Will GameStop regret the upcoming stock split?

Vvideo game retailer GameStop (NYSE: GME) plans to split its shares, likely later this year. Investors are loving the idea, sending GameStop shares up to 22.5% higher in after-hours trading Thursday.

Normally, I don’t pay much attention to stock splits. They make no difference in the value of your shares, and the option of taking a smaller share of the business for a lower cost per share is almost useless, now that most brokerages allow you to buy and to sell fractions of a full share anyway.

But GameStop’s stock split is something worse than a pointless exercise in pure math. I think the company and its investors may regret this decision in a few years.

Image source: Getty Images.

What does GameStop do?

GameStop is asking shareholders to increase the number of authorized shares from 300 million to 1 billion. The active count was only 76 million shares at the end of January, so the company already had the option of executing a 3-for-1 stock split without increasing the authorized share base. Assuming the proposed clearance goes through shareholder voting and other regulatory steps, GameStop will be able to split each share into 12 times.

The company has other plans in mind for the lifted share cap, such as issuing more shares as part of executive compensation and incentive plans. Selling more shares on the open market is another option, in case GameStop needs to raise additional funds. And those extra shares could also come in handy for a stock-based acquisition or two, taking advantage of the stock’s historically high market value.

Why is a stock split a bad idea?

GameStop’s planned split reminds me of a few mistakes from years past.

You probably know nokia (NYSE: NOK) and LM Ericsson Telephone (NASDAQ: ERIC). The two Scandinavian telecommunications infrastructure veterans were important names in consumer electronics, and particularly in the early development of the mobile phone industry. Nokia was the king of cell phones before the smartphone revolution, and Ericsson was a strong contender.

Times were good, business was booming, and both stocks soared in the late 1990s. From early 1995 to late 1999, Ericsson’s stock price rose 511% while that Nokia achieved a return of 1,970%.

Nokia and Ericsson wanted to keep their share price within reach of ordinary investors, so they split their shares a few times during this period. Nokia doubled its share count in 1995, again in 1998 and again in the spring of 2000. Ericsson had a 4-to-1 split in 1995 and another 4-to-1 in early 2000, sandwiching a 2-to-1 split 1. 1 split among these stocks in 1998. In both cases, one stock bought in early 1995 turned into 32 in the spring of 2000, reducing stock prices by the same amount.

The final splits brought Nokia’s price down to around $50 per share and Ericsson settled at around $100. Without the splits, investors would have faced share prices of $1,600 for Nokia and $3,200 for Ericsson. So everything made sense and telecom experts managed their stock bases with reasonable stock prices in mind.

But it was the year 2000, and you know what happened next. The dot-com crash came first, followed by the September 11 attacks. And as the mobile phone market recovered from these calamities, the market crash of 2008 coincided with the arrival of modern smartphones. The resulting stock chart is not pretty:

EUR Chart

NOK data by YCharts.

Ericsson took action along the way, performing a reverse stock split at a 1:10 ratio in 2002. Another adjustment followed in 2008, splitting the underlying stock in half on the Stockholm market while by performing a reverse operation of 1 for 5. divided on the American Depositary Shares. These movements were necessary in order to meet the minimum stock price requirements of the New York Stock Exchange (NYSE, a subsidiary of Intercontinental exchange) and avoid radiation.

These stocks have been brushing the boundaries of the penny stock market for two decades now. Mind you, we’re still talking about experienced telecom leaders with multi-billion dollar market caps and massive earnings – but golden age stock splits sent their stock prices crashing into the low single digit. Even now, the companies are worth more than $30 billion each, but their stocks still range between $5 and $10 per share.

This is the future I see for GameStop. Its stock has reached all-time highs thanks to the phenomenon of the “meme stock”, in which a large number of small investors have organized stock transactions via social networks. GameStop is now looking for a long-term strategy, but its management team and board have been tight-lipped on the details of this change in strategy.

The old business model isn’t working and GameStop needs to quickly overcome its high investment costs. The company is burning through cash at an alarming rate, and eventually investors will run out of patience to go into debt and sell more stocks to keep the lights on.

And that’s GameStop’s version of the dot-com crash. The stock was trading at less than $5 per share in the summer of 2000, when the market capitalization was below $300 million. But since that low point, financial results have not improved significantly.

Let’s say GameStop splits its stock at, say, a 5 to 1 ratio…and then the market comes to its senses. Once the market capitalization drops from $12.7 billion to $300 million, the split-adjusted stock price will dive below $1. And then we’ll talk about reverse stock splits instead, assuming GameStop still wants to trade on the NYSE.

I don’t think I’m expecting a massive disaster here. All I’m saying is that GameStop hasn’t earned its massively inflated market cap, and I wouldn’t be surprised to see it show up soon enough. And this is where the next stock split starts to look like a big mistake.

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Anders Bylund owns Nokia. The Motley Fool recommends Intercontinental Exchange. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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