GameStop: Time To Go All In On NFTs

After a spectacular rise a year ago, GameStop (GME) shares began to depreciate in recent months, as the company’s business is not growing as fast as some investors want it to grow, while most short-sellers left the stock in early 2021, leaving little room for another squeeze. To improve the current state of affairs, GameStop’s new leadership team, with Ryan Cohen as its chairman, for months have been preparing to take the company to the next level by changing the business’s model of relying too much on retail sales and getting a foothold in the growing Web3 environment through an NFT marketplace. While the company hasn’t revealed its new projects so far, the latest developments within the digital assets industry show that the growth potential of NFTs is enormous, and having its own marketplace in a business that’s still in its infancy could yield great returns in the long run.

For that reason and considering the fact that at the current price GameStop trades at less than 2 times its forward sales, I decided to add some shares of the company to my portfolio. At the same time, the position is not that big, so it won’t cause major losses to the overall performance of the portfolio if things go south and the management fails to reorganize the business quickly enough. In addition, after GameStop fully reveals its marketplace along with the forward-looking guidance, only then I’ll consider increasing my position in the company.

For years, GameStop has been losing its edge in the video gaming industry, as its over-reliance on retail sales has been driving the business into the ground. That’s why its stock has been in a decline for a long time before the famous short squeeze occurred last January. However, things have also started to change since the beginning of 2021. First of all, a popular investment fund RC Ventures, led by Chewy (CHWY) founder Ryan Cohen, accumulated nearly a 12% stake in GameStop and added new people to the board of directors. After that, Ryan Cohen himself was elected as the company’s chairman and his vision of transforming GameStop into a tech play with a wide online presence has been put into motion.

After the new leadership team took reins of the company, GameStop has started to report decent earnings results, beating the analysts’ revenue estimates in the last three quarters in a row. In the recent earnings report for Q3, which was released a month ago, GameStop managed to generate $1.3 billion in revenues, up 30% Y/Y and ended the quarter with $1.14 billion in inventory. In addition, GameStop has also reached another milestone of having no major debt on its balance sheet at the end of the quarter, while its liquidity stood at $1.41 billion.

The improvement of the top-line performance signals that GameStop’s core business still has the ability to generate some growth under the right leadership, but it also gives the management some time to transform the overall company before things drastically deteriorate. That’s why a clean balance sheet along with a decent amount of liquidity should be more than enough for the company to execute Ryan Cohen’s vision and reorganize the business, which should lead to the creation of an additional shareholder value along the way.

Lack of a decent online presence has been GameStop’s major weakness, which prevented the company from improving its overall performance for years. All that the company had was its own website where people ordered either gaming hardware or software and later received it in their nearest GameStop store. As a result, when eCommerce giants such as Amazon (AMZN) and Best Buy (BBY) started to offer lucrative deals on gaming hardware, while gaming publishers like Electronic Arts (EA) and Microsoft (MSFT) began to launch their own cloud subscription services with broad libraries of content, GameStop was stripped of its advantages in the industry. The company was and continues to act as a middleman between gaming hardware and software developers and consumers with no edge against its peers.

The good news is that things started to change in 2021 and will likely continue to improve in 2022 and beyond under the new leadership. To survive and thrive GameStop needed to innovate its business model to decrease its overreliance on retail sales and to regain its edge in the video gaming industry. As a result, in May of 2021 amid the surge of new web3 projects, GameStop announced that it will launch its own NFT marketplace. On top of that, just recently, the Wall Street Journal confirmed that an NFT marketplace is indeed in development, it's expected to launch later this year, and GameStop is actively looking for partners such as gaming publishers and developers to quickly expand a foothold in this new business. In my opinion, this appears to be a genius idea, as it’s the only decent solution that can tackle GameStop’s biggest weakness and revive the company.

Since NFTs along with a Web3 environment are relatively new things in our world, to understand what I mean we first need to answer a couple of questions the first of which is what exactly is Web3. In simple words, Web3 is a decentralized version of the existing web where content and data are not collected and stored by big tech companies, but rather created, stored, and owned by users directly on various blockchains. By utilizing the power of blockchains, gaming developers, in particular, can create their own virtual environments known as metaverses in which users along with the same developers can mint, own, and resell gaming NFTs (non-fungible tokens), which are unique and verifiable digital assets with ownership rights that have value.

To facilitate minting and reselling of NFTs, gaming developers and creators use NFT marketplaces, which implement smart contracts that act as ultimate agreements between buyers and sellers of NFTs. Thanks to this, the ownership of every NFT could be traced through the blockchain on which that NFT was minted. What’s also important to note is that not only do NFT marketplaces generally generate profits by taking a fixed fee from each transaction, but initial creators of NFTs take a fixed fee as well from every secondary transaction. As a result, it’s in the interest of creators and mainly gaming developers to ensure that their NFTs are usable and highly valuable in metaverses to drive investments into their projects, which in the end will lead to higher profits.

While GameStop is not active in this space yet, as its NFT marketplace is still in development, the company knows this business model very well. For decades, GameStop has been buying and reselling used physical disks of video games to its customers. The problem was that as most of the gaming industry went online and games started to be sold on digital marketplaces such as Microsoft Store and PlayStation Store directly to consumers, the value of GameStop’s used physical disks has severely depreciated. However, with the increased adoption of blockchains, GameStop has all the chances to successfully relaunch its legacy business in a new format. Let’s not forget that unlike the case with physical disks where GameStop kept all the profits, NFT creators will now be able to earn a royalty on each transaction on a secondary market, giving an incentive for them to work with the company. In addition, the same NFT could also be minted and later sold on different marketplaces as long as it’s on the same blockchain, finally giving GameStop a decent hedge against suddenly losing its competitive advantages, as was the case with the adoption of first-party cloud subscription services, which cut the company out of a distribution chain.

Considering this, it’s safe to say that a marketplace for NFTs could be the thing that helps GameStop to successfully transform its business. However, it will likely take a few more months before the marketplace itself is launched. From what we know so far, the company has been actively hiring Web3 developers with experience working with NFTs throughout all of 2021, and just a couple of days ago announced that NFT creators can now send their applications to become part of the upcoming marketplace. On top of that, we also know that GameStop’s marketplace will be running on Ethereum (ETH-USD) blockchain and there’s already a smart contract address available for it.

Given this information, it’s still too soon to say how exactly this new project will affect the company’s financials. However, considering that in 2021 the NFT market generated over $23 billion in trading volume and is expected to generate more in the following years, there’s a high chance that GameStop will be able to get a decent share of this market, as it’s still in its infancy. In addition, GameStop will likely have the same model as the biggest NFT marketplace in the world OpenSea has.

Launched in 2017, OpenSea takes a 2.5% fee for every transaction that it facilitates for itself and it also gives another 2.5% royalty fee to creators of NFTs for each transaction that’s conducted on a secondary market. Due to its simple functionality, the marketplace quickly gained popularity last year and in the last 30 days alone it generated nearly $3 billion in trading volume. Thanks to its recent success, OpenSea recently conducted another round of financing at a $13 billion valuation, which is higher than the market capitalization of GameStop, which currently stands at ~$11.6 billion. Considering this, it’s safe to say that there’s money to be made in the NFT marketplace business and that’s why I believe that GameStop is moving in the right direction with its plan to launch its own platform.

On top of all of this, while OpenSea certainly should be considered to be GameStop’s major competitor, the one thing that the company has going for it is a loyal fan base that could financially support the business’s efforts to become one of the leaders of the DeFi (decentralized finance) world. Let’s not ignore the fact that retail traders were the driving force behind the initial rise of GameStop’s stock last year and they were the ones who indirectly forced major hedge funds to suffer significant losses for their decision to bet against the company in the first place. As GameStop looks for ways to transform itself, its loyal fan base of supporters could help the company again.

Despite all of those opportunities, there are still several risks, which could tarnish any hopes for a quick transformation. First of all, it’s very likely that an upcoming NFT marketplace is not going to have immediate effects on GameStop financials, and there’s even no guarantee that it will be successful in the first place. As a result, it could take a while before the marketplace starts to generate serious money if ever, to minimize the downsides of over-relying on retail sales.

Another problem is that in recent quarters no new major information about the upcoming launch of the NFT marketplace has been released. At the same time, the management stopped taking analysts’ questions and giving answers during its latest conference calls, which could’ve shed a light on the progress that has been made. As a result, GameStop investors are left in limbo, while the stock continues to lose value. Since GameStop’s next earnings call will be held only in March, there’s a risk that the stock will continue to depreciate until that time due to the lack of catalysts for growth.

On top of all of this, investors of GameStop shouldn’t bet on another squeeze of the stock. The current short interest stands at less than 15%, giving no room for a decent squeeze. The only thing that investors should care about right now is whether GameStop manages to successfully launch its new project or not, as I see it as the only thing that could help the company’s shares to appreciate higher.

At the end of the day – changing the current business model is a risky endeavor but one that’s necessary in order to ensure the long-term survival of the company. Despite GameStop’s improved top-line performance in recent quarters, over-relying on retail sales will very likely lead to the company’s dissolutions in the long-term, as the gaming industry is changing and so is the environment in which it operates. Therefore, by launching an NFT marketplace, GameStop has nothing to lose and a lot to gain if it’s successful.

Considering that Ryan Cohen managed to beat Amazon (AMZN) in the digital pet supply business, there’s a chance that along with his team he’ll be able to transform GameStop from a dying retailer to a major tech player in a Web3 environment. However, given the fact that the NFT marketplace is still not launched and the guidance is not issued, at best GameStop should be considered a major gamble at this stage. Nevertheless, the good thing is that the company’s stock trades at less than 2 times its forward sales, so investors have a relatively decent margin of safety to purchase GameStop at the current levels. That’s why I own a small position in the company in my portfolio but have no plans to increase my position before there’s more clarity about the current state of affairs so that I won’t suffer major losses in the worst-case scenario.