GameStop Corporation
Analyst: Alex M. Brandon
Company: GameStop Corp.
Recommendation: BUY
INVESTMENT THESIS
I recommend a BUY for GameStop (“GameStop” or the “Company”, Ticker: GME) for a number of
reasons:
-
The market has been down on GameStop and the video game industry as a result of the
recession.
The industry has showed signs of improvement in March (6% growth in March).
GameStop holds the largest market share in the industry.
GameStop earns above average margins as the result of its dominant position in the used video
game market.
The Company possesses a strong financial position relative to competitors.
The Company’s multiples are below historical levels despite GameStop’s strong financial
position.
INDUSTRY OVERVIEW
As consumer discretionary products, the video game industry was hit hard by the severe economic
downturn. Global video game sales were down 7% in 2009 and are down 7% at the end of March
compared with the first quarter of last year. However, total video game sales climbed 6% in March
(compared to March of 2009). This could be an indicator that the video game industry is ready to
rebound.
GameStop estimates the video game products and PC entertainment market to be $41 billion based on
2009 figures. Industry growth has been driven by hardware platform technology evolution, new
platform capabilities beyond gaming, backward compatibility, and new games. These same factors are
likely to drive the industry in the future.
1
COMPANY OVERVIEW
GameStop Corporation is the world’s largest retailer of video game products and PC entertainment
software. GameStop sells new and used video game hardware, software and accessories. The Company
operates 6,450 stores throughout the U.S., Australia, Canada, and Europe. In addition, the Company
operates an e-commerce website and publishes Game Informer, which is the largest multi-platform
video game magazine in the U.S. based on a circulation of 4 million subscribers.
The used video game market is a key reason for GameStop’s success. The used video game segment
provides customers the opportunity to trade in used video games for store credits and apply those
credits toward other merchandise, which in turn, increases sales.
Financial Review
Sales. Overall sales for GameStop were up 3.1% in 2009. This was the result of new store openings (388
in fiscal 2009). Same store sales were down 7.9% in 2009 as a result of the economic downturn.
Cost of Revenue. Cost of goods sold as a percent of revenue was 73.18% in 2009, down from 74.22% in
2008.
Operating Income. Selling, general, and administrative as a percent of revenue grew 13.03% in 2009.
This accounts for 19.80% of revenue, which is up from 18.06% of revenue in 2008. As a result, operating
income as a percent of revenue was down to 7.02%.
Net Income. Net income declined 5.28% in 2009.
Cash. The company’s cash position grew from $578.141 million to $905.418 million in 2009. Current
assets jumped as a result of this increase in cash.
Fixed Assets. Gross fixed assets grew from $1,084.893 million to $1,246.011 million in 2009. Net fixed
assets grew from $549.254 million to $584.201 million.
Debt. Long-term borrowings declined from $545.712 million to $447.343 (18.03% decline).
Future Outlook
The industry expects to see an increase in demand in the near future as the economy rebounds from the
recession. As such, the Company expects to see same-stores sales growth from increased demand. In
addition, GameStop plans to open new stores which would help revenue growth. I anticipate that sales
growth from new stores will be 2-3% each year and organic growth to be 3-6% each year. Obviously, as
the economy improves, so will video game demand.
Before the recession in 2008-2009, the Company’s net income was growing at a rapid clip (anywhere
from 30% to 80% NI growth each year). GameStop’s earnings took a hit in 2009; however, I expect the
Company to rebound significantly in the coming year.
2
Analyst Opinion
GameStop received 12 buy recommendations, 6 hold recommendations and 0 sell recommendations
since late last year (most recommendations came after February 1, 2010).
STOCK PERFORMANCE
5-Year
2-Year
3
1-Year
6-Month
VALUATION
Market Approach
The global video game industry is characterized by intense competition. GameStop competes with Best
Buy, Wal-Mart, Target, The Game Group, Movie Gallery and Blockbuster in the video game market.
These peers (aside from The Game Group) operate in multiple industries which may distort their market
4
multiples. However, when we look at GameStop’s multiples over time and against these competitors,
we can see that they are likely below their appropriate levels.
As you can see, GameStop’s multiples are well below current industry levels. Also, the Company’s
multiples are well below historical norms. I utilized this data to estimate the intrinsic value of the
Company based on 2009 financials.
I believe the multiples above are realistic estimates for GameStop. Based on the 2009 financials, the
Company has an intrinsic value of approximately $35 per share.
Income Approach
In addition to the multiples approach, I utilized a discounted cash flow analysis to estimate the present
value of all of the Company’s future cash flows. Using a beta of 1.05, a risk free rate of 3.79% (10-Year
Treasury Rate) and a historical market return rate of 10%, the return on equity is calculated as follows:
CAPM = 3.79% + 1.05 (10.00% - 3.79%) = 10.32%
I utilized the CAPM rate of 10.32% in my valuation of GameStop Corporation. In developing my
estimated free cash flow growth, I utilized economic, industry, and company-specific trends. Based on
my analysis, I calculated a value of approximately $32 per share for GameStop.
CONCLUSION OF VALUE
At the time of the analysis, the Company’s shares were trading at $25.46 per share. Based on my
analysis, I believe the intrinsic value of GameStop is between $32 and $35 per share. This represents a
difference of approximately 25% to 35% between my estimate of value and the current market price. I
believe this provides enough of a margin of safety to account for the risk associated with my valuation.
Thus, I recommend we BUY GameStop.
5
Sources:
GameStop Corp. 10-K
Google Finance
Yahoo! Finance
Seeking Alpha
St. Louis Federal Reserve
6