GameStop Earnings Preview: Focus On Digital Sales, Software Revival And Tech Expansion

GameStop (NYSE:GME) is scheduled to report earnings for the first quarter of  fiscal 2014 on Thursday, May 22. ^[1] The video game retailer reported an increase in net global sales of 3.4% in the fourth fiscal quarter of 2013 on the back of strong hardware sales after the launch of the long anticipated Xbox One and Playstation 4.  The demand for the next-generation consoles has been strong, with over 7 million PS4 units and 5  million Xbox One units sold so far. ^[2] ((March NPD Results: Titanfall on Xbox One is Number One Selling Game)) The success of new hardware consoles portends the revival of software sales, which are still lagging. This is reflected in GameStop’s earnings where new software sales were down 24% year-on-year for the fourth quarter while hardware sales increased 88%. ^[3]

According to research group NPD, video game software sales fell 10% year-over-year in April while video game hardware sales across the U.S. were up 76% over the prior year. ((April NPD report, 2014)) Since GameStop accounts for nearly 40% of the software sales in the U.S, it is likely to benefit the most when software sales pick up the pace. Although the company’s total software market share grew 2.8 points to 39%, the threat of competing retailers such as Wal-Mart (NYSE:WMT) still looms over GameStop’s future prospects. The company has given a guidance of 7%-10% growth in total sales  and 5%-8% growth in comparable same store sales for the first quarter. ^[4]

Our price estimate for the company’s stock is $52, implying a premium of 45% to the current market price.

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Digital Remains A Fast Growing Business

The digital revolution, particularly the advent of extra downloadable content (DLC), has revolutionized the gaming industry. GameStop’s strategy of pre-selling extra downloadable content (DLC) at the time of launch has helped the company adapt to this trend and drive their market share. Gamers are preferring this strategy as opposed to buying content mid-game, which generally foils their experience. This is evident as the fourth quarter witnessed a 4% increase in the digital receipts. PC digital grew 27%, driven by Steam cards that grew 110% during Q4, while console digital fell 6% as the performance of key software titles with corresponding DLC was not up to its expectation. Its free-to-play web business and mobile offerings segment also saw a significant growth during the fourth quarter.For the whole fiscal year, the digital receipts grew 15% to $720 million, which along with the mobile sales represent over $1 billion business.

Although there is a possibility that GameStop could lose out to this trend in the long term, if full games downloads gain momentum, we believe that it is currently well-positioned to capitalize on the digital revolution in the short term. The retailer giant believes cloud-based delivery of video games could be an innovative and supplemental way to play video games. As a result, it has partly shifted its focus on signing next generation games streaming services, such as a newly announced PlayStation Now. The company’s Power-up rewards and unique form of trade currency are the driving factors for this business.

New Video Game Software Sales To Gain Momentum

As mentioned earlier, the launch of next generation consoles such as Microsoft’s Xbox One and Sony’s PlayStation 4 drove up hardware sales to 76% in April over the prior year period, whereas the new software sales are still lagging. The excessive supply of PS4 and Xbox One hardware impacted legacy software sales, resulting in a reduction of PS3 and Xbox 360 software sales and also due to limited new title releases and decreasing store traffic. However, the popularity of the new consoles portends a software revival is just around the corner. With the launch of new game titles in the back half of this year, the software sales is expected to catch up. New Game Sales accounted for nearly 40% of the company’s total revenue and 30% of the gross profit in 2013.

Trefis estimates an annual growth of around 8% in the new video game software revenue per square foot in 2014, most of which would be seen in the later half of the calender year as the company usually earns 40% of its revenue in the fourth quarter.

Used Video Game Products: A Major Driver

Company’s integrated buy-sell-trade model has been a vital segment in the company’s core business for the past few years. Gamestop’s unique trading strategy, where a customer can trade any of the used video game products for a new product, is a huge success. This segment accounted for one-fourth of the company’s total revenue and around 40% of the total gross profit for the fiscal year 2013.

GameStop is looking to expand its pre-owned business by adding lower-priced products to the division, including softwares with price points below $20. This sub $20 category resulted in $400 million in sales last year, but GameStop does not have the same dominance that it enjoys in the regular price category. According to the recent trends, the sub $20 games are in high demand. Furthermore, trading of used video game products is expected to grow with the anticipated rise in pace of software sales. Moreover, popularity of new consoles are expected to stimulate a new cycle of trade-ins just as it did for the prior year, positively affecting the pre-owned business.

GameStop’s used game sales are highly correlated with new game sales, as the latter help replenish the company’s inventory; pre-owned game sales have consistently been around 65% of new software sales for the last four years.We estimate the revenue from this segment to have a double digit growth of  around 15% over the prior year and to account for nearly 43% of the company’s gross profit in the fiscal 2014.

Expansion In Tech Brands

GameStop is planning to reduce its core GameStop store count by approximately 2% (120-130 stores) this year and looking to expand its tech brands business. The company has projected capital expenditures of approximately $160 million for 2014; $120 million to $125 million for the video games business and another $35 million to $40 million for the Technology Brands stores and infrastructure.  GameStop acquired Spring Mobile, an authorized retailer of AT&T post-paid services and wireless products, in November 2013. Spring Mobile currently has 164 branded stores and GameStop is planning to open around 200-250 more stores by the end of 2014.

GameStop plans to open 20-25 more stores of its tech brand partners, Simply Mac., an apple specialty retail brand in 2014. The company estimates that the annual sales per store from Simply Mac. alone will surpass the corresponding figure of GameStop’s video game stores; $2-$3 million annual sales per store as compared to $1.3 million from GameStop stores.(( GameStop’s Investor Day, April 22, 2014)) We will closely monitor developments in this area and update our model accordingly.

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1. Q1 2014, GameStop Corp. Earnings Conference Call [↩]
2. PlayStation®4 (PS4™) Sales Surpass 7.0 Million Units Worldwide [↩]
3. GameStop Earnings Call Transcript, Q4 2013 [↩]
4. Guidance, 8-K report, Q4 2013 [↩]