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