On February 20, Sony is rumored to announce the next generation gaming console to follow up the PS3. While it’s certainly an interesting event for Sony, the consequences are probably even larger for GameStop given we will finally have an answer to the lingering question—will the next generation consoles allow used games?
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Why does it matter?
For those of you who don’t know GamSstop that well, the business makes its living off of the used game business (almost 50% of its gross margin). If Sony and Microsoft decide to kill the ability to play used games, GME will lose most if not all those gross margin dollars in the short term and all of it in the long term. Keep in mind, GameStop made about $780 million of EBITDA over the last 12 months and earned $1.2 billion in gross margin from used games over the same period so if that gross margin goes away, the business is no longer making money.
Vice versa, if Sony and Microsoft decide to keep the status quo, then GameStop should see a huge boost. New video game hardware (new consoles) sales have dropped off $500 million from their peak in 2009 to the LTM period. During that time, management has bought back a ton of stock so that the benefit of a new console cycle will accrete to Gamestop shareholders in a more meaningful way this time around.
How to play it?
We are playing it through a straddle (buy a call option and a put option) and play the volatility. You can buy at-the-money options (put and call) for a total of $2.40 in premium with a March 17 expiry. Another way to think about it is that you need a 10% move in the stock price in one direction to make money. The stock should move much more than that given the company’s fate is being determined in this time period. The biggest risk is that Sony decides not to announce the Playstation this week.
Also think about how this will affect the game publishers themselves. If they can access GameStop’s $1.2 billion profits from used games that could meaningfully change the value proposition for companies like Electronic Arts (Nasdaq: EA ) and Activision (Nasdaq: ATVI). The magnitude of the impact depends on your view of EA’s ultimate market share ($5 billion in LTM sales or 30% of US market) they could pick up an incremental margin of $300–$400 million which is really meaningfully for a company that barely broke even last year.
The Market Realist Take
The shift in the video game industry from physical CDs to online downloads has impacted the sales of brick-and-mortar retailers like GameStop. In June 2013, Microsoft dropped controversial restrictions on used games on Xbox One, and Sony said it would not block used games on the Playstation 4. The move boosted the stock price of GameStop, whose significant revenue comes from used games sales. In 2Q13, the company reported total global sales of $1.38 billion compared to $1.55 billion in the prior year quarter, a decrease of 10.7%. The company’s transition to mobile sales seems to be delivering results, as mobile sales expanded 121.4% to $55.1 million. It said pre-owned sales declined 6%, as consumers continued to wait for the launch of new consoles later in the year.
Next-generation Xbox and PlayStation games consoles are expected to release later this year and will represent a major catalyst for the electronics retailer since the earlier models are dated. The launch of next-generation consoles from Sony and Microsoft in the holiday season and a few major new games could encourage sales growth in the upcoming quarters. Competitors of GameStop include Electronic Arts (EA) and Activision (ATVI) in the digital gaming space, and Best Buy (BBY) and RadioShack (RSH) in the electronics retail space.
© 2013 Market Realist, Inc.