GameStop’s (NYSE:GME) shares dropped 5% on Thursday as Sony Corp applied for a patent that could hinder sales of used video games. Sony has filed a U.S. patent application (available here) for a technology that will identify the first console that a new game is played on, and will only allow the buyer to play that video game. Although the patent hasn’t yet been approved, it is believed that the Sony’s next generation console, Playstation 4 will incorporate this technology. This is bad news for GameStop, as the company earns almost half of its gross profit from used video game sales.
We believe that the stock is currently undervalued, our $33 price estimate for GameStop’s stock is at a premium of 20% to the current market price. Please refer to GameStop’s Long Term Growth Potential Remains Despite Weak Earnings for our take on future prospects for the retailer.
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GameStop has been affected by the fact that current generation consoles like Sony’s Playstation 3 and Microsoft’s (NASDAQ:MSFT) X-Box 360, are in the waning phase of their product cycles. The Playstation 4 and the X-Box 720 are expected to be launched in the next two years. Video game developers like Electronic Arts (NASDAQ:EA) and Activision Blizzard (NASDAQ:ATVI), as well as gamers are eagerly waiting for the next generation of consoles to launch new video games, specifically developed for the new platforms. As a result new video games sales have been declining across the video game industry.
This has also had an impact on used video game sales as back inventory is declining. GameStop reported a 17% year-on-year decline in used video game sales, in the first nine months of 2012. Although we project a recovery in sales following the release of the new consoles, this could be hindered if Sony implements the aforementioned technology in Playsation 4.
There are four major platforms for which GameStop sells video games: Sony’s Playstation, Microsoft’s X-Box, Nintendo’s Wii and the PC. As the company does not provide a breakdown of sales amongst the various platforms, we estimate that Playstation accounts for about a quarter of the sales.
If Sony blocks sales of used video games for the Playstation 4 platform, then the net used video game sales will drop to about three-quarters of our current projection. Should this happen, our model shows a downside of 10% to our price estimate. Even accounting for this, our model implies a premium of 10% to the current market price. You can modify the interactive chart below to gauge the effect a change in forecast would have on our price estimate.