Growth Potential In Mobile, Digital And Technology Brands To Keep GameStop Healthy

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Video game retailer GameStop (NYSE:GME) delivered strong results in its second fiscal quarter earnings released on August 21, as it beat its EPS guidance by $0.03. [1] The company’s comparable store sales increased 21.9% year-over-year (y-o-y), making it the fourth consecutive quarter with positive comparable sales. As reported by the research group NPD, the worldwide demand for the next generation consoles- the Microsoft (NASDAQ:MSFT) Xbox One and the Sony PlayStation 4- is still strong among gamers. [2] All of the company’s segments witnessed positive growth, driving the net global sales for the second quarter to $1.73 billion, an increase of over 25% y-o-y.

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

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Strong Next-Generation Console Sales

As mentioned in our prior article, the new console cycle is outperforming the last console cycle, as the combined sales of the Xbox One and PlayStation 4 (PS4) in the 9-month period is nearly up 80% from that of Xbox 360 and PS3 (see Strong Console Sales To Drive Revenues For GameStop & Electronic Arts).

  • Triple Digit Growth In Hardware Sales Drove Comparable Sales

In the second quarter, the sustained momentum in new console sales boosted new hardware sales to $332 million, up 125% y-o-y. This eventually led to a 22% y-o-y increase in the company’s comparable store sales, up 19.7% in the U.S. and 26% internationally.

Since the launch of the next-gen consoles, category-wide sales of the hardware have increased 140%. In a poll conducted by the company, 55% of PowerUp members have yet to purchase the next-gen consoles, indicating stronger hardware sales in the third quarter.

  • New Software Sales Picks Up Pace

The positive software sales in Q2 brought a respite to the company, as new video game software sales were $497 million, up 16% y-o-y, primarily driven by strong performance of recently released new titles, such as Ubisoft’s Watch Dogs and Nintendo’s Mario Kart 8, as well as popular franchises such as Electronic Arts’ (NASDAQ:EA) FIFA 14 and Activision Blizzard’s (NASDAQ:ATVI) Call of Duty: Ghosts. Overall, the company’s share increase by 240 basis points in the video game software market share in the second quarter, as software sales rose 8.5% in the U.S. The increase in demand for software titles is likely also a by-product of strong hardware sales, which might have lured gamers with new systems to buy new games. Moreover, the segment’s gross margins increased 30 basis points y-o-y.

GameStop is confident going into the second half of the year with a huge line-up of popular titles from top game developers. Some of these most awaited titles include Call of Duty titles, FIFA and Madden. Even though the title line-up for Q3 is great, the company believes that it will benefit more in the fourth quarter, as the company usually earns 40% of its revenue in the fourth quarter. We expect annual growth of around 8% in the company’s new video game software revenue per square foot in 2014.

  • Pre-Owned Segment Gets Added Boost From Strong Console Sales

GameStop’s Pre-owned and Value products still remain the highest revenue generating segment for the company, with $558 million net sales in the second quarter, up 5.5% y-o-y. [3] We discussed the significance and growth potential of these technology brands in detail in GameStop’s Focuses On Technology Brands For Top-Line Growth.

In Q2, the company opened 49 new technology brand stores bringing the total count to 319 and are on pace with its target of 300-400 tech brands in 2014. GameStop ended the quarter with 6,379 video game stores, out of which 4,197 are in the U.S. and 2,182 at international locations.

  • Developments in Multichannel & Other Mobile Platforms

GameStop’s international ecommerce business witnessed a double digit growth for the 4th consecutive year, increasing by more than 46% y-o-y, driven by:

  • Expanded product selection
  • Increase in number of customers using the cross-channel facilities

The multichannel domain played a vital role in the company’s operational business, reporting growth of 49%, whereas in store pick ups grew 141% in Q2.

Moreover, during the second quarter, Kongregate, the company’s mobile and casual gaming platform, showed excellent growth with 123% increase y-o-y. GameStop currently has 12 active games combines on the iOS App Store and Google Play Store, as well as plans to add 20 more games by the end of this year. Kongregate has provided an additional platform to the company to expand its reach and to adapt to the current trends.

Casual and mobile gaming is becoming increasingly popular in Western markets. According to Newzoo’s 2013 global games market report, games revenue will grow to $75 billion in 2014, up 7.1% y-o-y, with tablets and smartphones accounting for 21% of total sales. [4] The market share of casual and mobile gaming is expected to grow rapidly in the next two years.

Mobile and Casual gaming is rapidly taking market share in the industry and is an attractive market for number of reasons:

  • Accessibility: Games on phones and tablets can be played virtually any time and any place
  • Increased consumer base: Smartphones, tablets and other handhelds provide an additional customer base to the company, as these devices are present in every corner of the world.
  • Free-to-play: Most of the games on mobiles are working on free-to-play models, attracting additional customers
  • Technology upgrade: Due to increased competitive activity in the technology sector, innovation and technology (hardware and software) upgrades are at a much higher pace on these devices as compared to consoles and PC, providing more opportunities to customers

This provides a great incentive to the company to expand into a segment which is not dominated by any particular brand or company. Overall, the company has huge potential growth opportunities for the next couple of years, which might offset the industry’s declining trend of physical purchase of titles.

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Notes:
  1. GameStop Q2 2014: Earnings call transcript []
  2. July NPD Report []
  3. GameStop Q2 2014, 8-K)) The transition of gamers to next-gen consoles gave a push to already strong console trades, resulting in improved pre-owned inventory. Healthier inventory positions, coupled with expansion of the international loyalty programs to engage customers drove the segment’s sales.

    Around 30% of the company’s next-generation products to date have been purchased with the help of trade credits. Last week, the company introduced a simplified and detailed trade-in policy that will help the customers to get a better understanding of the value they get for their games and other devices, to create better transparency. This strategy has already been a success in Australia and might help the company in gaining consumer confidence.

    GameStop’s New Impactful Segments

    • Digital Domain: Future Of Gaming Industry

    The digital revolution, particularly the advent of Extra Downloadable Content (DLC), has revolutionized the gaming industry. As discussed in our prior article, GameStop is bullish on the growth potential of its digital segment and believes it is the future of electronic game industry. (See: Digital Domain & Technology Brands: GameStop’s Fast Growing Segments [Part 2]) In Q2, the company’s digital receipts grew 18%, with console digital increasing 13% and PC digital rising 24%. The company attributes this successful performance to its proprietary digital delivery system and its popular buy-sell-trade model. The company believes that most of the Microsoft’s and Ubisoft’s digital receipts sold at retail are at GameStop stores.

    International digital sales grew 53% y-o-y, primarily driven by Downloadable Content (DLC) in new titles and tremendous growth in Steam Wallet. 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.With the release of popular franchise titles in the third and fourth quarter, the company is fairly confident regarding the growth of its digital receipts. Titles such as FIFA, Madden, Destiny, Battlefield and Call of Duty have gained huge popularity and their Downloadable Content (DLC) has been widely in demand. Thus, the company has all the more reason to expect improved performance by this segment.

    Trefis expects margins to rise minimally in 2014, but remain a major driving force over the long term.

    • Technology Brands : Expanding To Mobile, Other Electronic Devices

    GameStop added the Technology brand segment in the fourth quarter last year, as it acquired the Spring Mobile and Simply Mac brands. Just nine months after the launch, it is the company’s fastest growing, accounting for 19% of the company’s operating profit in Q2. The company witnessed higher gross margins in the technology brands segment in comparison to the margins in the Video 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. Over that time, the company has strengthened its relationships with AT&T and Apple, indicating further growth opportunities in this domain. 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 []

  4. Newzoo’s 2013 global games market report []