GameStop (GME) is a company I know well, having covered it and Electronics Boutique as a Senior Equity Analyst at Standard & Poor's. So when I learned it was one of the most heavily shorted stocks on the market, it caught my attention.
It looks like GME had a rough 2012, especially once it became apparent the console cycle was near its conclusion. The gaming industry follows a cycle of its own, and it is as important to it as the economic cycle is to most other American businesses. The gaming cycle is centered on the introductions of new hardware gaming consoles every few years or so. Just before the end of an aging cycle, gamers will hold off purchases in anticipation of the next generation games. We've reached that point in this cycle now, and it's apparent in the company's sales and pessimism around the share price.
However, the company expects at least one new console to be available for this year's holiday season, either from Sony (SNE) or Microsoft (MSFT). GameStop's important market position ensures it gets its fair share of product when new gear comes to market. Also, the company's pre-order program aids its sales efforts significantly. Finally, every gamer knows GameStop and will come to it before visiting a random store for new product.
This time around there's another question, but it is also one that has been hanging over the industry for a while. The success of Zynga (ZNGA) and Facebook (FB) in the offering of games to members of online platforms has darkened an already existing shadow over the brick and mortar sellers like GameStop. Still, you can't play the major games on Facebook or at Zynga today, and the majority of new game sales are to the console platform, meaning they come through GameStop and other retailers.
Is GameStop threatened by increasing online sales downloads to the PC and mobile markets? Yes, but when the game gets challenging, GameStop will be positioned to compete digitally as well, having initiated its own effort in this regard over the last couple years. GameStop did over a $100 million in mobile sales in Q4 alone and grew its digital business 48% in 2012.
In terms of valuation, I used to value the company in a unique way to capture its cyclical nature, since its results could vary wildly around those console events. But the company has gotten better at smoothing its sales through things like its pre-owned game offerings and through growth domestically and abroad. I think the current P/E ratio of 9X its fiscal year 2014 (Jan.) consensus estimate is cheap enough considering the year brings growth. If earnings were going to fall this year, especially on a critical fundamental issue, then we might question even this low of a P/E, and that's why there are so many shorts in this stock.
EPS estimates may be threatened by the timing of new game releases, and so some caution is warranted, but the company generates enough free cash flow to support shareholders with repurchases as well. Analysts see 10% growth for the company over the long-term, and that may underestimate what GME could do digitally.
By digitally, I'm speaking of the direct download market, not competition with online sellers like Amazon.com (AMZN) and eBay (EBAY). Such competition is a factor for every retailer today, and GameStop shares all the same compelling arguments other brick and mortar stores have against online sellers, including the ability of customers to talk to other gamers who are employed in the stores (as corporate strategy) and to see and test games in the store. Those thinking critically about digital sales should remember that GME is actively working to defend its turf against the download prospect, having initiated such sales efforts itself, so the company has the ability, customer information and the will to keep hold of its customers. Moving forward, I'll likely be analyzing and writing regularly on the company depending on interest, so shareholders, shorts and prospective investors may want to follow this column.