GameStop (NYSE:GME) is expected to announce results for the fourth quarter and the fiscal year ending February 2 later this week. The video game retailer had a disappointing holiday season as global sales declined 4.6%, year-on-year, through the nine weeks ending December 29.  The holiday period is usually the most profitable for retailers like GameStop, and the disappointing sales observed in 2012 will have an adverse effect on earnings. The retailer expects sales for the fourth quarter to be down 4% to 7%, while full year sales are expected to decline by 7.5% to 9%.
Our $33 price estimate for GameStop’s stock is at a premium of 20% to the current market price.
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Why Are Sales Declining?
Console fatigue is one of the main reasons for the slump in the video game industry. Two of the major seventh generation consoles, Microsoft’s (NASDAQ:MSFT) X-Box 360 and Sony’s Playstation 3 are in the eighth year of a prolonged product cycle. According to recent press releases by the manufacturers of the consoles, both have crossed 70 million in life-to-date sales. And most people who wanted a seventh generation console already own one. GameStop reported a 3% year-on-year decline in hardware sales through the holiday season, despite the launch of Nintendo Wii U.
Sony has already announced that its next generation console, the Playstation 4 will be launched in the 2013 holiday season.  We expect Microsoft to follow suit with the launch of its eighth generation console, named by the media as X-Box 720, within the next year. We expect these consoles to revive hardware and new game sales in the coming years.
If Wii U Was Unsuccessful, How Will X-Box 720 And Playstation 4 Fare Any Better?
Nintendo’s next-gen console, Wii U, proved to be disappointing, selling just 3 million consoles since its release last year.  The Nintendo Wii was substantially more popular worldwide than the Playstation 3 and X-Box 360, with global life-to-date sales approaching 100 million units. 
In the U.S. however, the story is a little different. Although Nintendo has sold more than 47 million units of the Wii in the U.S., the X-Box 360 has been the top selling console for the last 26 months in the country.  According to data compiled by the NPD group, the X-Box 360 sold 1.2 million and 1.4 million units in November and December respectively. In contrast, Playstation 3 sales were around 600,000 units per month, while Nintendo’s consoles sold just over 400,000 units. 
Given these figures, it is clear that the X-Box is more popular in the U.S. than its Nintendo counterpart, and GameStop is banking on Microsoft’s next generation console being as successful as the X-Box 360.
Is Casual Gaming A Hurdle?
The popularity of smartphones and tablets has led to the rise of the casual gaming industry, spearheaded by companies like Zynga and games like Angry Birds. This might be one of the reasons for the decline in Wii U sales, which dropped to 57,000 units in the U.S. in January. The unique selling point of the Wii was the portable motion detecting controller and the easy on the eye graphics and interface. Now smartphones and tablets provide most of these aspects with the added advantage of portability.
On the other hand, the X-Box 360 and Playstation 3 were targeted towards hardcore gamers offering cutting edge graphics and technology. This hypothesis can be confirmed by looking at the revenue breakdown for two of the leading video game developers, Electronic Arts (NASDAQ:EA) and Activision Blizzard (NASDAQ:ATVI), which are regulars in the lists of highest selling games in the U.S., according to data from VGChartz. EA earns around 30% of its revenues from X-Box and Playstation each, and less than 2% from Nintendo consoles. Activision earns around 20% of its revenues from Microsoft and Sony consoles each, while the contribution from Nintendo is just 6%.
GameStop is more than just a retailer, and it has developed as a swap shop where customers can trade in their games and use this money to buy other games. Almost half of the company’s gross profits come from sales of used game products. Most of its customers are hardcore gamers who we believe will not be deterred by mobile and tablet gaming. We expect the launch of the Playstation 4 and X-Box 720 to revive new game sales and also lead to increased swap trading of games. You can modify the interactive chart below to gauge the effect a change in our forecast for used game sales will have on our price estimate.Notes:
- GameStop Reports 2012 Holiday Sales Results, Press Release [↩]
- Sony Announces PlayStation 4 Videogame Console – WSJ.com, Feb 20, 2013 [↩]
- Game Over? Why Video-Game-Console Sales Are Plummeting, Time, Feb 11 [↩]
- Nintendo Co., Ltd. Consolidated Sales Transition by Region [↩]
- Xbox 360 US sales hit 302,000 in February [↩]
- U.S. Sales of Nintendo Wii U Drop to Catastrophic Levels in January [↩]