GameStop Earnings Likely To Be Tepid, Revival Could Be Around The Corner

| About: GameStop Corp. (GME)
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GameStop (NYSE:GME) is scheduled to report earnings for the fourth quarter of 2013 on Thursday, March 27. [1] The video game retailer reported disappointing new software sales for the crucial nine-week holiday period ended January 4, which usually accounts for 30% of its annual sales. [2] GameStop reported a 22.5% year-on-year decline in new software sales for the period, and lowered its guidance for fourth quarter EPS from $1.97-$2.14 to $1.85-$1.95. Software sales have not recovered since; research group NPD reported a 9% decline in overall video game software sales in the U.S. for February. [3]

However, this might be a temporary hiccup as the market goes through a transition phase after a prolonged console cycle, which lasted eight years. The eighth generation video game consoles, the Microsoft Xbox One and the Sony Playstation 4, were launched last year and have been well received by gamers. GameStop observed a 99.8% increase in new video game console sales during the holiday period, which led to a 10% increase in comparable store sales. NPD reported a 42% increase in hardware sales across the U.S. for February. This indicates that gamers are currently spending their money on consoles, and are likely to purchase games to play on the consoles in the coming months. New software sales are more valuable than hardware sales for GameStop due to the higher margins involved; new software sales have a gross margin of 22% and account for 30% of the company’s gross profits, while hardware sales have a margin of 7% and account for less than 5% of gross profit. GameStop has a strong market position in the U.S. and accounted for more than half of the Xbox 360 and PS3 titles sold in the U.S. during the third quarter. [4] We expect the company to gain from a video game revival in the coming months.

Our price estimate for the company’s stock is $54, implying a premium of 50% to the current market price.

Competition From Wal-Mart

Used game sales are GameStop’s most important business. With high margins of nearly 50%, sales of used games account for 30% of the company’s revenues and half of its gross profit. Pre-owned game sales have consistently been around 65% of new software sales for the last four years, and the two streams are complementary. However, GameStop now faces a new threat to this business from Wal-Mart (NYSE:WMT), which has announced that it will allow customers to trade in their old video games for store credit that can be used to purchase anything from Wal-Mart or Sam’s Club stores. [5]

Exchanging used games for store credit might be more attractive for customers who are not just looking to trade in their old game for another game, but can use store credit to buy other items such as groceries or apparel. GameStop successfully warded off competition from Best Buy (NYSE:BBY), which entered the used game domain in 2010 and has a loyal customer base with over 31 million PowerUp Reward members. The loyalty of this base and the specialization in the niche video game market is GameStop’s biggest strong point, which might help it ward off the Wal-Mart threat. The fourth quarter conference call might provide some insights on the management’s view of the threat and the company’s strategy for dealing with it.

Digital Growth

Video game publishers like Electronic Arts (NASDAQ:EA) and Activision Blizzard (NASDAQ:ATVI) are focusing on efficiency through digital streams like time-based subscription services and game-related content that needs to be downloaded. GameStop has been able to adapt to this trend by pre-selling digital downloadable content (DLC) and delivering it on the day of launch. During the launch of Disney Infinity, GameStop offered customers the opportunity to pre-order over $400 worth of characters playable in the game. GameStop was also the only U.S. retailer to offer the exclusive $150 collector’s edition of Grand Theft Auto V. During the holiday season, the company reported a 15% increase in digital revenues, accounting for 7% of total sales. It also reported a 24% increase in revenues from its mobile division, accounting for 3% of total revenues. Although there is a possibility that GameStop could lose out to this trend in the long term, we believe that it is currently well-positioned to capitalize on the digital revolution.

  1. Q4 2013 Gamestop Corp. Earnings Conference Call, Investor Relations
  2. GameStop Reports 2013 Holiday Sales Results, January 14, 2014
  3. February NPD: PS4 sells more, Xbox One leads in dollar amount
  4. GameStop Management Discusses Q3 2013 Results – Earnings Call Transcript, Seeking Alpha
  5. Walmart Doubles Down On Video Gaming, Wal-Mart Company Statements, March 18 2014

Disclosure: No positions