GameStop: The Product of Evolution

Palwasha is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Over a month ago, I predicted that GameStop (NYSE: GME) stock will pop in wake of Nintendo's new console launch, the Nintendo Wii U--which came out two days ago. Two days prior to its launch, GameStop reported its third quarter earnings. The game retailer reported Q3 EPS of $0.38 which beat analyst estimates by $0.05, and revenues in-line with analyst expectations ($1.77 billion). These articles led the stock to a 12% increase within three trading days. The question is, will the stock maintain its upward momentum? I believe its ability to evolve to changing trends is an answer in the affirmative.

The Buy-Sell-Trade 'Electronics' Retailer

GameStop, famously identified as a video-game retailer, expanded a few quarters ago to sell pre-owned smartphones and tablets; along with new and pre-owned video game hardware and software and digital gaming of all kinds, thus making it more of a global specialty retailer than just a video-game retailer. GameStop has over 6600 stores across the US and about 3000 are now equipped to provide walk-in customers the chance to actually experience Nintendo Wii U's game play before they buy it.

Winning in the era of smartphones

GameStop is run by a management that strongly believes in adaptability to external change. They saw the smartphone and tablet trend and decided to follow it. Today, they've broadened their horizon to non-video game electronics, which helped deliver better than expected results. GME's latest quarter mobile business grew to $43 million, a greater than 30% margin rate than management had previously communicated. Today they sell new Android-based tablets in over 1,600 stores domestically and 800 internationally. They've also launched an online used-tablet store for the US market. The company has already converted 268 US stores to now cover a selection of pre-owned and new mobile devices and related accessories, and intends to convert additional stores in the coming year.

DLC is the future of gaming!

When the popularity of cloud-based gaming and online/downloadable content started posing a threat to GameStop's initial business model, they knew they had to evolve to meet shifting trends. Today, GameStop's total gaming software market share in the US is 44%. GameStop's digital revenues grew 32% from Q3 of last year, with PC digital growing at 55% and console digital growing at 20%. In fact, PC digital download sales nearly tripled during the latest quarter. GameStop is also the only retailer that is selling Microsoft game-specific DLC (downloadable content) for Xbox 360, allowing customers to purchase and begin downloading the content to their consoles even before they leave the store. GameStop's management expects Q4 digital sales growth to be higher than Q3 and anticipates ending the year with a digital sales growth between 30% and 40% or $590 million to $635 million. The game retailer at present offers over 2,000 downloadable games on its website,

Hardware is still in demand

Games like Call of Duty: Black Ops II, which has become the largest selling game ever for GameStop, will keep consoles in demand as long as such heavy games remain non-downloadable via average internet connections across the US. The demand of such games still widely exists and one can get an idea of its magnitude from the fact that GameStop alone sold over 1 million copies of Black Ops II worldwide. COD franchise owner and publisher Activision-Blizzard (NASDAQ: ATVI) is said to have sold over $500 million worth of copies of Black Ops II within first 24 hours of availability. Two other such franchises doing good business for the game retailer are Halo 4 and Assassin's Creed 3. 

Nintendo's (NASDAQOTH: NTDOY) Wii U finally came out on Sunday. GameStop had nearly 500,000 pre-launch reservations for the console. The console's software has had over 1.2 million reserved titles worldwide which also include Black Ops II and Assassin's Creed 3. According to GameStop's management, the reservation of Wii U games before Wii U launch is more than double that of the original Wii launch. Microsoft and Sony's new consoles are expected to hit the market by fall next year. With the new console cycle will begin the round of new game titles. So next year quarters are likely to bring good news after good news.

The younger target market

In order to target the younger generation, GameStop has opened up 82 Kids-specific stores in malls across the US, which hold an expanded selection of kids games, toys, action figures, plush toys, clothing and accessories. These stores are helping the retailer to drive sales of popular titles such as Activision's Skylanders Giants which, according to the company, has grown 5.5 times since last year. This category of its business faces intense competition from Toys R Us and more aggressively from retail behemoth Wal-Mart, which typically threatens its competitors with its cut throat pricing. Nonetheless, this is one market where GameStop has an opportunity to explore its moat.

Return to Shareholders

During Q3, GameStop repurchased 3.7 million shares at an average price of $20.59 for a total of $76.8 million. The company has bought back more than $1 billion worth of shares in over two years. GameStop's current repurchase authorization stands at $500 million. The company has also declared a quarterly dividend of $0.25 per share (in line with last quarter but up from $0.15 two quarters ago). Its dividend yield is reasonable at 3.9%.

GameStop management expects Q4 diluted EPS to range from $2.07 to $2.27. Full year 2012 EPS guidance lies between the range of $3.10 to $3.30. Forward P/E of 8.15 gives the stock a fair value within the range of $25.27 to $26.90, and an average fair price of $26.08. Slight undervaluation still makes it a buy.

PalwashaS has no positions in the stocks mentioned above. The Motley Fool owns shares of Activision Blizzard and GameStop. Motley Fool newsletter services recommend Activision Blizzard and GameStop. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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