GameStop’s (NYSE:GME) PowerUp Rewards members and the public attending the GameStop EXPO beginning in August will have the chance to play the next generation consoles, Microsoft’s (NASDAQ:MSFT) Xbox One and Sony’s Playstation 4, months before the scheduled launches.  The consoles, particularly Playstation 4, generated much hype at the recently concluded Electronic Entertainment Expo (E3) and are expected to revive the video game industry. The U.S. video game market, which accounts for 70% of GameStop’s revenues, saw a 25% decline in hardware sales and a 21% decline in software sales through 2012. However, GameStop stayed ahead of the market with a 30% market share. The company 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. 
GameStop’s stock has gained more than 50% since the turn of the year. Our $36 price estimate for the company’s stock is now at a discount of 10% to the current market price.
How Will The New Consoles Affect GameStop?
Hardware sales, which account for 15% of GameStop’s revenues, will be the first to be affected by the launch of the new consoles. The company reported a 17% decline in hardware sales in 2012, as gamers across the U.S. help off the purchase of consoles in anticipation of the next generation of consoles. We expect a 5% increase in sales this year as the next generation consoles are released during the holiday season.
However, hardware sales are not the biggest prize for GameStop as they have very low (7.6%) gross margins. Hardware sales account for just 4% of the company’s gross profits.
The launch of new consoles will also revive new software sales as publishers like Activision Blizzard (NASDAQ:ATVI) and Electronic Arts (NASDAQ:EA) launch games for the next generation consoles. Activision has already announced a next-gen console version of its popular Diablo III game, which sold more than 12 million copies last year and was the fastest-selling PC game of all time. Activision also plans to launch Call of Duty: Ghosts and Destiny, in collaboration with Bungie, the developers of the Halo franchise for the new consoles. The game was unveiled for the Playstation at E3 and received rave reviews, being described as a mix of Halo and Call of Duty, combining the best elements from both games. 
We expect a 7% increase in new software revenues as the console cycle is refreshed. New software sales have a gross margin of 22% and account for 44% of GameStop’s revenues and 30% of its gross profits.
The main boost to GameStop will come from a revival in the used game trade. Used game sales account for 27% of GameStop’s revenue, but have a 48% gross margin and thus account for 44% of the company’s gross profits. The good news for GameStop is that both Microsoft and Sony will allow used games to run on their new consoles and we can expect the company’s trading business to continue.
The decline in new software sales last year had an adverse effect on inventory last year, leading to a 6% decline in used games sales. GameStop estimates that only 4% of its used game sales come from games that were released in the last 60 days and so we expect the used game business to remain low this year. We expect a sales revival from 2014 onwards.Notes: