So I'm a little late to the party but I decided to cover Gamestop in my next few
videos, given that now it's technically a tech company given its transition to
e-commerce What is up everyone, my name is Ben I'm a
former JP Morgan investment banking analyst and welcome to rareliquid the
best channel for tech investing With the company's latest earnings
report, I know there's a lot of hype around the stock, confusion about what
the company should be valued at, so that's why I wanted to first start off
this video with valuation In this video, I'll be sharing with you
guys the model that I built and walk you guys through all the different
assumptions and how the model works In my next video, I'll be going over what
I personally think that Gamestop should be trading at
and in the next video after that I'll be doing a deep dive analysis on the
company Also if you don't have a lot of context
about why the company is such a big deal these days, check out
my video that I made about a month ago explaining the whole Gamestop situation
Also I know that a ton of you probably have done a lot of research and read a
lot of articles about the company so if you feel like
in these next few videos there's something I missed you know I'm still a
small channel and so I read and respond to every single
comment and I'd love to also learn more from you guys about what you think about
the company the stock the whole situation
Please also remember I am not a financial advisor so please treat all
content in this video as for education and entertainment purposes only
First off, let me help explain what a DCF is and why it's a helpful analysis
The discounted cash flow analysis is one of the most common valuation
methodologies bankers and investors use to estimate the stock price of a company
and in this video I'll be going over the model that i built. I'll be making a
video later on going into the more technical details step by step of how a
DCF is built and what all the technical terms really mean but if I try
to include that in this video, it'd be just way too long, so today
I'm just going to go briefly over the main key topics. To put it really simply
a DCF is a valuation method that is based on the idea that a company is
worth the amount of cash it's able to generate from now
until the end of time. The example I like to use when explaining this concept
is if you were to start a lemonade stand basically the value
of what your lemonade stand would be is the amount of cash you're able to
generate from that business from selling your
lemonade to other people, paying off employees, paying for your
actual lemonade stand, your chair, and the stand itself, and whatever cash
is left over that you can bring home at the end of the day-
that's really the value of your business Of course a DCF for an entire business
that's large and complicated is a little bit more complex and so what I
want to do today is just cover three core important topics
that you need to know for a DCF. First is that cash is defined by the formula EBIT
times 1 - the tax rate + D&A - CapEx - Change in Net Working
Capital. Second is that you usually project cash flows
out five to ten years, and then calculate your terminal value,
which is the value of the company from the last projected year
until the end of time. Third is that cash in the future is worth less than cash
today and so all projected cash flow and your
terminal value are discounted by what's known as your Weighted Average Cost of
Capital or your WACC. I'll leave more details to
these terms if you're not familiar with them in my comment below this video,
but the next thing we'll do is go over the model that I built for Gamestop
and hopefully these concepts will make a little bit more sense or at least
provide some more context Okay so with that said, let me go through
my Gamestop DCF with you guys As a high level overview, this is a
pretty simple model with three cases: a base case,
optimistic case, and very optimistic case and as you toggle between the three
different cases the assumptions change and the model
will produce the implied share price for Gamestop
So now let me walk you a little bit through step by step of how I built this
model The first thing I did was copy-paste
Gamestop's past 6 years of earnings in the financials tab
I then connected these numbers to my DCF, which allowed me to get an overview of
how Gamestop has been operating over the past
6 years. To project out cash flow for the next five years, I took the bull case
numbers from the model from the research done at GMEdd.com
which I'll link to in my description below. GMEdd.com is a site dedicated to
Gamestop due diligence, and there's a free report and model that you can
download The model comes with a Bear case, Base
case, and Bull case and what I did in my model was take the
bull case and make that my optimistic case
Their research and data is as of January 2021 and since there has been a lot of
positive changes for the company, that's why I wanted to add a very
optimistic case in my model So basically the numbers you see in
green and highlighted in red here are what the GMEdd.com model projects
Now let me take a bit of time to explain why their model assumes in their most
bullish case that revenue will decline after a few years which I
personally found a little bit odd at first
After digging into their model a little bit and doing a little bit of research I
came up with three reasons for this negative trend
First, they assumed that Gamestop will be closing down 3,000 retail stores from
2021 to 2025, which means less overall revenue for the
company. Second new consoles for the Xbox and
Playstation 5 both were released in November 2020,
and these consoles generally have a lifespan of six years
As a result the model assumes naturally that sales will decline over time as
people stop buying these consoles Third though the first two reasons cause
a pretty steep decline in revenue, the model assumes that in the next five
years e-commerce from stores increase 35% to
45%, that there is a 25% increase in
e-commerce sales per store, and that Gamestop's total ecommerce
revenue share goes from 40% to 50%. So going back to our model,
the reason revenue increases at first is because of the recent release of Xbox
and Sony consoles and a large increase in sales and e-commerce
which are then later offset by the closing down of stores and outdated
consoles Taking a step back and looking overall
at these projections, you can see that they're all pretty aggressive when
compared to historical revenue growth, which has mostly been negative
My base case assumes that 50% of the GMEdd.com's revenue assumptions can be
met, while my very optimistic case assumes
that an additional 50% can be met until 2023, and then 2024 to
2025, I assume that revenue declines by 50%
instead of going negative The reason I'm adding more optimism is
because I'm trying to give Gamestop the benefit of the doubt in this case,
that their shift to e-commerce succeeds beyond expectations
Moving on to EBIT, you can see that the GMEdd.com optimistic case is
also aggressive, going from negative five to negative eight percent over the past
few years to positive 11% and growing to 16%
This can be largely attributed to the closing down of stores and the shift to
e-commerce as well as the firing of a lot of employees,
but to me still this seems like a pretty optimistic scenario
Either way, what I assumed in my base case is 25%
of GMEdd.com's EBIT margins in the first year, which gets us to three percent
and that ramps up to 75 percent of GMEdd.com's EBIT margin in the last
year, giving us 12%. For the very optimistic
case, I assume a 25% increase, which I think is still really
really aggressive Now you might think that because
e-commerce is tech related, that e-commerce would result in a higher
percentage margin business, but that's actually not the case and
e-commerce businesses tend to be pretty low margin
For example, in Gamestop's last quarter, despite ecommerce sales growing by 175
percent and representing more than a third of the company's sales,
gross margins actually dropped from 27.2% to 21.1%. The next significant
assumption in my model is regarding taxes which are all based on my own
assumptions In my base case I assume that the
corporate tax rate is raised to 28 which is what the Biden presidency aims
to do. In my optimistic case, I have a slow ramp
up to at 28, and in my very optimistic case I assume a flat 21
meaning that nothing changes. After that I calculate EBIAT, which stands for
earnings before interest and after taxes, and this is
just your ebit minus your taxes Then because the change in net working
capital for Gamestop has been really all over the place over the past
six years, I essentially just take it out of my model since it's just a negligible
impact anyway For D&A and CapEx, I take an average
percent of sales over the past three years
and just keep that assumption the same over my projected five years
Then as we talked about before, I calculate my free cash flow and then
discount it back using my discount rate or your WACC
Then I calculate the terminal value which if you recall is the value of the
business from the last projected year until the end of time
and I use the perpetuity growth method and discount the terminal value to
present value That leads us to our Enterprise Value
and from there we add Cash and subtract Debt to get to
our Equity Value. The last step is we divide our number of shares to get to
our share price of $178.78 for our very optimistic case
Now this doesn't necessarily mean that this is what I believe Gamestop should
be trading at and that's the topic for my next video,
but I wanted to show you guys a share price because you guys watched his
entire video and I assume the very optimistic case for
all of the assumptions and this is the number I get to. I also know I just went
through a ton of different numbers and potentially new
concepts for you so if you do have any questions,
please do leave them in the comments below and I'll try to reply to every
single one Also this Gamestop model and future
models that I built will be available on Patreon in my Terabyte Tier so feel
free to check that out in the description below
I know that $99 a month sounds a little bit steep,
but equity research analysts who create models like this,
although they are a little bit more detailed, charge companies something like
thousands of dollars per month, so from that perspective because I put
so much time into these models I do feel like it can be a pretty good
deal if you are interested in looking through these models and testing out
your own assumptions I also actually don't really mind if you
split the access for the terabytes here amongst your friends and you share it
amongst each other Please don't send it anyone outside of
those circles and don't post it on any public forums, but if you guys are want
to do that then you know go right ahead I really think
that's what the internet is for Alright, so that concludes the video. As
always, thank you so much for watching if you found it helpful
please give it a like and share with your friends and hope to catch you in
the next one Thanks and peace out
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