Strong Demand For Next-Gen Consoles & Growth In Technology Brands Drive GameStop’s 2014 Fiscal Revenues

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The video game retailer, GameStop (NYSE:GME) missed its financial guidance in its fourth fiscal quarter report, released on March 26. In Q4, the company’s net global sales were $3.48 billion, down 5.6% year-over-year (y-o-y), due to a decline in demand for new video-game hardware. Comparable store sales declined 1.8%, with a 1.4% decline in the U.S. and 2.6% decline internationally. On the other hand, mobile and consumer electronics, as well as the new video-game software segment, showed promising growth. The highlight of the quarter was the increase in digital receipts by 41.4% to roughly $369 million, primarily led by growth of downloadable content and mobile digital downloads. [1]

Despite a dull fourth quarter, the company managed to outperform last year’s sales figures by roughly 2.8% to reach $9.3 billion in the fiscal 2014. Moreover, the full year comparable store sales increased 3.4%, driven by growth in console sales and the pre-owned category. In 2014, GameStop’s full year diluted EPS grew 16% to $3.47. In 2014, GameStop achieved its highest ever market share, with 28% share of next-generation hardware, 46% share of next-generation software, and roughly 42% market share of the downloadable content. Growth in the technology brands contributed significantly to the operating income and consequently, to the annual gross margins of 29.9%, which the company claims to be the highest gross margin rate in its history. According to the company, core game business and technology brands together drove 8% y-o-y growth in the operating income and 16% growth in EPS.

Our price estimate for the company’s stock is $39, which is slightly below the current market price.

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Decline In Q4 Hardware Sales Offset Growth In Other Segments

The gaming industry witnessed a decline in software title sales in 2014, due to a fewer number of AAA title releases. However, the top game developers in the country released some of the year’s most awaited popular titles just before the holiday season to drive software sales. This strategy worked and the software sales increased in the holiday period. However, on the other hand, hardware sales somewhat slowed down due to early purchases of the consoles in 2014. According to the NPD January report, the software sales outperformed last year’s figures, with a 5.5% year-over-year (y-o-y) increase in software sales in January. On the other hand, the declining demand of video-game hardware continued in January, as the hardware sales declined 23% y-o-y. [2]

As a result, GameStop’s hardware sales declined 30.2% to $ $808 million in the fourth quarter, due to tough comparison with last year, which witnessed the launch of the eighth generation consoles. Additionally, software sales grew 6% y-o-y to $1.29 billion, due to an increase in demand of titles for the console systems. Also, for the fiscal year, the whole scenario was just the opposite of what happened in Q4. For the 2014 fiscal year, GameStop’s hardware sales grew 17.3% y-o-y, whereas the software sales were down 11.3% y-o-y. [3] Hardware sales outperformed expectations by $500 million, due to strong console sales, whereas the physical software sales fell short by $800 million. Gross profit for the hardware segment also declined 43% y-o-y in the fourth quarter, whereas it increased nearly 11% y-o-y for the whole year.

Pre-owned and value product segment still remains the most profitable segment for the company, with net sales of $2.39 billion (up 2.6% y-o-y) and gross profits of $1.146 billion (gross margins of 48%) for the whole fiscal year, despite the decline in software revenues. GameStop’s game sales through the buy-sell-trade model 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. This trend might have slightly changed in fiscal 2014. On the other hand, for the fourth quarter, the decline in the hardware segment affected the pre-owned segment more, as the revenues for Q4 declined 1.7% y-o-y.

Growth In Digital Domain

GameStop’s Non-GAAP digital receipts rose 31% y-o-y, as the company delivered nearly $948 million in digital revenues. However, the company might fall short of its digital growth guidance given way back at its 2010 Investor Day. Nonetheless, the growth in this segment is still better than its competitors. According to DFC Intelligence data provided by the company, out of the total number of AAA titles, 12% were downloaded and 88% were physically sold. Out of the 12% downloaded games, 40% were actually paid by the customers. So according to the estimates, full game downloads of AAA titles accounted for 2% of total physical and digital software sales. Even in this small market, GameStop managed to capture a considerable amount of growth, with currently 42% market share. GameStop is still confident of its performance in downloadable content, full game downloads, and fast growing Steam PC download business.

Technology Brands To Provide Future Growth In Revenue Stream

After just two years, the company’s technology brands business has been reaping significant profits, thus, improving its margins. In the fiscal 2014, the revenues from technology brands reached $329 million, with operating margins of 10%. According to the company, the technology brands contributed $0.19 to the EPS. GameStop has shown interest in some of the store locations of RadioShack, which declared bankruptcy earlier this year. RadioShack got the approval from a U.S. Bankruptcy Court Judge to auction its 2,000 stores. [4] GameStop has been aggressively expanding its Spring Mobile stores, and the strategy took a further step when the company bid for the right to take 163 leases from RadioShack. This allowed GameStop a two month period to decide whether to go forward with the deal or not. GameStop agreed to pay $15,000 for each RadioShack store lease. [5] GameStop expects a potential IRR of 25% from these stores.

In 2014, the company acquired or opened net 266 technology brand stores around the world. GameStop expects growth of 350-550 technology brands stores in 2015 to include acquisitions and conversion of GameStop stores. The company expects the segment to contribute over $1.4 billion in sales and $170 million in operating profits by 2019. It might become one of the most profitable segments for the company in the coming few years.

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Notes:
  1. GameStop Q4 earnings call transcript []
  2. January NPD report 2015 []
  3. Ref: 1 []
  4. RadioShack goes to auction to test hedge fund $200 mln deal []
  5. GameStop nabs 163 RadioShack leases for Spring Mobile push []