Ticker: GME SELL
Ticker: GME Sector: Services Industry: Electronics Stores Recommendation: SELL Pricing Closing Price $18.85 (7/8/10) 52-wk High $28.62 (10/15/09) 52-wk Low $17.12 (2/25/10) Recommendation I believe GameStop’s economic moat is insufficiently wide for Market Data Market Cap $2,865.63 mil Trading Vol. 5,971,000 Total assets $4,955.33 mil our portfolio to hold in the long run. GameStop operates in an industry with intense competition and little differentiation. Other concerns in the long term include alternate delivery Total Liabilities $2,232.32 mil Valuation methods of games and changing dynamics in the used game trade. Because of these reasons, I believe that the class should reduce our holdings in the company. We currently hold 1,000 EPS $2.32 P/E 8.15 (ttm) P/Sales 0.33 P/Book 1.08 GameStop Corporation is the world’s largest retailer of video Div Yield 0% game products and PC entertainment software. GameStop sells shares worth $18,850 making up 1.9 percent of our portfolio. Company Description Profitability & Effectiveness ROA 7.99% ROE 15.11% Profit Margin 26.82% new and used video game hardware, software and accessories. The Company operates 6,450 stores throughout the U.S., Australia, Canada, and Europe. In addition, the Company operates an e-commerce website and publishes Game Informer, which is the largest multi-platform video game magazine in the U.S. based on a circulation of 4 million Analyst: Patrick Riordan subscribers. Email: [email protected] The used video game market is a key reason for GameStop’s success. The used video game segment provides customers the opportunity to trade in used video games for store credits and apply those credits toward other merchandise, which in turn, increases sales. The pre-owned video game segment of GameStop represented 26 percent of revenue and 47 percent of gross profit in 2009. This area it crucial to the success of the store, as it drives purchases of other products in the store, which include new video game hardware and software. The chart shows the cycle of trading according to GameStop. This model has provided a means of differentiation between the store and its big box store competitors such as Best Buy and Wal-Mart. Customers can trade in their used games for either cash or store credit and with that money purchase new or used products from GameStop. However, Best Buy announced in June that they planned to roll out a nationwide in-store program for buying and selling pre-owned video games. Best Buy plans to offer gift cards to the store in return for used video games. This increases the fears and about the long term viability of the GameStop business model. After the Best Buy announcement in June, share prices of GameStop fell by 11 percent. Competition The video game retail industry is highly competitive, and subject to rapid changes in the tastes of consumers as well as frequent product introductions. GameStop has a number of competitors that consumers can choose to purchase products from instead of GameStop. Competitors include big box stores, regional chains, computer product and consumer electronic stores, other video game specialty stores, direct sales by publishers, online businesses, and video game rental companies. Video games also rival other forms of entertainment such as movies, television, sporting events, and family entertainment centers. GameStop cites Wal-Mart, Target, Best Buy, Movie Gallery, and Blockbuster as their main competitors in the United States. GameStop also has over 2,000 stores outside the United States, and much other international competition. Other Risk Factors Pricing competition from rivals: Wal-Mart offered gift cards with the purchase of game consoles last holiday season. Amazon had a similar promotion with software at the same time. Pricing completion leads to declining revenues and extremely small operating margins. Digital Distribution: publishers are increasingly attempting to improve their own profitability by selling game updates directly to gamers through online transactions. Stores such as GameStop have large profit margins from selling video games; the makers of these games see opportunities to seize these profits for themselves. Growth in residential bandwidth as well as increased hard drives in consoles – obviating any need to mass retail sales of games. Video game publishers disrupting used game business: new games are including codes for online game play that allow only one use, making it difficult to sell the game used to retailers such as GameStop. International business risks: with over 2,000 locations overseas, GameStop is subject to international risks such as currency exchange fluctuations, economic downturns, international incidents, as well as international competitors. Adverse holiday sales: holiday sales account for over half of GameStop’s operating earnings during the fiscal year. A poor fourth quarter would result in poor earnings for the entire fiscal year. Seasonality GameStop’s business is seasonal, similar to most retailers, with most of their business realized in the fourth quarter, which includes the holidays. In 2009, GameStop generated 39 percent of their sales and nearly 55 percent of their operating earnings in the fourth quarter Opportunities/Positives GameStop plans to open nearly 400 stores in 2010 following the great revenue growth the last ten years. The company plans to add stores in both the United States and across Europe. Currently, demand for games has allowed sellers across the board to keep prices high. GameStop has seen a combined profit of more than $1 billion over the past three fiscal years. Some analysts believe revenue will grow 16% next year Digital games can be as large as four GB, making the download time intensive, and gamers have not yet fully embraced digital games. Valuation To value GameStop, I used the discounted cash flow method and the 10 year beta of 1.124 to compute an intrinsic value of $26.70, which is nearly $8 higher than the current market price. I used a fairly low growth rate, due to my belief that the business will stumble in years ahead due to its small economic moat and numerous competitors. Despite the small growth rates, GameStop has had record earnings the last few years, and has good free cash flow numbers resulting in a computed intrinsic value fairly above the current stock price. Conclusion GameStop is currently doing extremely well, adding stores and increasing revenue every year. However, I feel that with their current business plan and fierce completion that we should sell our position of GME. If we are looking for a company that may do well in the short run, GameStop is a pretty good candidate, but if we are looking for a company using Warren Buffett’s tenants, then we should sell. The company has no economic moat, with numerous rivals providing the same service, and now Best Buy is moving into the area which made GameStop unique for a large retailer. Another fear with the company is that increasingly publishers of games are directly distributing games to customers through the internet. It seems very likely to me that GameStop will face the same issues as record shops have faced in recent years with the growing popularity of digital music. GameStop will be fine in the near term, but faces an uncertain position in the future. Sources http://www.fool.com http://www.gamestop.com http://www.thestreet.com Bloomberg MorningStar
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