GameStop Software Sales To See Revival Post E3

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Video game retailer GameStop (NYSE:GME) reported strong figures in the last couple of quarters, amidst the notion that the company’s business model has become obsolete. The gaming industry is going through a revolutionary transition, particularly with the advent of extra downloadable content (DLC). However, the company is adapting well to the change with the introduction of its Sub $20 category (Value Products), buy-sell-trade program, pre-selling of the extra downloadable content and its technology brands.

In the first quarter, the company reported a 24.5% year-on-year increase in net income and the diluted earnings per share grew 28% to 59 cents. The industry has been facing a dry spell in terms of title sales since the start of this calendar year. However, at the recent 2014 Electronic Entertainment Expo (E3), held in Los Angeles June 10-12, the world’s leading gaming giants showcased their much awaited title releases. This has boosted investor’s confidence in the company’s second quarter performance, as the stock rose 11% to $40, just one week after the event.

GameStop is positive on its outlook for the upcoming quarters, as it expects strong hardware sales in the previous quarters to translate into better software sales. Top game developers such as Electronic Arts (NASDAQ:EA) and Activision Blizzard (NASDAQ:ATVI) unveiled their most awaited games of the year at the E3, revealing trailers and prototypes of newer editions of their famous title franchises. With a turnout of around 49,000, E3 also witnessed other video game developers such as Microsoft (NASDAQ:MSFT), Sony Corporation, Ubisoft and Nintendo disclosing concept visuals and early designs of their title releases. With a significant number of software titles and hardware accessories to be launched over the next 12 months, GameStop expects its pre-owned products segment to benefit from increased sales.

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Our price estimate for the company’s stock is $47, implying a premium of 17% to the current market price.

See our complete analysis of GameStop

New Software Sales To Get Tremendous Boost

Being the first at the E3 after the release of next generation consoles- the Microsoft Xbox One and the Sony PlayStation 4, GameStop was eagerly looking forward to the event. The expo provided an added platform to gaming giants such as EA, Activision, Ubisoft, Sony, Microsoft and Nintendo to showcase their innovative concepts and brand new trailers of their respective upcoming games. The new video game titles to be launched over the next few months include big franchises such as Star Wars: Battlefront, Battlefield Hardline, Call Of Duty: Advanced Warfare, FIFA 15 and Destiny. Apart from these much awaited titles, other popular games that remained the center of attraction for gamers included Mass Effect 4, Madden NFL, Ubisoft’s Assassin Creed and Far Cry 4.

In the first quarter, GameStop witnessed an 81% growth in hardware sales as compared to a 20% decline in software sales. [1] The company believes that the success of new hardware consoles in previous couple of quarters portends the revival of software sales. This cyclical effect was already visible in the month on May. According to the research group NPD, gamers spent $274 million on new software games in May, up 57% over the prior period last year and up 20% month-over-month. [2]This indicates that U.S. gamers can sustain high spending in the holiday season when the blockbuster games go on sale. With plenty of games to be launched this holiday season, GameStop is likely to benefit the most as the company accounts for nearly 40% of the software sales in the U.S.

Core gamers who have upgraded to next generation consoles, will be rushing out to get new games for their system. The company is bringing the best of E3 games to more than 6,600 global stores and also offering its core gamers an opportunity to pre-order their favorite games. This will drive revenues from new software sales for the company throughout the holiday season.

Pre-owned Products’ Segment: Additional Boost To The Sales

The 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.

Apart from pre-order bonuses, it is also providing the customers trade credits for their pre-owned games to help them trade for more games through the buy-sell-trade program. [3] The company is also offering 40% bonus to the PowerUp Rewards Pro members on any games or accessories traded toward the pre-order of any titles announced at E3. In terms of Pre-owned hardware products, GameStop offered that till June 22, customers that trade-in any gaming hardware system for the purchase of either a PlayStation 4 or Xbox One will receive a 50% bonus credit for their trade value. The weekend after the expo, GameStop hosted a PS4 weekend sale, which was full of trade-in specials and discounts.

The company believes that these initiatives will boost the revenue for the segment, at least in the initial stages of the holiday season. 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.

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Notes:
  1. GameStop 8-K SEC filing, Q1 May 2014 []
  2. May 2014, NPD Report []
  3. GameStop News release, June 12, 2014 []