certainly none that are publicly traded. The best group of comparable companies in the public market that I could justify included specialty retailers. I did not include cosmetic or furniture retailers as they comprise their own industry groups. Of the seven companies shown below, Build-A-Bear is likely the most comparable due to the format of the stores and unique product focus. The group below is certainly not perfect, but I think is the best group to which GameStop can be compared. I am happy to consider other companies if you have suggestions — feel free to leave me a comment. The date of comparison is January 25, 2021.
There are six general factors that I like to analyze to determine how a business compares to its peers: size, growth, liquidity, profitability, operating efficiency, and leverage. I will briefly summarize some of my observations for each of these factors.
Size: Size is often referenced as one of the more important factors in the selection of multiples relative to guideline public companies. Generally, larger companies are characterized as less risky due to greater levels of geographic and operational diversification, more sophisticated and extensive management teams, greater access to financial resources, and lower vulnerability to economic and market downturns. In Figure 1 below, you can see that GameStop ranks toward the middle of the group in terms of its size (note that “Subject Company” refers to GameStop).
Growth: Historical and future growth is an important consideration in selecting appropriate multiples for a business. High growth companies are generally regarded favorably as compared to low growth companies and projected growth weighted more heavily than historical growth. Figure 2 presents comparisons of revenue and EBITDA growth. For clarification, “LFY” means latest fiscal year, “LTM” means latest 12 months, and “NFY” means next fiscal year. Since none of the companies analyzed have filed their 2020 financial statements, LFY represents 2019, while NFY represents the expected results for 2020. The Company’s LTM growth rates and expected growth rates for 2020 were on par with Build-A-Bear Workshop, which was pummeled in 2020 (one reason likely being the pandemic).
However, as shown in Figure 3, analyst expectations suggest that the GameStop is expected to stage a turnaround in 2021 (NFY+1) and 2022 (NFY+2). Note that NFY+1 EBITDA growth presents an “NM” for GameStop as growth rates cannot be calculated from negative figures. Consensus forecasts do suggest that the company will return to profitability in 2022.
Liquidity: A company’s ability to pay its short-term liabilities is an important factor in assessing financial risk for a business. The more liquid a company’s balance sheet, the lower the overall financial risk and, in general, the greater the valuation multiple applied. In Figure 4, GameStop’s liquidity ratios rank toward the lower 50% of the group, indicating less liquidity for the company as compared to the overall peer group.
Profitability: Profitability ratios measure a business’ ability to generate a return from its revenue or assets. This factor is particularly important in the selection of a revenue multiple but is also a consideration in assessing financial risk for a business. In general, the higher a company’s profitability, the more an investor will be willing to pay per dollar of revenue (i.e., higher revenue multiples). Companies with higher levels of profitability also tend to be less susceptible to declines in revenue and increases in expenses. In Figure 5, GameStop clearly ranks unfavorably toward the bottom of the group.
Turnover/Efficiency: Turnover (or efficiency) ratios provide an indication as to the efficiency of a company’s financial management. In general, higher turnover ratios (or lower days ratios) on assets suggest that a company requires less assets in order to maintain its operations. Thus, higher turnover ratios and lower days ratios indicate a higher level of efficiency. Based on the ratios presented in Figure 6, GameStop appears to better manage inventory, generates more revenue per dollar of total assets, and has comparable terms on the satisfaction of its accounts payable.
Financial Leverage: There are a number of financial leverage ratios available to measure financial risk. These ratios are meant to provide a comparative measurement of a company’s ability to meet its debt obligations. Lower levels of debt are generally associated with lower levels of financial risk. In this case, I would characterize GameStop as having more financial risk due to its relatively high level of financial leverage. GameStop ranks poorly on all of the ratios shown in Figure 7, indicating a much more substantial use of debt as compared to the peer group.
Tying It All Together
To summarize the size broad factors of comparison:
- Size — Neutral factor.
- Growth — Negative factor due to recent declines in revenue and EBITDA. However, if you buy into a turnaround story and that GameStop is now past the “hard times”, this factor may be somewhat positive.
- Liquidity — Negative factor.
- Profitability — Negative factor.
- Operating Efficiency — Positive factor.
- Financial Leverage — Negative factor.
Generally speaking, I would view GameStop unfavorably relative to the peer group based on the comparisons described above. In assessing whether the company is overvalued, I present in Figure 8 below the valuation multiples of GameStop relative to those of the comparable company group in Figure 8. Note that LTM and NFY EBITDA multiples are not presented as they could not be calculated for GameStop (due to negative margins in those periods).
In reviewing the multiples as of January 25, 2021, it appears that the market is possibly overvaluing GameStop when you consider recent growth trends, expectations for 2020, historical and projected profitability, and its significant usage of financial leverage. The only argument (based solely on the financial analysis here) to support the extraordinary run-up in stock price and the crazy valuation multiples shown in Figure 8 would be the expectation for growth in 2021 and 2022. If you think that the growth expectations are achievable, then perhaps GameStop’s valuation does not seem so crazy. On the flip side, if you think that the turnaround story is a fantasy, then it would be natural to think that the company is overvalued. At the end of the day, it comes down to the legitimacy of the story behind the growth.
Intuitively, I think this all makes sense when you read some of the commentary out there on LinkedIn and in the news. The demand created by Redditors and other retail investors who are either riding the wave, fighting the “Man”, or truly believe in the GameStop story put a significant squeeze on short sellers. Therefore, one could rationalize that the company’s current valuation reflects the expectations of those investors who went long on GameStop and the expectation that the company will achieve the future projected revenue growth and improvement in margins.
What does this appraiser think? I think that I should have put some money down on GameStop before the run up in price occurred 😉.
For another analysis related to the video game industry, see my earlier article discussing the video game studio industry.
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