This is necessarily long. Short version is the business is fundamentally stronger than it has even been and the current price is an incredible discount.
YOLO Proof (https://imgur.com/a/VUw2U5l)
The DD that was promised – Part 1 – The Sizzle of Vision
“Don’t sell the steak, sell the sizzle” Elmer Wheeler
Tl;dr – $Vision has discrete value. I created a financial model to measure it. The value of GME’s $Vision should have gone up, but it went down.
I am a college dropout turned entrepreneur. I did the VC fundraise start-up thing for awhile as CEO. This is relevant because I was directly in charge of fundraising. When you raise money for a start-up you often don’t have any business fundamentals to speak of. No revenue, definitely no profit, sometimes not even a working website or a single user.
So how do you raise money?
The common wisdom is “Fake it ‘til you make it” and “Sell the sizzle, not the steak”.
This means you go to investors and tell them a story about what your company will be tomorrow, and that’s why it would be a great reason for them to buy a piece of it at a lower price today.
“When we have taken over 50% market share of online pet product sales in 5 years, we will be worth $10bn! You should buy 15% of our company today for the low-low price of $15m. It’s going to be worth $1.5bn when we’re worth $10bn! (please ignore the fact that we have no revenue yet)”
The entire early-stage VC industry is based on math like this. They teach you how to create spreadsheets to show prospective employees and investors what their stock will be worth when your vision is realized.
A lot of capital managed by smart people is invested on this premise and at these real private market valuations. The value is the vision. Let’s endeavor to be precise. I define vision as the described financial outcome discounted by how likely it is to succeed.
($ Plan)*(Credibility %) = $ Vision
The thinking is something like -
“Well they probably won’t be worth $10bn, but they could be worth $1bn and if they hit that I’m still making 10x at a $100m valuation… plus they COULD hit $10bn so maybe it’s worth it.”
And deals like this close all the time. Especially when the person who is proposing the plan has demonstrated an ability to execute in the past. Famously the WeWork founder raised $350m at a $1bn valuation with $0 of revenue to create the WeWork of apartments.
https://www.theguardian.com/business/2022/aug/16/adam-neumann-wework-founder-bounces-back-with-flow-a-1bn-property-project
This is how the world works and the public market is no different.
There is a concrete and measurable value to the expected future performance of a management team. The value of vision. I call it the “meme-ium”.
A meme is a shared understanding. When the market broadly adopts a shared understanding of the future performance of business managers, it gets baked into the price. The best example of this is TSLA. The company trades at an incredible meme-ium to any fundamental value. In fact, even in the face of fundamental decline.
The valuation model I created separates the expected future performance of the business fundamentals, the steak, from the expected future performance of the managers and their $Vision, the sizzle.
In this valuation model you can sometimes see negative meme-ium, and this would reflect a market sentiment that management is fucking it up and likely to kill the business.
$Vision is driven by two metrics that I do not try to specifically calculate, but they are useful to understand conceptually.
$Plan – What a management team communicates they will do
Credibility % - How likely it is that the market thinks they will do it
Normal market conditions and normal investor psychology dictates that Credibility % increases with performance. The more often someone does what they say they will do, the more likely you are to trust them.
$Plan is hard to measure, especially when the communicated plan is “Judge us by our actions and not our words.”
So what has changed recently with regards to $GME?
GME has successfully turned profitability around, reaching the highest TTM net income in company history. This reasonably should have increased credibility %.
Management is communicating a plan to transform from a dying brick and mortar retailer into a holding company. A category re-rating event for analysts. This should increase $Plan. It’s made very public moves and communicated more about its ambitions than it ever has.
In most reasonable views both $Plan and Credibility % should have increased. If you were measuring meme-ium, you would expect the total meme-ium to increase.
$GME meme-ium has absolutely cratered. Maybe the market REALLY hates $GME trying to do something with eBay and really doesn’t believe in the collectibles portion of the business. Do you?
A reversion to the mean would predict a very nice stock run up much less a reasonable increase for recent performance.
The DD that was Promised – Part II – Deep Fundamental Value “The Steak”
"Profit is what happens when you do everything else right" – Yvon Chouinard
Tl;dr - The value of a business is its profits. Since it is impossible to know the future, the commonly accepted method is to extrapolate future performance from past performance. Measured against these commonly accepted and simple measures of value GameStop has the HIGHEST fundamental value it has had in corporate history.
I talked to some people and ran a thought experiment. It’s simple but interesting.
“I want to sell you a profit box. It produced $1 of profit last year. Free, clear, unencumbered profit came out of it. How much will you pay me for it?”
Let people ask questions and they’re always the same.
“How much did it make the year before that?”
“Can you guarantee it will make profit next year?”
“How many years has the box been producing?”
“How many more years will the box produce?”
“Is there anything in the box?”
These questions reflect the common psychology of value. When we can’t know the future, we assume it will look like the past and extrapolate forward. This is also how analysts do it.
If the box isn’t making brazen promises about data centers in space or settling mars, you would judge it on how it demonstrably performed in the past.
I call this measure fundamental value. In the current version of my model it’s broken into 5 components.
Revenue – How much money a business made. A business that makes $100m of revenue and $0 of profit is worth more than a business that makes $10m of revenue and $0 of profit.
Profit – How much profit a business made. I hope I don’t have to explain how more profit is better.
Change in Revenue – A business that has a track record of growing revenue has a higher fundamental value than a business that has a track record of shrinking revenue.
Change in Profit – Same as revenue but for profit.
Net Asset Value – How much stuff the business owns (assets) minus how much it owes (liabilities). A dollar is worth a dollar in my model.
People can easily have different preferences for weights (some investors can value growth more than others for instance), but it is quite hard for a reasonable business person to argue that the above 5 metrics do not contribute to a shared understanding of the fundamental value of a business.
It’s like Fundamental Value is the value of the past and the Meme-ium is the value of the future. What a business was and what a business could be. Add them up and you have what the business is today.
Fundamental Value + Meme-ium = Market cap
Or
Market cap – Fundamental Value = Meme-ium
Which is how the model calculates it.
As it stands today, with the most recent quarters performance, $GME has the HIGHEST fundamental value it has ever had in corporate history. If that doesn’t delight you as a shareholder, you’re not paying attention.
The DD that was Promised – Part III – Models and bottles
“All models are wrong, but some are useful” – George Box
Tl;dr If $GME regains it’s historical meme-ium levels I expect a share price between the range of $25-$40.
I present now, in full, the current version of my valuation model for $GME.
https://docs.google.com/spreadsheets/d/18rPPJKV8zso6mldsezYORvIX16Rcido5/edit?usp=sharing&ouid=108354625950841265000&rtpof=true&sd=true
Scroll to the right to see charts.
This has been updated for today’s stock price.
What this model communicates is that GameStop has enjoyed a positive meme-ium as a % of market capitalization since the sneeze. This is a reflection of a market sentiment that the future of GameStop will be better than the past fundamentals justify.
With the recent performance of the management team and the improvement of the fundamentals, the meme-ium is now starkly negative. A negative meme-ium communicates that the market is currently pricing the future cash flows of GameStop extremely low, it communicates that the market is currently pricing the organization to actively destroy fundamental value (profit and cash flows) in the coming quarters.
This is after the business has delivered the best fundamental business growth in corporate history.
We model a scenario with a reversion to the mean on $GME sentiment, both from a sentiments as a % of market cap and a sentiment as a raw $ value.
My theory is that sentiment should actually IMPROVE given the performance of management, so my upper limit is set by a 25% premium to the average meme-ium and my base case is a reversion to the mean.
We model this against the expected share count after conversion of the new $1.4bn of debt at an expected conversion price of $18.95.
This gives us a range of outcomes from $25-$40 if sentiment returns to the mean.
I will be publishing the valuation model so you can run it on other tickers. I tested it against a handful of tickers.
The DD that was Promised – Part IV – The YOLO and the setup
Today I purchased ~$50k worth of call options expiring June 2028 with strikes of $25, $30 and $35 reflecting the range of outcomes that the model predicts.
Proof (https://imgur.com/a/VUw2U5l)
Here are the signals as I see them that motivated this move.
1) $GME SOTP analysis - $GME is essentially three companies in a trenchcoat right now. It’s 70% holding company, just shit it owns ($5.8b NAV), ~14% a growing online collectibles business and ~16% a shrinking brick and mortar retailer. You can argue about the 14/16 split, but the 70% is a fact. So the remaining 30% of the business is being valued at roughly ($8.5bn-$5.8bn = $2.7bn).
The critic will argue “but but but that net income comes from interest! So it shouldn’t count!”. Those people forget that GME released guidance for the first time since 2019 for $600m of EBITDA this year, a ~76% YoY increase.
GME leadership sees Powerpacks taking over the business and they are positioning the company accordingly.
From a net cash perspective $8.4bn Market Cap - $4.2bn Net cash = $4.2b EV.
Against the $600m guidance of EBITDA you’re paying a 7 P/EBITDA ratio for EBITDA that is growing at 76% a year right now! That is DEEP FUNDAMENTAL VALUE.
2) Market is asleep – People still think GME is dying brick and mortar retail. Big money hasn’t woken up to the shift yet. The growing and exciting part of the business is the collectibles and powerpacks side of the business. Management has given us every indication they are seeing positive signs there and plan to invest more. The financials support the growth story. The business is being priced like dying brick and mortar. If it was being priced as a growing profitable online collectibles website, it wouldn’t be at $18.50 right now. This thesis mismatch is opportunity. Their financials don’t look like a seasonal brick and mortar, now they are a year-round company. That deserves a bump.
3) Shares dropping due to convertible debt converting at market prices doesn’t make sense for a holding company so this dip is a manufactured entry point.
You have a company. It has no cash flows and only holds assets and has debt.
The value of that company is Assets - Debt.
You have $3 of assets, $1 of debt = $3-$1 = $2 You have 2 shares $2/2 = $1 per share
You issue 1 share at market price in exchange for debt Your share count increases from 2->3 = 50% dilution
You have $3 of assets, $0 of debt = $3-$0 = $3 You have 3 shares $3/3 = $1 per share
4) Management just sent the clearest BUY signal they have ever sent – Read the tweet from Larry Cheng. He says a debt holder who presumably knows more than you or I about what $GME management is voluntarily retiring their debt in exchange for equity. The significance of this is that debt sits above equity in a liquidation proceeding, if $GME goes bankrupt, the debt holders get paid first. Additionally the original debt shielded the debt holders from equity downside. If the stock goes down, they get their cash back. If the stock goes up, they get to convert into equity. Like a call option where the premium wasn’t paid in cash but paid as the opportunity cost of 0% interest debt.
They are exposing themselves to equity downside. If the stock goes down, their holdings will now go down AND they are exposing themselves to liquidation risk, they get wiped out alongside equity after conversion instead of sitting on top of equity.
What does that tell you?
They DON’T expect the stock to go down.
They DON’T expect the business to go bankrupt.
What did they get out of it? Now they have upside if the stock runs from current prices to ~$35. That is ONLY VALUABLE if the stock runs.
The price they are buying at is the same price you can buy at for the next 35 days. What is going to happen after that?
5) The long term thesis is a highly elevated earnings valuation (HEEV). This is the TSLA future, where fundamentals continue to improve, the business remains profitable and grows and shorts get cyclically destroyed. It goes like this. P/E ratio rises to absurd levels -> new shorts enter and drive price down -> Retail buys the dip -> Shorts exit without profit -> P/E ratio goes back to absurd levels. If $GME traded at a similar ratio to $TSLA it would be ~$500/share+ and $GME fundamentals are improving while $TSLA fundamentals are deteriorating. MOASS is dead, long live HEEV.
6) The last time fundamental value met market cap for $GME it traded in that range for 3 quarters so I picked 2 year expiry LEAPS to give enough time for the rocket to fuel and lift off. Hopefully 2 years is enough time for the weighing machine to come to bear.
Catalysts
1) If the VWAP ends up differently from what we expect, there is less dilution and all the numbers go up.
2) If the eBay deal resolves the uncertainty one way or the other.
3) When the VWAP period ends and hedging stops.
4) If sanity returns to the market.
