GameStop Still Says It Will Grow EPS 30%+ as Game Sales Drop 24%

GameStop Still Says It Will Grow EPS 30%+ as Game Sales Drop 24%
By Blubberboy92 (talk · contribs) (Retraced from original logo.) [Public domain], via Wikimedia Commons

GameStop Still Says It Will Grow EPS 30%+ as Game Sales Drop 24%

This is from a post I did in Mid august on Gamestop:

Same store sales down in excess of what was projected, SSS guidance for the rest of the year ratcheted down lower (again) than projections, cash falling, current liabilities not falling, etc etc etc

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Now, here is the key point. The main reason results aren’t materially worse is because of the buybacks. Buybacks aded $.02 to earnings in the current quarter and $.06 YTD. Without them, earnings for Q2 would have been 14% lower and 9% lower YTD. Here is the problem with that, they are running out of cash to keep this up without taking on more debt. The company has made $.71 YTD and expects $.32 (middle point of guidance) in Q3 for a total of $1.03. That means Q4 must deliver $2.17 to hit the middle point of their annual guidance.

That will be quite a trick seeing as they made $1.61 last year. They are below results from ’11 YTD ($.71 vs $.78), have guided Q3 well below the $.39 they earned in Q3 last year but are magically going to grow Q4 EPS 35%. Anyone want to explain that to me?

Today the news is out that video games sales continue to crater (emphasis mine):

ideo game retail sales declined for the tenth consecutive month in September 2012. According to market research firm NPD, U.S video game store sales slumped 24.0% year over year to $843.3 million in the month of September. Although the year-over-year decline widened compared with the prior-month level, dollar sales increased from $515.6 million reported in August.

Hardware sales plunged 39% year over year to $210.9 million while total software sales declined 14.0% year over year to $547.3 million. Accessories sales declined 11.0% annually to $139.9 million. The weak retail sales were primarily due to the ongoing transition from physical to digital platform and aging hardware consoles.

At the end:

However, declining consumer spending on video games and the continued rapid adoption of free-to-play games remain the main headwinds over the long term. Although, we believe that the ongoing transition from the physical to the digital platform will ultimately benefit the video game industry (due to the cost effectiveness), low priced digital games have failed to offset the rapid decline of high priced retail sales in recent times

Moreover, the highly fragmented video game market continues to witness increased competitive pressures, which are hurting overall profitability.

Now GameStop Corp. (NYSE:GME) came up short and guided lower after both Q1 and Q2 so it is no surprise that they are silent now (Q ends 10/31). It is surprising that traders have bid the stock up while the macro environment they operate in continues to tank. This is akin to people buying stock in Electronic Arts Inc. (NASDAQ:EA) as national auto sales fall 20% YOY. The ONLY way GameStop Corp. (NYSE:GME) makes their annual guidance is to go all in on their share buyback plans which means emptying the bank accounts (cash is already down 40% YOY as of the end of Q2 and receivables down 10%). At today’s prices that would take ~6.2M shares off the market or ~5% of the total. Seeing the trends we see, this isn’t nearly enough to offset the collapse in video/console sales.

The main argument from bulls of the stock (at least those who contact me) is that digital games are not like video. They are too big and take too long to download so the transition to them will take years (or never). The problem with that argument is that for $GME to suffer it does not need to be an But Gartner estimates that consumer spending on global online gaming (through subscriptions and microtransactions) will grow at a compound annual growth rate of 27% through 2015. This will improve monetization from digital distribution and free-to-play games going forward. Moreover, as compared to the physical platform, digital games are more profitable since they require minimum packaging cost. Electronic Arts Inc. (NASDAQ:EA), which is seeing a slowdown in sales like everyone else is seeing digital growing 20%. Additionally, once makers produce the majority of games for digital download, why do they even need a GameStop Corp. (NYSE:GME)? Why not just have gamers go directly to the Electronic Arts Inc. (NASDAQ:EA) site to download and cut out the middle man and his piece of the pie.

Here is the thing. Let’s just say the bulls are right and Madden and Black Ops will never ever go digital (they will, but lets pretend). We know that countless other games are in droves just by looking at the sales data. Further we know game producers are making this a priority as the profitability of digital trumps the physical model. So the # of games available for download is going to explode. We also know that unlike current games console’s, the next generation models are going to be optimized for download (more memory, faster processor speeds). So, even if the mega games never are able to go to download (they will), most of the others will.

Speaking of the consoles, bulls like to say that GameStop Corp. (NYSE:GME)will get a huge boost when the next gen console’s are rolled out. Again, let’s go with that. While I am sure they will (although I am more than a little sure Wal-Mart Stores, Inc. (NYSE:WMT) and, Inc. (NASDAQ:AMZN) will compete intensely here) it may indeed be a Pyrrhic victory. While they will get a quarterly boost from the actual console sale, that new console, optimized for the downloading of games will ultimately do significant damage to GME’s core model over the longer term.

So, if you are GME and your model mainly depends on selling physical games and the trade-in business that generates (50% of profits), when the number of games sold via physical DVD dwindles to only a few, do we really think that is a business worth nearly $3B? I don’t.

By: valueplays

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Todd Sullivan is a Massachusetts-based value investor and a General Partner in Rand Strategic Partners. He looks for investments he believes are selling for a discount to their intrinsic value given their current situation and future prospects. He holds them until that value is realized or the fundamentals change in a way that no longer support his thesis. His blog features his various ideas and commentary and he updates readers on their progress in a timely fashion. His commentary has been seen in the online versions of the Wall St. Journal, New York Times, CNN Money, Business Week, Crain’s NY, Kiplingers and other publications. He has also appeared on Fox Business News & Fox News and is a contributor. His commentary on Starbucks during 2008 was recently quoted by its Founder Howard Schultz in his recent book “Onward”. In 2011 he was asked to present an investment idea at Bill Ackman’s “Harbor Investment Conference”.

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