Gamestop: Consensus Needs to Catch Up to Reality
Leading video game retailer Gamestop has a lot of fans on the buy and sell aside alike. On the back of new console releases and attractive growth story, the stock has been hot. But recently, the stock has seen some technical slippage and we think this is the beginning of a further meltdown, rather than a hiccup that will quickly correct itself.
Out of the 16 analysts that follow GME, only one has an underperform rating. We find the bullishness on GME excessive and a sign that the sell side has fallen into confirmation bias mode, which is a behavioral finance precept that says investors choose to emphasize everything that supports their prior convictions while downplaying any negative news. In the case of GME, which is already down 28% this year, there have been plenty of defense machinations playing to the company’s longer term prospects (diversified business model, robust merchandise mix, etc).
On the last conference call, it was all fireworks: The Company noted that the installed base of video games grew 31% in 2007, “the highest incremental growth in the history of the business,” and he says hardware unit sell-through should match those levels in 2008. The company said it opened 210 new store in Q1, and is shooting for as many 600 new stores in 2008.
But not many GME followers have really given much consideration to the following:
- Even after the recent beating, Gamestop still trades at a 30% premium to the market. This is as the main product cycle is winding down: big games have already been released, and the tough consumer environment is likely to stick around a bit longer than anyone expected. Certainly, when we ramped up on Dicks Sporting Goods, we did not imagine $135 oil. Specialty retail didn’t see the poor economy effect until recently, and Dick’s got destroyed after a missing slightly on the top line. Gamestop is looking at tough comps ahead and analysts are likely to ratchet down their expectations and possibly “kick down to a hold stance,” as one of our buy side contacts puts it.
- In a move that would put it in direct competition with GameStop, Blockbuster (BBI) recently introduced expanded game sections in its stores, with a focus on selling game consoles and new games in addition to renting games and selling used titles. Unlike GameStop, however, Blockbuster is focusing on the casual, mainstream buyers as opposed to hard-core gamers, and gunning them down with attractive packages. One such bundle for $499 included a Sony PS 3 game console, an HDMI video cable, remote control, a copy of the Spiderman 3 Blu-ray movie, a copy of the PS3 Transformers game and a 12-week PS3 game or Blu-ray movie rental card.
Most of the sell side seems to think that Blockbuster is in no way going after Gamestop’s core franchise. Many expect BBI to take market share from mainstream retailers such as Wal-Mart instead. However, Blockbuster is desperate and could eventually go more aggressively after the used games market, which carries margins that far supersede those on consumer electronics. Right now, used games account for 40% of GME’s profits. In other words, if the Blockbuster/Circuit City deal falls apart, and it becomes clear GME is itself not a target for Blockbuster (GME has several anti-takeover provisions in place: poison pills, golden parachutes, and a staggered board), we’d expect Gamestop to sell off further given the belief that Blockbuster will beef up its video game pursuits to make up for the inability to close in on Circuit City. You add this to the fact that online delivery of games is becoming increasingly feasible and you have a scenario where portfolio managers are calling in their analyst into the conference room to decide if its time to let go of GME.
Bottom line: GME is a well run company (with 1/5th of the market) and a monster of a stock. But there is some near term challenges the company will be facing. Long term, you can argue all day that owning the name is the best way to play the secularization of gaming (families and females joining the young male core base), but the near term window is presenting a shorting opportunity; management insists the download threat is “way down the road,” but they’ll have to be a bit more specific at some point – and soon.
If not, there is no way all those outperform ratings on the stock will stay in place. A test of the $40 level will likely be the next move.
Disclaimer: The author did not hold a position in GME at the time of publication
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This article has 15 comments:
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Brighteyes
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7 Comments
Jun 11 01:47 PMI believe the consensus is overvalued at this point as suggested in the article. Between the recession, the weak dollar, high gasoline prices and dropping consumer confidence, GameStop earnings and revenue will decline caused in part, by the fact that the new Generation console rush is old news. I like GameStop and their management is good so it is not likely that they are near failure, but the current price is not worth the valuation and near term potential.
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Gaucho420
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53 Comments
Jun 11 05:14 PM1) barely anyone has crossed over from the PS2 to any of the new consoles..check the stats...well over 60% of PS2 users have not bought anything new. Once the 360 and PS3 fall in price (and they most certainly will), their will be a rush to buy one or the other or a Wii. I know many, many, many people who have not bought a Wii, PS3 or 360...its the wide majority of gamers out now .
2) Prior to today's fall, GME's PEG ratio was below 1.0, indicative that bad news is already priced in. I think its heading towards 0.90 soon.
3) The PE ratio, at 21.71, is right in the range of other retailers, suggesting it is not over-priced and suggesting the PEG ratio is severely undervalued.
4) The Nintendo revolution of mass gaming is bringing in many, many new gamers who simply weren't here this time around. That is a large widening of the market and you cannot compare the last cycle to this one.
5) Many existing gamers have more money than last time around. I'm 32 now and I own multiple consoles. This was never possible before. As the core demo gets older, many buy more games as they can, for the first time in their lives. The attach rate of 360 games to the system is further proof...Nintendo also claims the Wii has the highest attach rate of any Nintendo console before. This is simply due to the core demo getting older, having jobs and choosing to spend money on their favorite hobby. I am proof, so are my friends...this isn't brain science.
6) The stock is approaching its 52 week low and is down over 33% from its 52 week high. How much more of a retrenchment can possibly be expected?
7) I agree 100% with GME, downloading of games IS YEARS AWAY. Have you tried downloading a movie on Xbox Live? Its not a quick thing. Games are much larger and games that are on the 360/PS3 are much too large to go to full download. Once movies get there, I'll start to worry, But yes, down the line this will be a problem, for all videogame retailers.
8) BLOCKBUSTER? That's ridiculous. Who shops at Blockbuster and why would anyone think gamers or families are headed to blockbuster for their gaming purchases? I don't know any gamers that thinks of Blockbuster for their gaming needs. The company's rep is simply atrocious so I don't buy that at all.
The true problem with GME is its customer service, which is not very good, anywhere. Stores run by 20 something gamers who feel they have to prove to everyone they are the videogame savant really turns off quite a few people, especially as they feel the need to comment on every game you buy (why are you buying that game...bla, bla, bla). Also, GME is always out of stock on almost every single hot product and the stores, in my opinion, could be better laid out. They still feel from 10-15 years ago and remind me of Babbages.
Interesting take though on a possible collapse of sales. If that's the case, forget GME, the entire industry is in trouble. But I believe given the downfall in the stock's price, that soon, it will be a good buy. We'll see if my mouth is where my money is, as I don't have a position on this stock yet, but I'm watching it carefully.
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John Doe 1973
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3 Comments
Jun 12 06:13 AM2) Blockbuster? The only Blockbusters I know are in the middle of suburbia, hardly close to any like shopping. The Gamestops I know are in malls and in other locations with a lot of foot traffic and exposure. Location, location, location.
3) Current gen console are NOT orientated towards full game downloads. Typical network connections are NOT currently fast enough to make frequent (next gen) game downloads feasible either. Package goods are going to dominate for at least another 7-10 years. You can't tell me the market is starting to discount this stock for something that might happen 7 years from now!
4) At $40 this stock would be trading at 13-15 times forward earnings...that below both the industry and sector averages, for a company that is certainly going to outgrow the average next few years. Is this rational?
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East Coast
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50 Comments
Jun 12 09:08 AM-
John Doe 1973
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3 Comments
Jun 12 12:02 PMLess than half of those people that own PS2s currently own a next gen console and when they finally upgrade that will lead to increase software sales. Isn't this a simple but powerful formula for comp store sales growth? As far as market share is concerned, new game prices are mostly fixed giving the bigger players no real advantage, and GameStop will continue to have its monopoly on used games. I don't see serious risks in either of these areas.
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the good doctor
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1 Comment
Jun 13 07:22 AM-
Dan Jacome
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617 Comments
Jun 14 01:42 AMCOMMENT: Lynch was a god in many ways, but his tenets don't hold as much water today as they did 15 years ago. See this article --
www.nytimes.com/2007/1...
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Dan Jacome
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617 Comments
Jun 16 04:17 PMNOTE that "Goldman has upgraded GameStop (GME) to Neutral today, but the only because the stock fell below its $50 target (which the firm cut to $45 today)..." according to Clusterstock.com
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East Coast
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50 Comments
Jul 11 10:57 AM-
Risky Business
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4 Comments
Jul 14 02:34 PMWhile they can recoup some of the lost margin by lowering trade-in values, it's a losing proposition: lower values on trade-ins for store credit will lower purchasing power and impact volume. Trade-ins for cash don't usually generate related sales volume from rational beings.
Blockbuster and Circuit City are non-issues.
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Dan Jacome
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617 Comments
Jul 14 03:26 PMexcellent pts, thank you.
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flyer
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1 Comment
Jul 14 06:57 PMWhat a dumbass statement. It's "at least" 10 yrs away from "mainstream feasible". Games are getting bigger and bigger while way too many people are still dealing with satellite & dial-up (yes, dial-up) service. Even with DSL it's a challenge to try downloading huge files the likes of newer games. Additionally, most people still feel better about having a physical disc in their grubby hands. I know people cutting back on cable internet to DSL & even dial-up so they can save $20-$40 a month. They're taking the savings and buying an extra new VG every few months (extra as in 1 more game that they wouldn't have bought otherwise).
People are spending less on big vacations and trips that require gas. Staying home and enjoying some VG playing is a very cost advantaged form of entertainment. Even people who are barely getting by somehow always seem to have a nice big TV and a game system (or two)... The escapism of VG's is just what people want in difficult times and will keep sales robust.
GME's real problem is the multiple compression that's occurred as people have been scared into "expecting" bad news for "all" retailers. People aren't willing to take the risk even though they're in the specialty sector that actually still does good in a weak economy. Fear and uncertainty is plain and simple the only reason the stocks fallen as the multiple people are willing to pay has come in. At these levels the risk/reward definitely favors the long side...
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buyforeclosures
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118 Comments
Jul 17 08:08 PMoh wait..did I forget the "Watch and learn?" lol - SHORT everything when Oil goes up! except oil that is .hehehehhe
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RoundTheCorner
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1 Comment
Aug 01 05:03 PMPerhaps the authors case will be confirmed in the announcement, OR it will be totally blown out of the water in a bounce back to the upper 40's, pushing to 50's in the normal run to Black Friday.
Place your bets!
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Dan Jacome
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617 Comments
Sep 28 02:24 AM