GameStop’s (NYSE:GME) reported better-than-expected earnings for the fiscal fourth quarter of 2012. Net sales and gross profit for the quarter were in line with last year’s figures. Lower asset impairments and restructuring charges for the quarter led to a 50% year-on-year increase in net income. The company had earlier warned that sales for the quarter would be down by 4% to 7%, after a disappointing holiday season. The holiday period is usually the most profitable for retailers like GameStop, which had reported a 4.6%, year-on-year decline in sales through the nine weeks ending December 29. 
We believe that the company will gain from the release of the eighth generation Microsoft (NASDAQ:MSFT) and Sony consoles, which are expected to be launched later this year.  Our $33 price estimate for GameStop’s stock is at a premium of 20% to the current market price.
Tough Year For The Industry
GameStop reported a 7% decline in sales for the fiscal year with a 17% decline in hardware sales and a 12% decline in new software sales. The company stayed ahead of the industry, which saw a 25% decline in hardware sales and a 21% decline in software sales through the year. GameStop has a market share of over 30% in software sales, helped by its customer relationship business model. 
The company has developed as a swap shop where customers can trade in their games and use this money to buy other games and also earn store reward points. There are more than 30 million members enrolled in GameStop’s PowerUp, Megacard, EB World and GameStop Plus programs in the United States, Europe and Australia.
Digital Is The Way To Go
GameStop’s digital sales have grown at a CAGR of 48% over the last two years, surpassing $630 million in 2012. The company has been able to adapt its business model to the digital domain, particularly for downloadable content (DLC). GameStop provides DLC both, in-store and in online, offering its customers PowerUp points for transactions that can later be traded in for more games, accessories or DLC. Mobile sales also remained strong, reaching $184 million for the year.
New Console Will Bring New Life
GameStop has over 900,000 members in its PlayStation 4 First to Know List. Although Nintendo Wii U was disappointing for the company, selling just 3 million consoles since its release last year,  we expect the Playstation 4 and the next generation Microsoft console to boost sales in the coming years.
The X-Box 360 has been the top selling console for the last 26 months in the U.S.  and Playstation 3 has been more popular than the Wii console. Although the advent of casual and online gaming has had a detrimental effect on Nintendo sales, we expect Sony and Microsoft to remain strong.
The reason for this is that the Wii, with portable motion detecting controller and the easy on the eye graphics and interface was targeted towards casual gamers. The X-Box and Playstation, however, offer cutting edge graphics and controls, and target hardcore gamers. Electronic Arts (NASDAQ:EA) and Activision Blizzard (NASDAQ:ATVI), who are regulars in the lists of highest selling games in the U.S., earn significantly more revenues from X-Box and Playstation than the Wii. 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%.
Console fatigue has been a major reason for decline in video game sales. The seventh generation consoles are now in the eighth year of an extended product cycle. Reacting to this and in anticipation of the next generation of consoles, developers like EA have been cutting down on the number of titles released per year. The company launched 36 titles in fiscal 2011, 22 in 2012, and plans to release just 14 titles in 2013. We believe that the new consoles will revive software sales in the coming years, as developers release more games and gamers explore new gaming territories.Notes:
- GameStop Reports 2012 Holiday Sales Results, Press Release [↩]
- Sony Announces PlayStation 4 Videogame Console – WSJ.com, Feb 20, 2013 [↩]
- GameStop Management Discusses Q4 2012 Results – Earnings Call Transcript [↩]
- Game Over? Why Video-Game-Console Sales Are Plummeting, Time, Feb 11 [↩]
- Xbox 360 US sales hit 302,000 in February [↩]