GameStop is Ready for Play

The Oct. 2005 acquisition of rival Electronics Boutique made GameStop (GME) the world’s largest videogame retailer. The company currently operates 5,123 stores in North America, Europe, and Australia. The U.S., with 4,008 stores, produced 77.4% of revenues through the first nine months of fiscal 2008.

GME sells videogame hardware such as Microsoft’s (MSFT) Xbox 360, Sony’s (SNE) PlayStation 3 (PS3) and PSP, and Nintendo’s (NTDOY.PK) Wii and Game Boy DS. Hardware accounted for 22.4% of first nine month revenues. GME also sells new videogame software, which produced 37.7% of sales. Related accessories and peripherals such as controllers and memory cards produced 15.3% of sales. Remaining revenues were derived from a rapidly growing business selling pre-owned games and hardware. GME obtains used merchandise from customers who sell or trade them in for newer products. GME resells used products at discounted prices. Because new videogames tend to be expensive, customers welcome the opportunity to sell back old games or trade them in for new ones. The company has benefited immensely from the explosive growth of the videogames market.

According to market research firm NPD Group, videogame sales jumped 43% in 2007 to $17.94 billion. GME’s sales through the first nine months of fiscal 2008 were up 40.3% to $4.23 billion. Same store sales climbed 30.2%. Price cuts on the Xbox 360 and PS3 helped boost new hardware sales by 102.5% to $949.1 million. New software sales grew 39.8% to $1.59 billion. Sales of other products rose 22.7% to $647.6 million. Used product sales climbed 18.2% to $1.04 billion. Lower gross profit margins stemming from higher hardware sales were more than offset by cost saving synergies arising from the Electronics Boutique acquisition. The pro forma operating profit margin improved 110 basis points to 4.93%. Net income more than tripled to $98.5 million or 60 cents per share. GME said fiscal Q4 results will come in above prior expectations due to higher than expected holiday demand and strong follow through in January.

Despite encouraging financial results, the stock has fallen since the start of the year, no doubt due to concerns about slowing trends in consumer spending. Greater competition from large format retailers who discount popular new game titles also poses a risk. Yet no rival can touch GME’s used game business. Indeed, Electronics Boutique represented the only real threat in this area.

Furthermore, GME’s Edge program promotes customer loyalty by awarding bonuses for trade-ins and purchases. In addition, pressure on new game sales arising from deteriorating consumer spending trends should be offset by the used game business as shoppers try to save money. This bodes particularly well for GME since profit margins on used games are more than double those for new titles. GME is a retailer that offers products from virtually every software/hardware maker. It incurs no development costs and avoids the risk that any particular title may flop. This allows GME to participate fully in the growth of this market.

We expect strong growth to continue due to more family-oriented games and new innovations such as motion detection technology. Finally, GME sales could see a nice boost in the second half of the year as consumers start spending their federal tax rebate checks.