Valuation of Gamestop

Gamestop is the world’s largest video games retailer. As of Dec-31-2013 it had 6,675 retail stores across USA (4,249 stores), Australia (418 stores) , Canada (335 stores) and Europe (1,455 stores). Company was started in 1984 , was acquired by Barnes & Noble in mid nineties and spun-off in 2002. In this blog post I try to gauge the factor of safety that I would need to invest in this stock.

1. MARKET SIZE : Global market (countries where Gamestop operates) for new physical game products and PC entertainment software was $22.4 billion (As of Dec-31-2014). USA’s share was $13 billion. In addition the digital market for games , ones downloaded from Mobile phones was $7.2 billion. 2. GROWTH IN INSTALLED BASE UNITS : One of the key metrics in the pre-owned games business is the growth in installed base of video game hardware platforms. As of Dec-31-2013 it was 200 million in USA (grew by 16 million in 2013) and it was 158 million in Europe (grew by 12 million units in 2013). Installed base of gaming software titles in USA was 2.45 billion units.These figures reflect the firepower of the pre-owned gaming business. Because as the installed base increases, so are the chances of it being sold in the used market. For instance think about couple of scenarios : SCENARIO-1 : You own 5 video game titles. SCENARIO-2 : You own 50 video game titles. The chances of you trying to trade in your video game title is higher in SCENARIO-2 than SCENARIO-1. 3. This in a way can be deterrent to pre-owned gaming industry , because there is no way a person can trade in the digital downloads. Thus if people cut their budgets from traditional gaming and shift it to mobile gaming , this would reduce the overall market for pre-owned games . As of today Mobile gaming is more of a complimentary to the hard core gaming. 4. Game informer : This is Gamestop’s monthly magazine. It had over 7 million monthly subscribers. This is as per Audit media (Independent third party auditor of medi publication subscriptions). Following link has details of circulations of magazines in USA. 5. Leader in Pre-owned Games retailing : Gamestop is the leader in Pre-owned games retailing.It has maintained its core competence by enhancing its domain knowledge and keeping ahead of competition. The basic question is , Can Walmart replicate Gamestop’s experience? The unique customer experience that Gamestop provides is that one can trade-in their old games and buy new ones at same location. Plus the rich domain knowledge of the gaming business creates loyalty amongst customers because of which they also buy new Consoles from it. 6. FREE DIGITAL GAMING : The company operates congregate.com . I checked out the website, the FREE games seems OK , tried a couple of games and between them was showered by advertisements. Free digital gaming has very low barriers to entry, a bunch of school kids can start a web site offering FREE games. I was impressed by the web site’s Alexa rank. Overall it was ranked 853 in USA, very impressive because the nearest web site that offered similar product was miniclip.com ranked 1,529 in USA. Kongregata attracted 18 million unique visitors a month, the web site’s main revenues were from in game transactions utilizing virtual currency called Kreds. 7. OTHER MOBILE USED HARDWARE : In 2011 the company started selling pre-owned mobile devices like tablets. I am somewhat skeptical of this move. Gamestop’s core competence is its rich gamin domain knowledge which have helped it to create a loyal following. But the used hardware business is very commoditized and not sure how it will leverage the company’s gaming domain knowledge. Gamestop's 5 year results - Period ending Feb-1 Figures in $ millions SEGMENT 2014     2013     2012     2011     2010     Sales $9,039     $8,886     $9,550     $9,473     $9,078     Gross Profit $2,661     $2,651     $2,679     $2,537     $2,434     Net income $354     $(270)     $338     $406     $375     Shares outstanding 118.4     126.4     141.0     154.0     167.9     Diluted EPS $2.99     $(2.13)     $2.41     $2.65     $2.25     Gamestop : Breakup of Revenues - Period ending Feb-1 Figures in $ millions SEGMENT 2014     2013     2012     New video Game Hardware $1,730     $1,333     $1,611     New video Game Software $3,480     $3,582     $4,048     Pre owned products $2,329     $2,430     $2,620     Video Game accessories $560     $611     $661     Digital $217     $208     $143     Mobile & Consumer elec $303     $200     $12     Other $416     $519     $453     TOTAL $9,039     $8,867     $9,550     Gamestop : Breakup of Gross profit - Period ending Feb-1 Figures in $ millions SEGMENT 2014     2013     2012     New video Game Hardware $176     $101     $113     New video Game Software $805     $786     $839     Pre owned products $1,093     $1,170     $1,212     Video Game accessories $220     $237     $251     Digital $149     $120     $66     Mobile & Consumer elec $65     $41     $3     Other $150     $193     $183     TOTAL $2,661     $2,651     $2,679     8. ANALYSIS OF INCOME STATEMENT : Increase in net sales in 2013 was attributable to : i) Increase in comparable store sales of 3.8%. ii) Offset by decline of $185.9 million due to 4.1% decline in domestic store count , changes in foreign exchange rates which had effect of decreasing sales by $23.3 million. iii) Microsoft Xbox One and Sony Playstation 4 released their new versions in Nov-2013 that sparked sales increase of 29.7%. iv) For the first six months of 2014 the sales grew from $3,249 million to $3,727 million and gross profit grew from $1,059 million to $1,177 million. This was mainly because of after effects of the launch of the launch of Xbox one and PS4 in Nov-2013. Gross profit increased in a slower pace from $1,059 million in 2013 to $1,177 million in 2014 because of the faster pace growth of lower margin business – New consoles. v) Sales / store : Total sales was around $9 billion and number of stores were 6,675 , thus sales / store was $1.3 million. vi) What has been trend of Operating margins ? For the 3 years 2013 , 2012 and 2011 it ranged from $569 million to $580 million, averaging around $570 million . Thus the operating margin has been around 6.2%. vii) Income Tax expense was $214 million, pre-tax income was $568 million, thus tax rate was 37.6%, looks fine with me. viii) Off balance sheet items : Total Lease commitments was $1 billion. 9. ANALYSIS OF BALANCE SHEET : i) Current assets as of Feb-1-2014 was $1.94 billions and current liab was $1.72 billion. Thus the working capital for the business was just around $200 million, which is not bad for a business of its size. ii) Total liab was $1.84 billions. This shows that the company practically has zero long term debt. iii) Inventories was $1.19 billion and total sales was $9 billion (for fiscal ending Feb-1-2014). Thus we can say that the company takes around 48.67 days to sell its products once it gets in its shelf. ($1.19 / $9) x 365 = 48.67. iv) Goodwill is around $1.41 billion, this might be somewhat high for a business of its size engaged in specialty retail. 10. CONCLUSION : i) The business economics is fine , compared to other specialty retailers as it employed just around $200 million working capital and its total book value was $2.2 billion and Free cash flow (FCF) was $500 million , thus the ratio of FCF to Equity was 22%. It suggests that the company is doing a great job using shareholder’s equity. ii) The moat of the business are its 6,000 odd stores that helps it closely connected with its customers and helps in its model of trading software games. Plus its domain knowledge is evident by the popularity of the Game informer magazine that has 7 million subscribers. iii) On the flip side, the sales growth in future will be negligible because the business is somewhat saturated . Thus the management is forced to enter other markets like the used wireless hardware markets. These are highly competitive and don’t align with the company’s present domain. v) Management’s record in acquisition is not that great , given its recent $627 million impairment charge. FACTOR OF SAFETY Thus I would go with the factor of safety of 35%. This means that I would not pay more than 65% of the calculated fair value of the stock , which was $50 / share. Thus I would only buy if the stock is trading below $32.50 / share. Following is the stock chart along with my calculation of fair value of the stock. Updated - 10/12/2014  GME Valuation : $50.85 / share , Total value : $6 billions (Base FCF : $0.5 billion , multiple 12 , Net book value for val : 0) Shares oustanding : 118 millions  LINKS SEC  Company