Friday, November 4, 2016

The Buck GameStop's Here

I've owned video-game retailer GameStop more than once over the last 7 years. I've written about it many times. After a several year hiatus, this week I bought back in.

The price has finally come back to an area where I think it's attractive. It now trades at just 5.7 times the company's estimate of its earnings for this year despite a decent balance sheet, and has a dividend of 7%!

Over the years that I have followed it, I have become a big fan of its management team. While the company started out as a retailer with little competitive advantage, it developed some that I think will allow it to generate earnings for years to come.

The first advantage it developed was a used-game business that other retailers have tried and failed to replicate. This business now has network effects, as GameStop now has the most games and can pay the most for games, so it's the go-to spot to trade used games. You can see from the margins how strong this business is, with gross margin of 45% for used games versus 26% for new games.

The second advantage they have created stems from their PowerUp rewards membership program. They are able to keep their 49 million members buying from GameStop using this platform through marketing, and they also use it as a mining source to improve and create new products. They have a new "Collectibles" segment that came out of this initiative.

This is a management team that also deploys capital very well. On projects they finance, they are looking for an IRR of 20%, and with excess cash they dividend it out or buy back stock: the number of shares has declined by 30% in the last 5 years.

The physical gaming industry is experiencing a secular decline as buyers shift from buying physical games to downloading games directly. For this reason, GameStop has diversified into other businesses like collectibles and AT&T stores. This diversification accounted for 29% of profits last quarter. This, combined with the moats they have created in their physical gaming business, leads me to believe that the company's P/E is far too low in the mid-single digits.

Disclosure: Author has a long position in shares of GME

2 comments:

Anonymous said...

I'm just starting to poke around as it has gotten pummeled, very much agree on the importance and success of management in building the used/turn-in game vertical. Do you know if the new expansion into AT&T/Spring Mobile stores has a similar used element or is that business a typical cell phone store?

Saj Karsan said...

As far as I can tell, no. Instead, to me they seem to be trying to be the most efficient operator in less consolidated space.

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