Digital format risks
While an industry-wide shift toward digital copies of games is highly unlikely, a more conceivable risk to the thesis is that more consumers migrate toward digital formats. The latest NPD numbers suggest that there is, as yet, no immediate danger in the face of a strong software pipeline. Meanwhile, management is ably positioning GameStop (GME) to be an active player in digital formats by touting the application of its rewards programs to that subset of customers.
A secular decline
Bears see GME as the next Circuit City, Blockbuster, or RadioShack (RSH), an aging brick and mortar specialty retailer that will die at the hands of the behemoth online marketplace. The flaw in that logic is that gamers have heretofore shown themselves to generally be a distinct animal from other consumers of specialty electronics, as evidenced by the company’s sustainable top-line development through both console and macroeconomic cycles. This is not to say that there might not be a latent effect pending, but such observations have thus far failed to manifest. For now, GME’s store network and brand ecosystem have allowed it to hold serve as it explores newer growth verticals.
Used game disruption (the “Wal-Mart effect”)
Wal-Mart’s (WMT) deft management of supply chain and powerful competitiveness will likely scare some shareholders off, but the truth is that any big box retailer lacks the network capability to hit the high dollar gamer markets in the same manner as GameStop. Square footage per store associate is 10x higher in a Big Box format versus GameStop, such that it is unlikely for gamers to have the same meaningful and efficient customer experience. Moreover, GameStop has the distinct advantage of having to only worry about a narrow (niche) category of inventory to effectively manage within overall working capital needs.
GameStop is a nimble specialty retailer that has mastered the ability to effectively deploy capital into both real estate and inventory (the two critical assets on or off any retailer’s balance sheet), and in turn return capital to its shareholders. While the shares remain elevated from their 2010–2012 levels, valuations are definitively attractive ahead of a full new software calendar that should beneficially hit multiple parts of the P&L (notably, an extension of the trade-in phase to the console cycle). The Tech Brands segment is still de minimis, but management has outlined an ambitious, albeit achievable, store plan to make this vertical a credible aspect of the future company. In the interim, we are confident in the company’s near-term ability to add further channels (buying from liquidation closeouts and retailer inventory purges) to bolster its flagship video game business.
The Market Realist Take
The video game industry outlook seems optimistic.
PwC noted, “New consoles will renew consumer interest in console gaming, and Xbox One’s emphasis on being a key piece of technology for the living room means that this interest will last longer than previous generations, with devices being used more often and appealing to a broader demographic. Global console games revenue will reach $31.9bn in 2018, a CAGR of 4.9%, with physical console games revenue increasing by a 0.6% CAGR over the forecast period.”
GameStop said on its 1Q earnings call, “[The company] intends to leverage its core competencies, category knowledge, customer relationships, buy-sell-trade expertise and refurbishment to capture a broader sales opportunity in pre-owned games as well as an expanded set of technology products.”
For 2Q 2014, the company forecast comparable-store sales to range from 12.0% to 19.0%. Diluted earnings per share are expected to range from $0.12 to $0.20. This is a 33% to 122% increase over the prior year’s second quarter. Revenue is expected to increase between 14% and 22%. GameStop noted that the “second quarter is the lowest volume quarter of the year for video games, so the rapidly growing revenues from Technology Brands will have a larger impact on the gap between comp growth and revenue growth.”
GameStop noted that it will continue to create shareholder value, and that “dividends and buybacks remain an important part of our capital allocation strategy.” During the first quarter of 2014, the company repurchased 1.33 million shares at an average price of $39.28, or $52.2 million of stock. It has $405 million remaining on the existing repurchase authorization. The board also declared a quarterly cash dividend of $0.33, representing a yield of around 3.2%.
An Oppenheimer & Co. analyst was bullish on the stock and recently said, “We came away from the event (E3 video games conference) very encouraged that the forthcoming launches of the Xbox One and PS4 along with related software will drive a resurgence in sales and hence EPS growth at GameStop.”