Digital Domain & Technology Brands: GameStop’s Fast Growing Segments [Part 2]

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GameStop

Video game retailer GameStop (NYSE:GME) is scheduled to release its Q2 2014 earnings figure on Thursday, August 21. [1] The retailer giant witnessed a 7% increase in net global sales in the first quarter, of which 3% was due to technology brands. According to the research group NPD, the electronic game industry was approximately a $13 billion market in the U.S. in 2013, excluding the sales of pre-owned video game products. On the other hand, the digital content market summed up to approximately $7.2 billion in 2013.

In the first quarter, the company delivered $190 million of digital receipts with a growth rate of 9.5%, primarily driven by the Xbox One and PlayStation 4 digital currency coupled with international PC digital sales. [2] Although the digital segment accounted for only 2.4% of the net sales in the fiscal 2013, gross profit as a percentage of sales on digital sales increased from 58% in fiscal 2012 to 68.5% in fiscal 2013, due to conversion of full retail price revenue digital currency cards into commission only currency cards. [3]

GameStop has recently shifted focus to the technology brands due to the scope of expansion and growth opportunities in the technology sector. The new technology brand segment, which was included in the fourth fiscal quarter of 2013, added nearly $63 million to the company’s net sales for the fiscal year 2013. It accounted for a similar figure of sales in Q1 2014, where strong wireless promotions led to higher margins for this segment. Ultimately, it resulted in widening the company’s gross margins by 40 basis points to 31.4% year-over-year. [2]

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In our previous article, we discussed the possible impact of the sustained console sales on the company’s core profitable businesses – pre-owned products & value, and the video game hardware & software segment. ((GameStop’s Earnings Preview: part 1)) In this article, we will discuss the company’s future growth plans and current performances of its two new segments: Digital Sales Segment and Technology Brands. GameStop is yet to make an impact in these two segments, but have high hopes from them in the coming few years. The company believes that sales of video games with digital content is the future of gaming industry. Moreover, to compete against other retail giants such as Walmart (NYSE: WMT), GameStop switched to mobile and other consumer electronic items.

Our price estimate for the company’s stock is $47, implying a premium of 17.5% to the current market price.

See our complete analysis of GameStop

GameStop Adapting To Digital Revolution

The digital revolution, particularly the advent of Extra Downloadable Content (DLC), has revolutionized the gaming industry. Many people are bidding down on GameStop, whose core business has been the sales of physical media, which included physical software and hardware accessories. However, most of them are missing out on the fact that GameStop has not only moved into the digital segment, but are delivering good margins as well. According to our estimates, the Retail PC and Digital Segment’s gross margins were 39.5% in 2013. GameStop also believes that the future growth in the electronic game industry will be driven by sales of inter-game content available in digital form. The company is positive with the growth potential of its digital segment due to the below mentioned factors:

  • The company’s core buy-sell-trade model works on the idea of providing its customers with trade credits. When a digital expansion pack or Downloadable Content (DLC) is released for a title, those customers would prefer using trade credits to buy digital content from the company rather than buying it online and wasting the trade credits.
  • For all the digital purchases, to attract more customers the company is offering PowerUp Reward points, which currently has nearly 28 million members in the U.S. and over 37 million worldwide.
  • The company’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 prefer this strategy as opposed to buying content mid-game, which generally foils their experience.

For the fiscal 2013, the digital receipts grew 15% to $720 million, which along with the mobile sales represents over $1 billion business.

With the growing popularity of the concept and increasing demand for easily accessible digital content, the segment’s margins are expected to grow in the upcoming quarters. Trefis expects margins to rise minimally in 2014, but remain a major driving force over the long term.

Focus On Growth Of Technology Brands

As mentioned earlier, as a result of the acquisitions of Spring Mobile and Simply Mac, the company added a new reportable segment-Technology brands,  in the fourth fiscal quarter of 2013. The company witnessed higher gross margins in the technology brands segment in comparison to the margins in  theVideo Game Brands segment, as a result of acquisition activity in the former over the last two fiscal quarters, offsetting potential margin erosion associated with the lagging new video game software sales. The segment’s contribution to revenue growth might play a vital role in the company’s overall market growth.

During the Q1, the segment reported sales of $60.2 million and an operating profit of $6 million, representing 6% of company’s net operating profit. The video game retailer added a total of 52 technology brands stores (36 acquired and 16 opened) during the first quarter and plans to acquire or build 300-400 stores in 2014. 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. The company estimates that the annual sales per store from Simply Mac. in 2014 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.

The company’s technology brand stores are generally located in high traffic power strip centers, local neighborhood strip centers, and high traffic shopping malls. These locations are easily accessible and have high daily traffic and high frequency of visits.

We have discussed the significance and growth potential of these technology brands in detail in our prior article. (See: GameStop’s Focuses On Technology Brands For Top-Line Growth)

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Notes:
  1. Q2 2014 GameStop Corp. Earnings conference call []
  2. GameStop Q1 earnings call transcript, May 2014 [] []
  3. GameStop Q4 2013, 10-K []