GameStop - Excellent Entry Point For Opportunistic Investor

Aug.21.12 | About: GameStop Corp. (GME)

Shares of GameStop (GME), the video game retailer, continued to move upwards on Friday, after some volatile price action over the past week. Shares ended Monday's session 5% higher after numerous take-out rumors last week. Furthermore, the company published its second quarter results last week.

Second Quarter Results

GameStop reported second quarter revenues of $1.55 billion, down 11.1% on the year. Comparable store sales fell 9.3% compared to last year. Traffic fell due to a lack of new game releases, resulting in lower sales for software and hardware. On the bright side, digital receipts rose 27% to $134 million. Mobile sales came in at $29 million, more than double the $12 million in the first quarter. The company remains on track to reach its full year target of $150-$200 million in mobile revenues, with the important holiday season approaching.

Net earnings came in $21.0 million, compared to $30.9 million last year. Diluted earnings per share fell from $0.22 to $0.16 per share. On average, analysts expected GameStop to earn $0.15 per share.

During the quarter, the company repurchased 7.6 million shares at an average price of $17.96, for a total consideration of $136.4 million. GameStop, currently has about $300 million in further buybacks authorized. The company's board also raises the quarterly dividend from $0.15 to $0.25 per share.

After the repositioning in 2008, GameStop has made some major transformations. Used games and hardware, now make up for 36% of total sales. Pre-owned games sales were flat vs. a decline of 16% in new games. Pre-owned hardware sales rose 24% vs. a 25% decline in new hardware. GameStop currently has a global user base of 24 million PowerUp members, which can buy and sell games in a worldwide library containing 334 million used games.

Furthermore, the digital business and mobile business are growing rapidly as well. These businesses carry much higher gross margins, resulting in gross margin expansion of 230 basis points to 33.5%, on a company-wide basis. With more activity occurring in the digital space, the total store count of 6,628 is anticipated to fall by 1% at year's end.

CEO Paul Raines commented on the results, "We continue to see solid sales growth as well as strong margins in our new retail offerings and digital channels. We are focused on staying ahead of the curve as the competitive landscape evolves and we manage through the trough of the console cycle. The ongoing share buyback and increase in dividend demonstrate our confidence in the future of GameStop and our commitment to improving total shareholder returns."

Outlook

For the third quarter of 2012, GameStop expects comparable store sales to fall between 5 and 10%. Diluted earnings per share are expected to come in between $0.28 and $0.36 per share.

For the full year of 2012, the company expects diluted earnings per share to come in between $3.10-$3.30. Full year comparable store sales are expected to fall between 2 and 10%. On average, analysts expected the company to earn $3.15 for the full year.

The company is performing an impairment test of its goodwill and intangible assets according to the FASB standards. Any impairments would be related to the international units, carrying a valuation of $920 million at the moment. GameStop expects that the impairment test would be completed during the third quarter.

Valuation

GameStop ended its second quarter with $139 million in cash and equivalents. The company operates without any debt, but it carries a goodwill post of almost $2.0 billion on its balance sheet.

For the first six months of 2012, net sales came in at $3.55 billion. Net income came in at $93.4 million, or $0.71 per diluted share.

For the full year, the company is on track to report revenues of $8 billion and earnings of $3.20 per share. Based on Friday's closing price of $18.57, the market values the firm at $2.4 billion. This values GameStop at 0.3 times annual revenues and 6 times annual earnings.

GameStop raised its quarterly dividend to $0.25 per share, for an annual dividend yield of 5.1%.

Investment Thesis

Year to date, shares of GameStop fell some 19%. Shares steadily fell from $25 per share to lows of $15 in the beginning of August. Shares bounced back almost 25% in recent weeks on the back of the results and numerous rumors about a acquisition, or private-equity deal.

Shares of GameStop roughly halved over the past five years. While the share price developments are quite dramatic, operating performance kept up reasonably well. Net revenues fell from $8.8 billion in 2008, to an expected $8 billion for the full year of 2012. Net income is expected to rise from $398 million in 2008 to little over $400 million in 2012. As the company has repurchased roughly 25% of its shares outstanding, annual earnings per share are set to rise from $2.38 in 2008 to $3.20 per share in 2012.

While GameStop operates in a really difficult business, its management appears strong. Management is open to change and even seems to embrace it, resulting in strong performance given the industry circumstances. While an impairment could depress accounting earnings, operation cash flows remain untouched.

The company is committed to distribute cash flows to shareholders who receive a dividend yield of 5.5%. Furthermore, the company has aggressively been repurchasing its own shares. It currently has the authorization to retire another 13% of shares outstanding.

On top of that, there is always a possibility of a take-out at a nice premium.

Opportunistic investors, could pick up some shares for a rebound as shares trade at depressed valuation multiples. Additionally, there is always the very real chance of a take-out.

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