Why GameStop Is A Hidden Value Play

| About: GameStop Corp. (GME)

Summary

Physical game sales is in a decline but Gamestop benefits from growing interest in virtual reality which requires in-store demonstration.

Mobile games with an augmented reality function drive higher sales for GameStop if it converts into an in-game location.

Current dividend yield of 4.7% is attractive for value and yield investors but the stock also has a growth side given the interest in virtual reality and mobile games.

Pokémon GO has gotten a lot of publicity in recent days and I have written an article on the potential of Pokémon GO, saying that it could potentially become a $12b opportunity for Nintendo (OTCPK:NTDOY). The problem is that Nintendo stock has more than doubled since the launch of the game and the valuation seems to be stretched. My concern is a pullback in Nintendo shares after the company came out to say that the financial impact from Pokémon will be limited. On the other hand, I believe that GameStop (NYSE:GME) could be a good way to play the Pokémon GO theme. We have seen examples where Pokémon GO is helping pizza place and bars to get higher than usual traffic that led to better than expected sales. As for GameStop, sales from its 462 stores saw sales more than doubling after they became Pokémon gyms. In addition, merchandise sales have also gone up and this is very good for GameStop given that summer months are the slow seasons. I think there are more to go for GameStop than just Pokémon.

Although the business of games retailing is not as great as it used to be, I believe that the company is in the midst of transition and the market could be overlooking some positives that may turn out to be near-term catalysts. As video games become more of a digital marketplace, I believe that GameStop's management could maintain the current business as a free cash-generating segment while it slowly evolves into the digital model. What gives me this confidence that GameStop can evolve? For years investors and the market expected Wal-Mart (NYSE:WMT), Amazon (NASDAQ:AMZN) or even Best Buy (NYSE:BBY) to squeeze GameStop out of the business and yet none of them successfully did this. Now GameStop is slowly evolving its business model and I think there are several positive trends that support the company's growth.

First, GameStop will remain the dominant player in the physical game sales market and this will be particularly important as gaming transitions into virtual reality where consumers will be attracted to in-store demonstration. Retail video game sales have been in a decline as game producers encourage digital downloads over discs. Regardless, the good news is that virtual reality gaming will be the next growth phase for video games. However, not many people can afford virtual reality because they are quite expensive so virtual reality game developers will rely on demonstrations to persuade the gamers to spend $600 on a headset and possibly $1500 on a gaming PC. GameStop is the ideal spot to demonstrate the power of virtual reality games as consumer interest increase. This will help GameStop to generate store traffic, cross-sell gaming accessories and video game consoles when Microsoft (NASDAQ:MSFT) releases the new Xbox in the coming months.

Second, management is keeping its options open by leveraging its real estate portfolio. As we have seen in the recent Pokémon phenomenon, there is tremendous value of GameStop's real estate portfolio and this suggests that the old-fashioned brick and mortar stores are not as hopeless as it seems. It is true that most of the game sales have gone digital but it is also important to consider the fact that mobile games have also become a growth area. As more mobile games incorporate real elements into their games such as Pokémon GO's augmented reality, I think GameStop could benefit from this trend by becoming phone charging stations for the players and a place where store associates could provide hints and tips on the games to keep the players engaged and maybe cross-sell accessories such as portable batteries. The possibility is endless and we already saw store sales more than doubling due to this trend so I think this is a positive.

Finally, value investors should appreciate GameStop's capital return program and current dividend yield of 4.7% given the low yield environment. At 4.7%, GameStop is just as attractive as AT&T (NYSE:T) at 4.5% or American Electric (NYSE:AEP) at 3.2%, but with higher growth potential due to the mobile game and augmented reality phenomenon, so investors are benefiting from both yield and growth by buying into this stock. GameStop has been paying dividend since 2012 and paid out $1.41 per share last year. Last quarter, it paid out $0.36 per share, which is an equivalent of $1.44 this year, or 4.7%.

GameStop is also maintaining its share buyback for this year between $75m-$125m, which is still not bad after the planned $400m acquisition of Tech Brands. The company has historically kept its buyback between 30% and 50% of operating income compared with the current 15%, but I expect GameStop to increase its buyback back to the normalized 30%-50% range after the company digests the Tech Brand acquisition.

In conclusion, I think GameStop is an attractive value play where investors can benefit from growth in store traffic and mobile games, and attractive capital return program. I consider GameStop as a long-term holding in light of these outlooks. Additional catalysts could be a potential acquisition by the major retailers to due to its attractive real estate portfolio but I do not believe this will be a near-term catalyst. For the near-term, mobile games, interest in virtual reality and capital return are keys to generate investor interest.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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