Why would Buffett buy Fossil

On a Previous post I had mentioned about the Sumzero challenge where the contestants are supposed to submit an Investment idea that they feel would be Buffett's next investment choice. After going through a list of around 50 shortlisted stocks I finally came to the conclusion of recommending Fossil. So Why would Buffett consider purchasing Fossil? (i) The business has huge moat. And its products would be in demand for decades to come. (ii) The business belongs to Jewelry industry that Buffett understands really well. This can be said by looking at Berkshire Hathaway Inc’s portfolio of Jewelry businesses.(iii)Balance sheet is strong. Business also generates healthy free cash and does not need any major incremental Working capital. Current RETURN ON EQUITY = 38%. (iv) Company has a Strong management in place. (v) The business is selling for a discount. As of April-4-2015 the stock was trading at $83.75. The fair value is between $132 and $102 per share. Let us look at each of the above point closely.

Updated - 03/16/2015  FOSL Valuation : $102.83/ share , Total value : $5.45 billions (Base FCF : $0.350 billions , multiple 15, Net book value for val : $0.20 billion) Shares oustanding :53 millions  LINKS SEC  Company FACTORS THAT ENHANCE THE MOAT OF THE BUSINESS BRAND STRENGTH: i) The FOSSIL brand has developed from its origin as a watch brand to encompass other accessory categories, including handbags, belts, small leather goods, jewelry, soft accessories, sunglasses and clothing. ii) Since its inception in 1984, they have continued to develop, acquire or license other nationally or internationally recognized brand names, such as ADIDAS®, ARMANI EXCHANGE®, BURBERRY®, DIESEL®, DKNY®, EMPORIO ARMANI®, KARL LAGERFELD®, MARC BY MARC JACOBS™, MICHAEL KORS®, MICHELE®, RELIC®, SKAGEN®, TORY BURCH® and ZODIAC®, in order to appeal to a wide range of consumers. iii) Their industry is highly competitive and subject to changing preferences in style, taste and price points. By owning the vast majority of their global distribution, they are also able to create and execute consistent pricing strategies and brand image presentations that protect and enhance their proprietary brands and those of its licensors. LICENSING STRENGTH: i) Since 1997, they have attracted highly recognized and respected brand names to license within their watch and jewelry portfolios. They attract such quality brands due to their ability to provide them with access to their global design, production, distribution and marketing infrastructure. ii) As a result of their vertical integration, they, unlike many of their competitors, can offer an integrated solution to launch or increase an accessory category presence on a worldwide basis in a consistent, timely and focused manner. iii) All of its major licensing relationships are exclusive to them and the licensors, which substantially minimizes risks to the licensor associated with dealing with multiple licensees in different geographic regions. iv) Additionally, in order to develop a broader relationship and maintain brand consistency across the accessory categories, they have broadened their infrastructure, allowing them to expand their licensing activities to products beyond the watch category, including their DIESEL, DKNY, EMPORIO ARMANI and MICHAEL KORS jewelry product lines. BREADTH OF BRANDS AND RETAIL PRICE POINTS: i) Through the multiple brands they distribute, they have developed a broad spectrum of retail price points. Within their watch collections, core retail price points vary from approximately $7 in the mass market channel up to retail price points of $4,990 in the luxury distribution channel, although the majority of their collections focus on price points ranging from $85 to $600. ii) The breadth of their brands allows them to anchor a brand to a given price point range and distribution channel, thereby maintaining a consistent brand image while focusing on the quality/value relationship important to the customer and not diluting the brand through overlapping distribution channels. The breadth of price points allows them to cater to various age and income groups while continuing to participate in sales consistently, regardless of a shift in income or the price/value preferences of its customers. OPERATIONAL CONTROL: i) The three entities that assemble the majority of their Asia watch production volume are majority owned by them. In addition, although they do not have long-term contracts with their unrelated accessory manufacturers, they maintain long-term relationships with several manufacturers. These relationships developed due to the significant length of time they have conducted business with the same manufacturers. This helps them to exert significant operational control with regard to their principal watch assemblers. In addition the relative size of their business with non-owned watch manufacturers gives them priority within their production schedules. Furthermore, the manufacturers understand their quality standards, which allow them to produce quality products and reduce the delivery time to market, improving overall operating margins. ii) They distribute substantially all of their products sold in North America from their warehouse and distribution centers located in Texas. In Europe, they distribute their products primarily through their warehouse and distribution center located in Germany. Their centralized distribution capabilities in the U.S. and Europe enable them to reduce inventory risk, increase flexibility in achieving delivery requirements of their customers and maintain cost advantages as compared to their competitors. iii) HOW THE TEXAS WAREHOUSE IS USEFUL? Their warehouse and distribution facilities in Texas operate in a special purpose sub-zone established by the U.S. Department of Commerce Foreign Trade Zone Board. This sub-zone provides the following economic and operational advantages to them: (a) They do not have to pay duty on imported merchandise until it leaves the sub-zone and enters the U.S. market, (b) They do not have to pay any U.S. duty on merchandise if the imported merchandise is subsequently shipped to locations outside the U.S. and (c) They do not have to pay local property tax on inventory located within the sub-zone. BERKSHIRE’S JEWELRY PORTFOLIO AND HOW FOSSIL WILL FIT IN? Berkshire’s Jewelry portfolio consists of: (i) Ben Bridge Jeweler (ii) Borsheims Fine Jewelry (iii) Helzberg Diamonds. Each of these businesses offers broad range of jewelry including fine watches. FOSSIL’s moat will complement the strengths of these businesses and in turn increase the value of Berkshire’s Jewelry portfolio. FINANCIAL STATEMENT ANALYSIS 1. GROWTH IN BOOK VALUE / SHARE: It’s the prime measure Buffett uses to measure Berkshire Hathaway inc’s progress. Thus we need to look at Fossil’s 10 year change in Book value per share. Book value per share grew from $7.27/share in 2005 to $18.53 in 2014 at a Compounded annual growth rate of 9.81% per year for last 10 years. 2. CHANGES IN WORKING CAPITAL AS COMPARED TO GROWTH IN SALES: As Buffett has mentioned in his letters before that his definition of an ideal company is something like See’s Candies that has steadily increased its Free cash flow with very minimal increase in working capital. Below table gives the formula for measuring changes in Working capital with respect to Sales. A : Current Assets B : Cash C : Current liabilities D = A - B - C E = Sales F = E/D For the years 2005 thru 2014 the value of 'F' has maintained a tight range between 3.89 and 5.10 last 10 years. This shows that the business does not need much increase in working capital. 3. FREE CASH FLOW FOR LAST 10 YEARS : The company's Free cash flow increased from $88 millions in the year 2006 to $288 millions in the year 2014. The agregate Free cash flow during this period is $1,615 million. The Free cash flow has increased with a CAGR of 13.86% 4. RETURN ON EQUITY: Buffett has often stressed on a healthy Return on Equity as one of his yardstick in measuring a performance of a business. Fossil’s current ROE is 38%. In 2005 it was 14.31% and has constantly been increasing every year since then. This indicates a very positive sign that the business needs very limited capital to grow. A LOOK AT THE COMPANY’S MANAGEMENT: Fossil Group was founded in 1984 by Tom Kartsotis . His brother Kosta Kartsotis is the CEO and Chairman of the board. He owns 12% of the company and is said to be one of the lowest paid CEOs of any large organization. This shows his conservative style of managing capital. It very well matches Buffett’s style of functioning. VALUATION OF FOSSIL: Following are the assumptions for valuation of Fossil i) Base Free cash flow: $300 million. ii) Growth rate for next 10 years : Higher range 10% , Lower range 7% iii) Growth rate beyond 10 years to 25 years : Higher range 5% , lower range 2% iv) Terminal Value at end of 25th year = Current tangible book value. = $610 million. v) Discount rate = 8%. vi) Shares outstanding = 53.08 million Applying the Discounted Cash flow valuation technique, we get the following ranges HIGHER RANGE: (A) Sum of Discounted Cash flows for 25 years = $6,448.03 million. (B) Terminal Value = $610 million (A) + (B) = Fair Value = $7,058.03 millions Fair value / share = ($7,058.03 millions / 53.08 millions ) = $132.97 / share. LOWER RANGE: (A) Sum of Discounted Cash flows for 25 years = $4,817.51 million. (B) Terminal Value = $610 million (A) + (B) = Fair Value = $5,427.51 millions Fair value / share = ($5,427.51 millions / 53.08 millions) = $102.25 / share.

Valuing Legal Contingencies

Usually while valuing a business one looks at the Happy path. Its like assessing a new car with the assumption that you will always drive it in perfect weather. Just think how practical is this approach??? Real life is full of surprises which mostly are not so pleasant. One such surprise for a business is costs related to legal settlements. These can run into Billions of dollars. Common notion is that only large banks run into such situations because of the recent mortgage crisis. But even other businesses can run into such issues.

Anadarko Petroleum (APC) is a large Oil and Gas company. Following is an excerpt from Foot Note#11 – Contingencies from its 2014 Q-3 10-Q report. TRONOX LITIGATION On November 28, 2005, Tronox Incorporated (Tronox), at the time a subsidiary of Kerr-McGee Corporation, completed an initial public offering (IPO) and was subsequently spun-off from Kerr-McGee Corporation. In August 2006, Anadarko acquired all of the stock of Kerr-McGee Corporation. In January 2009, Tronox and certain of Tronox’s subsidiaries filed voluntary petitions for relief under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the Southern District of New York (Bankruptcy Court), which is the court that presided over the Adversary Proceeding (defined below). In May 2009, Tronox and certain of its affiliates filed a lawsuit against Anadarko and Kerr-McGee Corporation and certain of its subsidiaries (collectively, Kerr-McGee) asserting several claims, including claims for actual and constructive fraudulent conveyance (Adversary Proceeding). Tronox alleged, among other things, that it was insolvent or undercapitalized at the date of its IPO and sought, among other things, to recover damages in excess of $18.85 billion from Kerr-McGee and Anadarko, as well as interest and attorneys’ fees and costs. In accordance with Tronox’s Bankruptcy Court-approved Plan of Reorganization (Plan), the Adversary Proceeding is being pursued by a litigation trust (Litigation Trust). Pursuant to the Plan, the Litigation Trust was “deemed substituted” for the Tronox plaintiffs in the Adversary Proceeding. The U.S. government intervened in the Adversary Proceeding, and in May 2009 asserted separate claims against Anadarko and Kerr-McGee under the Federal Debt Collection Procedures Act (FDCPA Complaint). The Litigation Trust and the U.S. government agreed that the recovery of damages under the Adversary Proceeding, if any, would cover both the Adversary Proceeding and the FDCPA Complaint. In February 2011, Tronox emerged from bankruptcy pursuant to the Plan. The terms of the Plan, which were confirmed by the Bankruptcy Court in the fourth quarter of 2010, contemplate that the claims of the U.S. government (together with other federal, state, local, and tribal governmental entities having regulatory authority or responsibilities for environmental laws, collectively, the Governmental Entities) related to Tronox’s environmental liabilities and tort claims asserted against Tronox by other creditors will be settled through certain environmental response trusts and the Litigation Trust. The Plan provides for an allocation of any proceeds from the Adversary Proceeding between the Governmental Entities and the other creditors. LIABILITY ACCRUAL : On April 3, 2014, Anadarko and Kerr-McGee entered into a settlement agreement with the Litigation Trust and the U.S. government (in its capacity as plaintiff-intervenor and acting for and on behalf of certain U.S. government agencies) to resolve all claims asserted in the Adversary Proceeding and FDCPA Complaint for $5.15 billion, which represents principal of approximately $3.98 billion plus 6% interest from the filing of the Adversary Proceeding on May 12, 2009, through April 3, 2014. In addition, interest will be paid on the above amount from April 3, 2014, through the date of payment of the settlement, with interest of 1.5% for the first 180 days and 1.5% plus the one-month LIBOR thereafter. Under the terms of the settlement agreement, the Litigation Trust, Anadarko, and Kerr-McGee agreed to mutually release all claims that were or could have been asserted in the Adversary Proceeding. The U.S. government (representing federal agencies that filed claims in the Tronox bankruptcy) and Anadarko and Kerr-McGee also provided covenants not to sue each other with respect to certain claims and causes of action. The U.S. government will also provide contribution protection from third-party claims seeking reimbursement from Anadarko and certain of its affiliates for the sites identified in the settlement agreement. The Adversary Proceeding has been stayed pending final approval of the settlement agreement. In May 2014, the Bankruptcy Court issued its Findings of Fact and Conclusions of Law recommending approval of the settlement agreement. The settlement agreement is subject to approval by the New York District Court and the issuance of an injunction by the New York District Court barring similar claims from third parties. The settlement payment will be made once both the New York District Court’s approval of the settlement agreement and the issuance of the injunction are final and non-appealable. The Company currently expects this process to be completed in early 2015. Anadarko recognized Tronox-related contingent losses of $850 million in the fourth quarter of 2013 and $4.3 billion in the first quarter of 2014. In addition, Anadarko recognized settlement-related interest expense of $38 million, included in Tronox-related contingent loss in the Company’s Consolidated Statement of Income, during the nine months ended September 30, 2014, for an aggregate $5.19 billion Tronox-related contingent liability on the Company’s Consolidated Balance Sheet at September 30, 2014. CONCLUSION: If one were valuing Anadarko Petroleum in the year 2005 then there was no way one could have predicted a charge of $5.19 billion that the company took in the year 2014. But what we can learn from this case study that we should always keep some buffer in our valuation for Legal contingencies. One can accommodate this as part of discount rate. If you have any doubts on discount rate then please refer to the following post Discounted Cash flow basics

Value opportunities in the year 2014

2014 has been great for Tech stocks. 37 out of 194 stocks in my watchlist grew more than 25% this year.Most of the stocks were already overpriced and the level of exuberance just increased. As a Value investor I would just ignore them. But 6 of those 37 stocks were value plays that were trading below my valuation and bounced back to their true valuation. Following are the details

1. HPQ : Stock moved from $27 to $40 in the year 2014. Had valued it for $39. 2. Western Digital : Stock moved from $82 to $110 in the year 2014.Had valued it for $107. 3. Broadcom : Stock moved from $30 to $43 in the year 2014.Had valued it for $35. 4. Amphenol : Stock moved from $44 to $55 in the year 2014. Had valued it for $55. 5. Omnivision : Stock moved from $17 to $27 in the year 2014. Had valued it for $30. 6. Omnicell : Stock moved from $25 to $33 in the year 2014. Had valued it for $31.

Valuation of Uber

Today I was reading Aswath Damodaran’s blog post Crowd Valuation of Uber . Aswath's text book on Investment valuation is a must have for any person seriously thinking of learning Investment valuation. In his blog post, he has invited his readers to give their opinion on Uber’s Valuation. Following post gives an overview of my valuation of Uber.

To start with , let me first state that Uber is not publicly traded company , thus we don’t have access to any of its financials or other business details. We need to believe on certain facts published in media that certainly need to be taken with grain of salt. While doing this kind of exercise, there is a high possibility for a person to cross the line from Investment to Speculation. Thus its important for us to again refresh ourselves on basics of “Investment vs Speculation” . What better than the text book SECURITY ANALYSIS by Ben Graham. Chapter-4 is entirely devoted to this topic. The chapter is just 10 pages long. While reading the first two pages of this chapter I could feel Graham is talking about his own experience. Basically he lays down the basic reason of the collapse of stock market in 1929. Following are Graham’s remarks “A more forceful reason, perhaps, might be the statement that the failure properly to distinguish between investment and speculation was in large measure responsible for market excess of 1928-1929”. I sincerely urge you to read this chapter as it will provide you with a great state of mind to value a business like Uber. Because the business has a very limited history to base upon our valuation. What is Uber and who are its customers? To be honest I have never used one, but during this Thanks giving dinner I met someone who had used it in New York area. He and his wife each owned a car, now they just have one car between them and use Uber as a backup. This statement might conjure a great story for this business, because if it can be scaled across USA then Uber’s power can be equivalent to replacing around 75 million cars (assuming 75 million households in USA) . But it will be a great mistake to scale something that’s applicable to New York City and apply it to USA. One of the main reasons my friend opted for Uber is because of the parking problem he used to face and plus the high insurance rates. Uber with its efficient service , provided a somewhat comparable alternative that other cab companies could not provide till date. If we move 200 miles north of New York city to Schenectady, NY (Home of GE Energy) . I can bet that there will be no trace of Uber, because residents there have ample parking spot and crime rate is very low (compared to NYC) and hence people are very comfortable owning a car. In fact if we look at human psychology, we rather prefer having something of our own than sharing it, but we get inclined to sharing when the cost of ownership goes beyond the value it creates. Coming back to the question posed at the beginning of this para - What is Uber and who are its customers?, Uber is a web based Taxi service catering to customers who find it inconvenient to own a car or for some reason cant own a car , but can still afford somewhat a high prized taxi service. What is the potential size of Uber’s customers? Following link gives list of cities that Uber caters to. https://www.uber.com/cities . I peaked at North American cities and could see that its covering around 80 metro areas with an average population of 2 million. Thus one can say that it caters to around 160 million, which is half of USA. I feel Uber has reached the limit as far as growing to additional metro areas. The reason is simple - Its service is only viable if the metro area is above a threshold population. But I can certainly see Uber expanding its user base in the metros its already offering, especially Generation ‘Y’. One very important factor that’s helping Uber is that the recent economic slump affected Gen ‘Y’ the most because most of them had just graduated and entered the job market, thus most of them did not have an opportunity for a stable job which affected their credit rating and thus affected their borrowing strength. This in turn has delayed their ability to own a car and hence has given Uber an opportunity to make them a loyal customer. What is my valuation basis? As per Uber’s web site it’s pretty much in all developed and developing countries. As a fun exercise I clicked on Pune and requested a quote from my parent’s house to Railway station . Uber X was Rs 1,800 and UberBLACK was Rs 2,400. Sounds little bit expensive, but I guess it’s targeted more towards the affluent. But I am skeptical if the Uber will have the same brand loyalty in India or any Emerging economy , because transportation services is very competitive in those areas and folks are very price conscious. So I would simply assume that half of Uber’s worth is the cash it will generate from USA. Thus the total value of Uber’s business will be twice that of the net discounted Free cash it can generate from USA. Average Earnings of an Uber Driver: The base of Uber’s business is its drivers. The more money they make, the more Uber gets, because Uber gets around 20% share of the fare collected by the driver. As I have no experience in Taxi business, so thought of finding a somewhat reasonable source for my answer. I found an answer in quora.com that answers my question http://www.quora.com/How-much-money-does-an-average-Uber-or-UberX-driver-earn-in-a-day-What-about-people-that-drive-full-time-for-Uber The person who posted the reply works over 50 hours a week and manages to get $1,500 / week. He is from San Francisco, which is at the highest end. Thus on an average we can assume that the drivers make around $1,000 a week , which is $52,000 / year. Uber’s share is 20%. Thus from each driver, Uber tends to generate a revenue of roughly $10,000 per year. On an average if we assume around 1000 drivers in each of the 80 metropolitan areas , thus total Uber drivers in USA is 80,000. Estimated free cash Generated by Uber in USA : With 80,000 drivers and $10,000 per driver per year, total cash receipts = $10,000 x 80,000 = $800,000,000, which $800 million. Assuming an operating margin of 25% , its pretax income is 0.25 x $800 million = $200 million. Tax rate of 35% would put its Net operating cash flow from USA at $130 million. Assuming that $30 million will be ploughed back for Capital expenditures , thus the Free cash generated by Uber in USA = $130 million - $30 million = $100 million. Discount Rate and Growth rate: Being a startup business with a very new business model I would give a discount rate of 15%. The initial growth rate of 35% for first 5 years , 20 % for next five years and 12% for next 10 years. Overall Discounted free cash flow in next 20 years : Above we found that the discounted free cash flow of Uber USA was $100 million and we assumed that half of Uber’s worth was its USA business, thus the total base Free cash flow of the business = $100 million x 2 = $200 million. Plugging in the growth rates and discount factors for next 20 years, we get aggregated discounted cash flow for next 20 years as $5.92 billion , which is roughly $6 billion. CONCLUSION : Uber’s Fair valuation is $6 billion (Assuming Base Free cash flow for first year as $200 million , growth rate of 35% for first 5 years , 20 % for years 6-10 , 12% for years 11-20 and discount rate of 15%). Click here to view the excel sheet that has the Valuation model that lists down the different factors for valuation.

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