Recently GameStop (GME) has taken a beating in the market with the release of some very unflattering news. As we all know the stock market is a very unforgiving place.

GameStop came across my radar a few years ago when I was doing my regular screening looking for new opportunities. Until recently I hadn’t pulled the trigger on the company, but after digging into it a little more it appeared to be a great opportunity. In the light of recent news, I am wondering if I made a good decision or walked into a value trap.

GameStop vs Blockbuster
Photo by JeepersMedia

I admit I was first attracted to the 6% dividend yield, which was very enticing. In addition to the low P/E ratio, it appeared this was a great opportunity, as well as other financial strengths.

In this article, I will take a look at my findings again and re-evaluate my decision to buy and whether or not to stay in at this point or to sell and just cut my losses.

Retail is a brutal environment and the competition can be fierce. With the recent announcement of Microsoft’s (MSFT) Xbox’s subscription service there has been a lot of concern among GameStop investors in how this will affect the company long-term.

Let’s take a look.

Business Overview

Founded in 1994 in Grapevine, Texas. GameStop operates more than 7600 stores now. These stores are located in the U.S., Australia, Canada, and Europe.

Gamestop’s primary business is selling new and used video game hardware and software. This includes accessories such as gaming consoles, controllers, headsets, and memory cards.

Segments:

 

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Source: GameStop Investor Presentation

 

Video Game Hardware/Software              49.58%

Preowned                                                 22.34%

Accessories                                              7.83%

Digital                                                      1.87%

Technology Brands                                  8.4%

Other                                                       2.96%

 

Obviously, videos make up a very large percentage of their sales with the current numbers being 71.92% of their total sales.

In recent years, GameStop has begun attempts to diversify their business. They have branched out into the consumer electronics business, selling smartphones and tablets.

In addition, they have launched Spring Mobile, where they have recently become the largest owner of AT&T (T) wireless retail stores, outside of At&T.

They also partnered with Apple (AAPL) to open 72 Simply Mac stores, which serve as tech support outlets for Apple products.

They now have a goal of reducing its reliance on video game sales to less than 50% of its revenue. Currently, they stated in the most recent earnings call that revenue from technology and collectibles make up 39% of their sales. So, they are not there yet but they are on the way

In 2016 they saw non-physical gaming revenues of over $2 billion. So while GameStop has changed its focus, they are still tied to the physical gaming hardware, which is now an industry that is in decline.

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Source: GameStop Investor Presentation

In addition to the increase in revenue from sources other than video games, the company recently announce that they will be reducing their store count by 150 stores. By eliminating stores that are underperforming they will cut overheads and other costs and thus far this has worked.

This is not unlike other retail stores, who are all reducing store counts, even mighty Walmart (WMT) is lowering their store counts.

In addition, GameStop also owns a diverse portfolio of video game websites such as Ebgames.com, Kongragate.com, and Thinkgeek.com.

All the changes in direction are a recognition by management that changes are needed if they are going to survive. And they are implementing them, although maybe not as fast as some investors would like.

Business Analysis

First, let’s take a look at some of the numbers that have driven the price down recently.

 

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Source: Intrinsic Value Formula

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Source: Intrinsic Value Formula

With the sales growth pretty stagnant for the last six years and free cash flow stagnant as well you have seen an increase in earnings per share and free cash flow per share rise because of the very aggressive share buybacks that have been instituted.

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Source: Intrinsic Value Formula

As they have reduced the share count it has helped elevate the earnings per share and free cash flow per share, even when the real dollar amounts haven’t grown that much.

Other bad news was released during the latest earnings release. It was revealed that same-store sales for Q4 2016 were down 16.3% and FY2016 were down 11%. In addition, adjusted EPS for Q4 2015 was down 0.8% at $2.38 and for the FY 2016 down 3.3% at $3.77.

Additionally, GameStop guided down for 2017 as well, with sales estimated down 2% and same-store sales down 5% to even. Net income and earnings per share were guided down as well with $320 million and $3.10 respectively, also guiding down were video sales and hardware.

The big news recently was that Microsoft (MSFT) just announced their new Game Pass which will allow you to use 100 of the most popular older Xbox One and Xbox 360 games, all of this for a $9.99 monthly subscription.

In addition to this news, the subscribers will also be able to buy these games at a 20% discount to their retail price.

Of course, this will hit GameStop right in the bottom line because GameStop generates over 30% of its gross profit from older game sales.

We all know that the video game industry is shifting away from physical games and towards downloads, and with Microsoft and Sony moving towards subscription services, this is no surprise.

The surprise was that Wall Street reacted very badly to this news and the price dropped 10% the day of the announcement.

Good news:

The Technology Brands segment achieved its goal of adjusted operating earnings for 2016. It came in at 90.2 million, which was a 216% increase over 2015.

In addition, the Collectibles business was able to meet its revenue target of $494.1 million in 2016.

As we stated before, the company is moving towards a goal of earnings from businesses beyond physical games of 50% and in 2016 they achieved non-physical gaming businesses comprising 36.9% of total adjusted operating earnings.

They also acquired 511 Technology Brands stores, ending the year with 1522 stores and as AT&T’s largest authorized retailer.

Technology’s brand’s sales increased 52.4% for the full year. And adjusted operating earnings grew by 216.4%.

Other good news was that the new Nintendo Switch sold out in the three major shipments they received in a matter of hours.

This is a prospect that most people haven’t considered. The impact of new hardware releases by Sony (SNE) and Microsoft (MSFT) and what that could do for the company over the next few years.

Gamers don’t want to order new consoles online, they want it now or on

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