Scenarios That Can Impact GameStop’s Stock

-7.40%
Downside
12.52
Market
11.59
Trefis
GME: GameStop logo
GME
GameStop

America’s biggest video game retailer, GameStop (NYSE:GME), is facing the wrath of the changing trends in the gaming industry. With interest of gamers shifting from physical video game software titles to digital available software and extra downloadable content, GameStop’s revenues from sales of new video game software shrunk more than 23% over the last 3 years, reaching $3.09 billion in 2014. On the other hand, the company’s stock has mushroomed more than 90% in the last 4 years, and is currently trading at roughly $40. According to Trefis estimates, Used Video Game Products segment, which works on the buy-sell-trade model, accounts for 41% of GameStop’s valuation. This segment has also introduced the sub $20 games (value products), which includes software with prices below $20. GameStop’s market share in the value market grew by 2% last year, but GameStop does not have the same dominance that it enjoys in the regular price category.

On the other hand, GameStop has been aggressively expanding its Technology Brand stores, and the strategy took a further step when the company bid for the right to take 163 leases from RadioShack. GameStop agreed to pay $15,000 for each RadioShack store lease. [1] There could be a significant upside for GameStop if the Technology Brands segment grows at a faster rate in the next 5-6 years. Moreover, decline in console demands will significantly impact the New Video Game Hardware segment. Another event that is a threat to GameStop’s business model is the declining trend of physical software sales.

Our price estimate for the company’s stock is $41, which is roughly the same as the current market price.

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Here are some scenarios that could impact GameStop’s stock:

Technology Brands- A New Business Model For GameStop

GameStop has recently shifted focus to the technology brands due to the scope of expansion and growth opportunities in the technology sector.  This segment was first introduced in the fourth fiscal quarter of 2013 and deals with consumer electronics, mobile products, and wireless services primarily through Simply Mac, Spring Mobile, and Cricket stores. As of January 31, 2015, the company had a total of 6,690 stores including 484 technology brands stores. The Technology Brands accounted for 4% ($329 million) of the net GameStop revenues in 2014. Moreover, the gross profits for the company increased $114.8 million, with the majority contribution from growth in the technology brands segment. [2]

The company expects the business to contribute over $1.4 billion in sales and nearly $170 million in operating profits by 2019. As a result, the company is closing some of its video game stores and opening technology brands instead. Trefis includes the revenues from technology brands in its Retail & Digital Segment, which accounts for 27% of the total valuation of the company. Currently, revenue per square foot from this segment was $187 in 2014, and we estimate it to reach $215 by the end of 2021.

Morever, Trefis estimate for the number of GameStop stores to decline to 6,375 by the end of 2021, due to a number of closures of regular GameStop stores being more than the new technology brand store openings. Furthermore, we estimate the segment’s margins to grow to 40.7% by the end of 2021.

The company’s technology brands (Simply Mac, Spring Mobile) deals with sales of Apple products and other consumer electronics. If the company aggressively expands the technology brands in the next 5-6 years, we might see a jump in revenue growth, since these stores deal with high priced electronic accessories. In that case, the segment’s revenue per square foot might jump to $300 by the end of our forecast period, and the number of total stores owned by the company might decline to just 6,500 over the same period. Technology brands, being a high margin driver, might also boost up the segment’s gross margins to 43%. This scenario might lead to a 12% upside to our price estimate for the company.

End of Physical Software Sales

The gaming landscape has changed over the last few years with the advent of smart-phones and tablets, providing easy access to games and eventually leading to the rise of casual gaming. Easy access to gaming content, with the help of extra downloadable content (DLC), has completely revolutionized the gaming industry. As a result, the gamers are gradually drifting away from physical sales of software titles. This was clearly evident last year, when the software sales lagged hardware sales. Lack of core titles in the market was another reason for the dull software sales.

In the fiscal 2014 year, GameStop’s software sales declined 11.3% year-over-year (y-o-y). 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. However, in 2014, this figure improved to 77%. This indicates that a decline in software sales might significantly impact the Used Video Game Products segment.

Trefis estimates the software revenue per square foot to increase to $368 by the end of 2021, and Used Video Game Product revenue per square foot to rise to $288 over the same period. In the above mentioned scenario, Software sales per square foot might drop to $250 by the end of our forecast period, whereas the used video game products revenue per square foot might drop to $240 over the same period. This scenario might result into a 12.5% downside to our price estimate for the company.

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Notes:
  1. GameStop nabs 163 RadioShack leases for Spring Mobile push []
  2. GameStop Q4 earnings call transcript []