The market has had a rough run over the past several days. But one stock bucking the general downward trend is GameStop (NYSE:GME).
GME stock has rallied nearly 25% from $13 to $16 over the past few trading days as go-private rumors have turned into a reality. Reuters first reported that GameStop was in talks to sell itself after receiving private equity interest. Retail private equity firm Sycamore Partners, who is behind retail companies like Hot Topic and Staples, was rumored to be one of the interested buyers.
Shortly after those rumors broke, GameStop management confirmed that they are indeed in exploratory talks with PE firms regarding a potential sale.
All together, this takeover drama has caused GME stock to roar higher.
Will the rally last?
I think so. This is the lifeboat that will save struggling GME stock. GameStop fits the PE archetype of a cheap, depressed, struggling retailer that has opportunity for a massive turnaround if managed appropriately. As such, GameStop being taken private at a premium to today’s price is quite likely.
That is why I’ve bought into the GME stock rally.
Here’s a deeper look.
GameStop Will Sell Itself
All signs point to the fact that GameStop will indeed sell itself in the foreseeable future.
For starter’s, GameStop fits the archetype of a retailer that PE firms want to take private. GME stock is dirt cheap, trading at just 5-times forward earnings. The balance sheet isn’t dirty or over-loaded with debt. The company operates more than 7,000 stores across various geographies, the sum of which is arguably worth more than the current market cap.
Meanwhile, operating results aren’t that bad. New energy in the video game market, driven by next-gen video game console technology, is lifting GameStop new hardware and software sales. GameStop also operates a collectibles business, which is red-hot, and a phone-selling business, which has cooled off but has solid long-term growth prospects through mobile usage proliferation.
In grand total, this is a struggling retailer that is dirt cheap and actually has potential to rebound in a big way through an up-cycle in next-gen gaming and business diversification into selling collectibles and phones. The only way that big rebound materializes, though, is if the company is excellently managed.
All PE firms think they are the best managers. As such, now that GameStop has opened itself up to go-private talks, PE interest in the name will likely be very strong, and the likelihood of a takeover materializing in the foreseeable future is quite high.
The Takeover Price Could Be Big
One of the rumored potential buyers is Sycamore Partners, the savvy PE firm, which took Staples Inc. private for $6.9 billion in 2017.
Back in 2017, Staples looked a lot like how GameStop looks today. Sales at both companies were gradually falling. Margins were eroding. Earnings were dropping, but not by a whole bunch. In other words, the sky was falling, but at an unusually slow rate.
As such, if Sycamore comes in and buys GameStop, it is likely that the PE firm gives GME stock a similar multiple to the one it gave Staples. At the time of the takeover, Staples’ adjusted earnings-per-share over the trailing twelve months was $0.88. The takeover price was $10.25. Thus, Sycamore took Staples private at roughly 11.5-times adjusted earnings.
Considering GME stock presently trades at 5-times forward earnings, I think it is unlikely GameStop goes private at a 10-times or higher multiple. But even a paltry 7.5-times multiple on this year’s projected earnings of $3.11 implies a go-private price of well over $20.
Bottom Line on GME Stock
GameStop has been waiting for a lifeboat to save it for some time now. That lifeboat is finally here in the form of PE interest.
Considering GME’s nature as a depressed retailer with turnaround potential, I think it is fairly likely this company does get multiple go-private offers over the next several months. Moreover, considering go-private precedents for struggling retailers, I also think that GameStop’s go-private price could be in excess of $20-per-share.
As such, with GME stock presently trading around $16, I think now is a good time to buy into the rally.
As of this writing, Luke Lango was long GME.