GAMESTOP CORP (NYSE: GME) Analysts: Cassandra Smalley & Al Clawson January 5, 2010 GameStop Corp Target Price $30.21 Sector: Consumer Discretionary Industry: Computer/Electronic Retail Current Price: $21.94 52-Week Range: $20.02-32.82 Market Cap: $3.61B Shares Outstanding: 165B Avg Daily Volume: 4.93B Beta: 0.90 P/E Ratio (Fwd 7.51 31Jan10): PEG Ratio (5yr exp): 0.59 EPS Est. (‘09): $2.55 EPS Est. (’10) $2.92 Company Profile GameStop Corp. (GME) is the largest retailer of video game and PC entertainment hardware, software, and accessory products in the world. The Company operates under the names GameStop and EB Games, retails through company owned outlets and www.gamestop.com, stands as the exclusive video game retailer on www.bn.com, and publishes Game Informer, a video game magazine with 3.5 million subscribers in the US. As of January 31, 2009, GameStop operated 6,207 stores worldwide and is on track to have completed an additional 400 stores by January 30, 2010 with segments in the United States, Canada, and Australia and Europe. Each segment retails new and used video game systems, software, accessories and PC entertainment software and related accessories. The unique value GameStop provides its customers is the opportunity to trade in used video game products and accessories for store credit towards other merchandise. This creates value for the customer and results in higher sales/higher margins for the company. GameStop began in November 1996 and was acquired by Barnes & Noble, Inc. in 1999. In February 2002, the Company completed an initial public offering and was majority‐owned by Barnes & Noble until November 2004 when it distributed GameStop Class B common stock. In October 2005, GameStop acquired Electronics Boutique Holdings Corp. (EB) and in February 2007, all Class B common stock was converted to Class A on a one‐for‐one basis. In March of the same year, the Company completed a two‐for‐one split. In November 2008, GameStop France acquired SFMI Micromania for $580.4 million funded through cash, revolving credit, and term loans which have all been repaid. GameStop began trading on the New York Stock Exchange as of January 31, 2009. The Company’s strategy includes the continuation of growth through new store openings in targeted markets and through increasing comparable store sales. New stores are primarily located in strip centers in major metropolitan markets and regional shopping centers. International expansion is primarily concentrated in Europe, Canada, and Australia. GameStop intends to grow the business by recognizing and capitalizing on 1) increasing popularity of gaming consoles and newly released software and accessories; 2) increasing availability and awareness of trade‐in benefits of used video game products; and 3) increasing awareness of the GameStop brand. Industry: Computer/Electronics Retail The electronic gaming industry is highly competitive among mass merchandisers and retail chains such as Wal‐Mart Stores and Target Corporation, consumer electronic stores such as Best Buy, video game and PC software specialty stores, toy retailers, video stores such as Movie Gallery and Blockbuster, mail‐order, catalogs, online retailers, and game rental companies. Changes in consumer preferences and constant new product introductions will continue to transform and evolve the industry. Seasonality is common in the electronic gaming industry with a large portion of sales and profits realized during the fourth fiscal quarter, which includes the holiday selling season. In fiscal 2008, GameStop generated 40% of sales and 56% of operating earnings during the fourth quarter. Electronic gaming trends are cyclical and respond to new technology introductions. Sales of new video game platforms and related software and accessories increase initially, while older platforms and related products decline after the introduction. New video game platforms are generally introduced every five years. Earnings Estimates Consensus EPS Trend FY(01/10) Growth % FY(1/11) Growth % Current Estimate (Mean) 2.53 6.3 2.86 13.0 Current Estimate (High) 2.64 10.9 3.05 20.6 Current Estimate (Low) 2.30 ‐3.4 2.40 ‐5.1 30 Days Ago 2.54 6.7 2.88 13.4 60 Days Ago 2.54 6.7 2.88 13.4 90 Days Ago 2.53 6.3 2.88 13.8 Number of Estimates 17 16 Numerical Source: Morningstar.com $9,143 Competitive Analysis GME – GameStop WMT – Wal‐Mart BBY – Best Buy XLY – Discretionary SPDR RSH – Radio Shack Current Trading Multiples GME RSH BBY WMT TEV/Total Revenue 0.4 0.5 0.4 0.6 TEV/EBITDA 4.6 5.2 5.8 8.1 TEV/EBIT 5.7 6.7 8.3 10.6 P/E TTM 9.4 12.7 15.1 15.4 Price/Book (MRQ) 1.4 2.4 2.7 3 Numerical Source: Capital IQ Profitability GME RSH BBY WMT Return on Assets % 8.9 9.3 6.4 8.6 Return on Capital % 14.4 13.2 16.1 12.6 Return on Equity % 16.7 21.6 20.7 20.3 Numerical Source: Capital Margin Analysis GME RSH BBY WMT Gross Margin % 26.5 45 24.7 25 Net Income Margin % 4.4 4.6 2.3 3.3 Net Income Avail. For Common Margin% 4.4 4.6 2.3 3.3 Levered Free Cash Flow Margin % 5.7 2.2 0 2.7 Unlevered Free Cash Flow Margin % 6 2.8 0 3 Numerical Source: Capital IQ Asset Turnover GME RSH BBY WMT Total Asset Turnover 20 18 23 24 Fixed Asset Turnover 16.5 14.9 11.4 4.1 Accounts Receivable Turnover 175 20 18.2 115 Inventory Turnover 42 33 42 77 Numerical Source: Capital IQ Liquidity/Solvency GME RSH BBY WMT Current Ratio 1.2 3 1 0.9 Quick Ratio 0.2 1.7 0.3 0.2 Total Debt/Equity % 16.9 68.8 30.7 70 Total Debt/Capital % 14.5 40.7 23.5 40.4 LT Debt/Equity % 16.9 62.5 18 55.6 LT Debt/Capital % 14.5 37 13.8 32.1 EBIT/Interest Expense 13.5 8.4 22.9 11.1 Numerical Source: Capital IQ CAGR 3‐Yr GME RSH BBY WMT Total Revenue% 24.6 ‐5.5 12.4 6.1 Gross Profit% 20.9 ‐6.4 12.3 7.3 Net Income% 51.4 68.7 ‐4.1 7.3 Total Assets% 17.7 5.8 11.1 4.6 Levered Free Cash Flow% 89.3 ‐31.2 N/A 55.2 Unlevered Free Cash Flow% 61.8 ‐27.8 N/A 44.7 Numerical Source: Capital IQ Fundamental Analysis GameStop trades at a discount in comparison to its closest competitors with a Price to Earnings ratio of 9.4. The Company has less debt with a Total Debt to Equity equal to 16.9%, the next lowest competitor, Best Buy, has nearly double that amount with 30.7%. The three year Compound Annual Growth Rate is an impressive 24.6%, 20.9%, and 51.4% for Total Revenue, Gross Profit, and Net Income, respectively. These growth rates are well above the 3‐Year Total Market Return of the S&P Consumer Discretionary Sector average of ‐6.3%. The Company’s profitability measures (Return on Assets, Return on Capital, and Return on Equity) all appear to be in line with its competitors. Q3 2009 Conference Call Highlights • Total Sales for the third quarter fiscal 2009 were the highest in GameStop’s history increasing by 8.2% to $1.83 billion. • Comparable same store sales declined 7.8% due to a decline in sales of hardware consoles. • GameStop gained market share with a 9% increase in new software sales as the industry reported a 12% decline. • Used product sales increased by 19% over the previous quarter. • Net earnings increased 12% to $52.3 million from the prior year Q3 earnings. Valuation A Discounted Cash Flow analysis was performed to provide an indication of value. The analysis assumed a 10.6% Weighted Average Cost of Capital, a 2‐4% Compound Annual Growth Rate for 15 years and a 3% perpetual growth. The resulting DCF indication of value is $30.21. Using forward earnings of $2.86 per share and a Price to Earnings multiple of 11.0 leads to a fair value estimate of $31.46. The P/E range of competitors in the Computer and Electronics Industry is 9.4‐15.9 with a median of 13.9 and an average of 13.1. A P/E of 11.0 was chosen due to risk inherent in GameStop’s business strategy and potential structural changes in manufacturers’ business model as they attempt to move to electronic data exchange sales in the future. Headlines 12/03/2009 GameStop Shares Tumble on Wal‐Mart Game Deals. www.wsbt.com 12/01/2009 GameStop’s 3Q as Expected. www.morningstar.com 11/30/2009 Game Informer Expanding to Australia. http://twincities.bizjournals.com 11/19/2009 GameStop 3Q Net Rises 12% on Increased New‐Game, Used Sales. Dow Jones Newswires. 11/03/2009 GameStop Announces New Senior Vice President and GM of Digital Business. Business Wire. 10/20/2009 Flat Industry Sales Prompt GameStop Stock Drop. www.gamasutra.com Positive Factors • GameStop has been continually increasing market share in the computer and electronic retail space despite competition from larger retailers such as Wal‐Mart and Best Buy. • The new frugal consumer provides greater sales and margins through the trade‐in business model and sales of used video games offered through GameStop. • Growth and changes in video game user demographics have enabled fast‐growing sales on new and used products for GameStop customers.