Guessing about GameStop (GME)

 GameStop Corp (GME) is a large chain of 6450 retail stores that sell new and used video games as well as related equipment . Some 69% of GME’s stores are in the US and 20% in Europe.  It also has several e-commerce websites, publishes Game Informer magazine with  4M subscribers, and just began selling downloadable games and add-ons at Internet kiosks inside its stores and from GameStop.com,  its main website.

GME was the monthly Online Stock Study for December at the Better Investing website.  It was led by Patrick Donnelly, a Director of the BI Pittsburg Chapter and the BI Volunteer Advisory Board.  Pat’s presentation slides, handouts, and the recorded session are available for downloading by BI members.

The purpose of the monthly Stock Study is to complete a SSG in about one hour with consensus decision-making by the on-line participants.  Participants made most of the judgments, but Pat also made a few.  No Consensus SSG is available, and may never be, so I had to rely on the recorded session which is awkward and time-consuming.

Company Background:

- In November, Value Line reported that GME has recently set up downloadable game content kiosks in it stores across the U.S. and is revamping its website from strictly e-commerce to a full-featured gaming platform.

- “Dismal long-term prospects” is how Morningstar began its late September report on GME which it called a no-moat retailer.  Pricing competition from rivals and the use of the Internet to play and/or download games, Mstar predicted, would eventually lead to declining revenue and razor-thin margins.

** Used video games represented 20% of revenue and 47% of gross profit in 2009, and are essential to GME’s financial health.  However, Wal-Mart, Best Buy and Target have begun in-store programs to buy and sell used video games.

** Mstar identified three, big risks faced by GME:

• large retailers like WMT, TGT, and BBY are starting to compete in the used video game business;
•  publishers of video games are adopting new initiatives, such as one-time downloadable online game content, that can ruin GameStop’s used gaming business; and
• it seems likely that most games soon will be delivered over the Internet, making GameStop’s (old) business model obsolete.

** Mstar concluded: “In the near term, we think retail rivals will impinge revenues and profits from new games and consoles. In the medium term, we expect video game publishers to disrupt the used game business [AF: by using the Internet to sell directly to gamers]. Thus, GameStop faces a bleak long-term outlook, selling the video game equivalent of vinyl records.”

Recent Acquisitions:

 - In November 2008, GameStop spent $500.4 M to acquire Micromania, a French retailer of video and computer games with 368 locations. [2009 GME Annual Report, page 2]

- In November 2009, GameStop acquired a majority stake in Jolt Online Gaming, an Ireland-based publisher of online games that are free to play on Facebook or with most Internet browsers. 

** Terms were not revealed, except that GME will provide up to $30M in the next 2-3 years for the company’s development.

- In July 2010, GameStop bought Kongregate, a social gaming and game development site, that offers more than 36,000 free games and that Time.com recognized as one of the 50 best websites in 2010.

** Again, the acquisition terms were not disclosed in GME’s press release. 

SSG Discussion:

- The table below compares the Consensus SSG with mine, Take Stock, and with LenD’s SSG from 2009 (which I got from BI’s First Cut). 

** After the table, I discuss several key SSG judgments and dig a little deeper into GME’s Relative Value, down-trending Return on Equity, and its overall Financial Condition.

GameStop                 (GME)	Consensus  SSG & PatD	Armin	Take Stock		LenD
Date	11-30-10	12-18-10	12-16-10		4-21-09
Data	S&P	Same	Mstar-Hemscott		S&P
Price at SSG	$19.92	$21.67	$21.56		$29.80
52 week High &   Low Price	$26.75 &     $17.12	$25.75 &  Same	Not Used		$57.20 &    $16.91
Last Quarter of Reported Data	Q3 ending   10/31/10	Same	Same		Q4 ending  1/31/09
Project Growth           From End of	Last Q	Same	Last FY		Last Q
Estimated                Sales Growth	7.00%	6.60%	2.90%		11.0%
Estimated                EPS Growth	9.00%	6.60%	-6.00%		11.1%
Forecast                        High PE	15.5                  (Hi & Lo PE       5 yr ave)	14.4                 (from 2009)	19.4		18.0
High EPS	$3.71	$3.12	$1.65		$4.06
Forecast                   High Price	$57.50	$45.20	$31.97             (20% < VL)		$73.10
VL Estimated High Price  = $40-60 as of 11-5-10					VL=$70-$110    as of 11-7-08
Forecast                   Low PE	7.0                 (from 2008)	7.0                 (from 2009)	8.2		9.0
Low EPS	$2.41 (ttm)	Same	$2.14		$2.40
Forecast                 Low Price	$9.00       (lowest in       last 5 yrs)	$13.70             (80% x 52     week low)	$17.55          (low PE x       low EPS)		$21.60
Upside/ Downside Ratio	3.4	3.0	1.35 (imputed)		5.3
Total Return	23.6%	15.8%	8.20%		19.7%
Buy Under	NA	$21.58	$15.99		NA
RV/PRV                   (no outliers)	47.5/43.6	49.2/46.0	Not Used		64.6/58.2
RV/PRV             (outliers out)	Not Used	65.7/61.5	Not Used		Not Used
Quality	S&P = NA	S&P = B+	TS = 1.6 (fails)		NA
PTPM – 5 yr ave	6.2%              Trend even (thru 2009)	Same              Same	6.2%             Trend  NA		6.1%              Trend up       (thru 2008)
ROE – 5 yr ave    (with ending             year equity)	Not Used	13.8%      Trend down        (thru 2009)	Not Used		13.3%        Trend up        (thru 2008)
ROE – 5 yr ave    (with starting    year equity)	17.4%           Trend down(thru 2009)	Same             Same	17.6               Trend NA		Not used
Debt to Equity   – 5 yr ave	43.8%        Trend down (thru 2009)	Same            Same	Not Used		NA

 Estimating Future Sales Growth for the next 5 years:

- Pat gave the participants 5 choices: 24.0%, the 10-year historical growth rate; 11.0%, the industry average; 7.0%, Value Line’s estimate; 3.5%, from the latest quarter; and none of the above.

** None of the above is a meaningless choice which I will not repeat;

** Value Line’s 7.00% was for Sales per share (not Sales) and VL makes no estimate of future Sales growth;

** Zacks.com was also estimating 24.17% Sales growth for the next 5 years;

** Historically, GME’s sales growth has been steadily declining since 2006: down to 20.0% growth during the last four years; 13.1% in last three; and 3.1% during the last two years.

### The Consensus opted for 7.0% (from VL) which got 43% of the votes while 11.0% (the industry average) got 21%.

Estimating Future EPS Growth for the next 5 years:

 - Participants were again given 4 (meaningful) choices: 7.0%, same as their Sales growth estimate; 30.0%, last 8 year average; 17.0%, highest of seven long-term estimates that Pat found; and 11.0%, the average of the seven estimates.

** Presentation slide 34 vividly sets forth the distribution of the seven estimates that are all from different data sources;

** The company’s EPS growth, like its Sales growth, has also been steadily declining: 31.0% last four years, 12.3% last three; and -5.4% (that’s a negative 5.4%) during the last two years.  The recent downtrend in EPS and Sales is one negative indicator of quality based on BI standards.

** The Consensus choice was 11.0%, the average of the seven estimates (51% of the votes), while 7.0%, same as their Sales growth estimate, was next (24%).

### Pat decided to use 9.0% because of GME’s stock buyback program.

- I estimated 6.70% future EPS growth, the average of the same seven estimates that Pat checked less 3 Standard Deviations, because I guessed that GME was headed for tough times.

** Excel easily calculates the Standard Deviation and I usually go no lower than the average less 2 SDs (7.96% here) and more often use the average less 1 SD (9.25%);

** For how to find the seven long-term estimates and how I estimate EPS for all my SSGs, see: Estimating EPS.

** For my evaluation of these EPS estimates from seven different sources, see: Evaluating EPS Estimates.

Estimating the Future High PE for the next 5 years:

- Participants were given 4 options: 24.0, 5 year historical average; 26.1, 5 year average PE x 1.5 ; 18.0, estimated EPS x 2 or a PEG of 2; 13.5, estimated EPS x 1.5 or a PEG of 1.5.

** The Consensus chose 13.5 or a PEG of 1.5 (40% of the votes) while the next choice was 24.0 (24%)

### Pat decided to use 15.5, the 5 year average High & Low PE.

- I used 14.4, from 2009 and the lowest High PE in the last 5 years.

Final Results:

- The Consensus/Pat began with 9.00% EPS estimate and got a Forecast High Price of $57.50 (which was towards the high end of VL’s $40-60 estimate) as well as a 3.4 Upside-Downside Ratio and a 23.6% Total Return.

- I started with a very low 6.70% EPS estimate and got a Forecast High Price of $45.20 (near VL’s low end), a 3.0 UD and a 15.8% TR.  My SSG resulted in the most conservative appraisal and still satisfied the minimum SSG Buy Criteria of 3.0 UD and a 15.0% TR.

** I also satisfied another criterion that I impose: to never substantially exceed or fall below VL’s estimated High Price, at least not without a good reason.

- Len began with an 11.1% EPS estimate (in April 2009) and got a Forecast High Price of $73.10, a UD of 5.3 and a TR of 19.7%. 

- Take Stock began with a -6.00% EPS estimate (that’s a negative 6.00%) which seems unreasonably low and stupid.

 Relative Value (RV):

- Relative Value is defined as the current PE divided by the 5-year average PE and an RV between .85 and 1.10 is ideal according to the BI/NAIC Stock Selection Handbook [page 113, 2003 edition].

** Under .85 signals that investors are unwilling to pay more for the stock (and might know something we need to investigate) while over 1.10 suggests that we might be paying too much.

 ** Take Stock does not use the RV concept and the other three SSGs got an RV well under .85 with the Consensus & Pat the lowest at 47.5 while I got 49.2.  That’s a second negative indicator.

- Eliminating outliers changes the RV denominator so I try to report two sets of figures (with and without outliers eliminated).

 ** I almost never discuss RV/PRV because that feature is broken in the TK6 software.  I checked RV five times to make sure I got the same numbers and the software’s defect occurs when outliers are eliminated and then restored.

Return on Equity (ROE) and Pre-Tax Profit Margin (PTPM):

ROE:

- GameStop’s 5 year average ROE is trending down and that can be a red-flag warning sign of deteriorating fundamentals or, compared to its Industry Average, an indicator that the company has an unsustainably high ROE. 

**However, GME’s ROE is much worse with Morningstar-Hemscott data than its Industry Average (13.9% vs 19.5% Electronic Stores Industry) and ranks 4^th out of 5 companies with ROEs that range from a high of 25.9% to a low of 10.7%.

** And, GME’s ROE is slightly worse with S&P data than its Industry Average (17.4% vs 17.6% Computer & Electronics Retail).  There is no company-by-company listing so no ranking is possible.

** GME’s down-trending ROE is a third negative indicator!!

PTPM:

- GameStop’s PTPM is trending up, which always is a good sign, but I also like to know how the company compares to its industry since I prefer to buy industry leaders. 

** GME’s PTPM is slightly better with M-H data than its Industry Average (6.2% vs 5.7% Electronic Stores Industry) and ranks 3^rd out of 5 companies that range with PTPMs from 6.7% high to 3.8% low.

** GME’s PTPM is also slightly better with S&P data than its industry average (6.2% vs 5.7% Computer Electronics Retail). 

Financial Condition:

 - Value Line gave GME a B+ for Financial Strength and reported that it had $289 M in cash (down from $905 M in 2009) and $448 M in debt (all long term) as of 7-31-10.

- Morningstar thinks GME’s financial health is “okay”, but could deteriorate.  On 8-25-10, the company had $290 M in cash and $448 M in long-term debt.

- On Bob Adams’ one-click Analyzing the Annual Report spreadsheet, GME’s latest AR scored 83 out of 100 with 13 bullish and 5 bearish results:

** The Bullish or good things include: debt is decreasing as is accounts receivable and shares outstanding; sales are increasing and increasing faster than related costs; interest coverage at 14.0 gets a green flag (very good) as anything below 5.0 is worrisome to Bob; debt to equity is reasonable.

** The Bearish or not-so-goods include:  free cash flow at 5.0% gets a red, danger flag as anything less than 10.0 is bad news to Bob; ROE is inadequate and gets a yellow, caution flag; and short interest at 22.7% is very high and increasing as 20.0% or more is a warning sign that a sizeable number of investors are betting that GME’s stock price will decline (which might explain GME’s low RV).

- You can get this free, easy-to-use spreadsheet and a description of its many features by going to my Favorite Links page, click here.   

Conclusion: What Does It All Mean?

- Because of its several negative trends and the critical Mstar assessment, I’m way not interested in GameStop.  And, I have little reason to expect that GME knows how to profit from the Internet; even if it soon learns, what will the company do with its 6400+ stores?

- Furthermore, how does GME plan to make money from Kongregate and Jolt, the two free-to-play game sites it recently acquired? Also, what about the large amount of short interest that’s betting on the stock price going down? 

 - Lastly, what’s your guess about GameStop’s future prospects?  Please tell me what you think, especially if you’re a gamer, by leaving a comment in the box below.

 

Armin (happy holidays to all)

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