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GameStop Is in Trouble — and It's Not Because of Congress

The meteoric rise of GameStop (NYSE: GME) stock since late 2020 has drawn its share of detractors. The latest critic is the U.S. House of Representatives, whose Financial Services Committee believes regulators need to tighten rules on so-called "meme stock trading."

It remains unclear if or how much this attention will affect the retail stock. However, GameStop continues to face more pressing challenges that have little to do with Congress or the meme stocks it seeks to target.

The committee and GameStop

Much of the Congressional committee's focus was more directly tied to Robinhood than GameStop. It alleges that Robinhood's platform promoted "game-like" features that encouraged more stock trading.

Still, the committee cited the behavior of GameStop stock as exhibiting this trait. In the case of GameStop, traders leveraged social media to band together to buy the stock and attempt to unwind bets against GameStop by some hedge funds.

Whether these findings will result in additional regulations is not yet clear. Moreover, this has likely become another example of the regulatory framework significantly lagging the behavior of stocks and traders. Hence, it may come too slowly to materially affect GameStop stock.

How GameStop stock has boosted the company

However, GameStop faces more serious challenges from internal forces. Its stock plummeted to penny stock levels in 2020 for business-related reasons. The games it once sold had increasingly moved online, making the existence of GameStop less necessary.

Nonetheless, the meme stock craze sent the stock to record highs. Though it has never returned to the peak of $483 per share in early 2021, its current price of around $130 per share is far above its one-time penny stock status. This has allowed the company to issue shares and raise cash to keep itself afloat.

With the new funding, GameStop worked to revive its business. It closed numerous stores and established an online marketplace to sell game downloads. This made it a one-stop shop for finding games from numerous companies.

Additionally, it has ventured more heavily into new business lines. For one, it entered the collectibles business, which has given it unique goods to sell. It has also made plans to launch an NFT marketplace, though it has released few specifics about the new offering.

The problem with GameStop

Unfortunately, GameStop has chosen to enter the NFT market at a time when interest is fading in NFTs, according to NonFungible, an industry website. This will probably dampen interest in its new offering. Moreover, segments like online games and collectibles do not give GameStop much of a competitive moat. Consumers have numerous choices in either case, and its competitive edge does not appear to extend beyond its name recognition.

Furthermore, the company's financial picture continues to worsen. In Q1, its revenue of rose 8% from a year ago to $1.4 billion. Also, faster growth in the cost of sales and selling, general, and administrative expenses dramatically widened operating losses. This took its net loss to $158 million, up from $67 million in the year-ago quarter.

Additionally, the pain will probably continue as video game sales saw a steep decline in May. Analysts are not expecting improvements; they predict 7% revenue growth for the year and widening net losses.

For now, GameStop holds just over $1 billion in liquidity. Still, with losses widening, it may have to return to the capital markets by next year if it cannot maintain its stock price. As its business continues to struggle, the prospects for its recovery appear increasingly uncertain.

Avoid GameStop stock

In the end, the House Financial Services Committee is the least of GameStop's worries. The committee has not responded quickly to the meme stock craze, and any action will probably come too late to affect GameStop.

The more significant concern is the future state of GameStop when that committee acts. The higher stock price has enabled the company to raise more capital and stay afloat for now. Nonetheless, its continuing losses and moves into weak-moat business lines will likely not boost investor confidence.

Admittedly, GameStop has held on to its passionate supporters on social media. They have proven their influence and have made GameStop dangerous to short. But given the poor recovery prospects, investors should consider staying away.

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Will Healy has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.


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