GameStop (NYSE:GME) is expected to announce results for the second quarter of 2013 on Thursday, August 22. The video game retailer reported a 7% year-on-year decline in sales for the first quarter of the year, but it still managed to outperform the industry. GameStop reported a 3.8% decline in new software sales last quarter even as industry wide sales fell 14.2%. New software sales have been low in the last few quarters as gamers and publishers await the launch of the next generation of gaming consoles later this year. The latest figures released by research group, NPD, show that hardware, software and accessories sales were down 19% in July.  GameStop is one of the leading game retailers in the U.S. with a market share of around 30% and is expected to report another quarter of low sales. However, this trend is expected to change after the launch of the Microsoft (NASDAQ:MSFT) X-Box One and Sony Playstation 4 this holiday season.
GameStop’s stock has gained nearly 90% since the turn of the year. Our $33 price estimate for the company’s stock implies a discount of 25% to the current market price.
Fewer Games Lead To Lower Sales
Video game publishers like Electronic Arts (NASDAQ:EA) have been cutting down on the number of games released in order to allow for a smooth transition to the next generation of consoles. The company released around 36 titles in 2011, but cut down to 22 titles in 2012. In 2013, the company plans to launch just 13 titles. Electronic Arts is one of the biggest publishers in the world. According to our analysis, EA accounted for nearly 15% of global video game sales last year. 
Sales of popular titles has remained strong as both EA and Activision Blizzard (NASDAQ:ATVI), which account for around 17% of the global game sales,  have reported strong sales for their flagship titles like FIFA, Madden, Call of Duty and Skylanders. Sales for the top five titles grew 7% through the first six months of 2013, even as total retail sales fell.  This indicates that gamers are still interested in traditional console style games despite the popularity of mobile and tablet gaming. As such, we believe the gaming industry is likely to pick up once the new consoles hit the market.
Video game hardware and software sales grew by 60% during the Xbox 360’s first full year in the market while PS3 sales grew by 30%. We expect long term growth in GameStop’s new software sales, starting from 2014. However, the rise of mobile and casual gaming might lead to a lower increase in sales than we observed at the start of the last console cycle. You can modify the interactive chart below to gauge the effect a change in forecast would have on our price estimate.
Digital Sales A Positive Sign
GameStop reported a 47% increase in digital sales for the first quarter with a 44% growth in console digital sales and a 54% increase in PC digital sales. GameStop’s digital sales have grown at a CAGR of 48% over the last two years surpassing $630 million in 2012. Digital sales include game sales on mobile, extra downloadable content (DLC) and full game downloads. GameStop has been able to latch on to the digital trend by pre-selling digital downloadable content (DLC) and selling it on the day of launch.
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. The company is also working with game publishers to offer game-related items at the time of launch through its in-store web process. EA and Activision reported a 42% and 44% year-on-year increase in GAAP digital sales for the second quarter, respectively. Given this trend, a further increase in GameStop’s digital revenues can be expected this quarter. Digital sales currently account for just 7% of the retailer’s revenue, but we expect an increased contribution from this stream in the coming years.Notes: