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In Focus: Game Stop

Happy New Year! Thank's for checking out In Focus, our weekly look into a company or market that made the Wall Street news cycle. This week we bring Game Stop (GME) in focus.

Game Stop Quote Jan 4, 2019

Source: Yahoo Finance

Game Stop on Deck

On Friday, January 4, 2019, shares of Game Stop jumped 17% higher on news of a buyout. Who would buy Game Stop and why would someone buy Game Stop? According the Investor Place the buyer could be one of two private equity firms, Sycamore Partners or Apollo Global Management (APO). That answers the who, but why?

Well Game Stop still pulls in a nice chunk of change. In Fiscal year 2017, the company pulled in $9.2 billion in revenue and $35 million in net profit. Net profit was low in 2017 due to a $400 million charge off, but the chart below provides revenue and net income for the past five years.

Game Stop Revenue and Net Income 2014-2018

The company has generated positive free cash flow over the past five years, has a dividend yield of over 11% at the moment, is a global company with 7200 locations worldwide, and operates in an industry that continues to grow. So that may provide the answer as to why someone would want to buy Game Stop.

For all the good that Game Stop has going for it, it has one big issue, its industry as a collective hates it. This isn't iOS versus Android hate or Facebook versus Google hate or even Xbox versus Playstation hate, this is every gaming system manufacturer and every game maker in the industry versus Game Stop hate.

Why the Hate?

If you're not familiar with Game Stop's business model, they're a video game store, where gamers can buy new and used video games and gaming systems, emphasis on the used video games and gaming systems.

A gamer can purchase a game, play it through to completion or until their bored with it and sell the game to Game Stop. With cash in hand a gamer can buy a used game from Game Stop. The option for gamers to buy used games has infuriated game makers.

In my gaming hey day, you purchased a game brand new for $50 or $60. You played it through to completion or until you became bored with it, and then you purchased another new game for $50 or $60. Maybe you'd trade a game that you've finished playing to a friend for something of equal value, but ultimately the gaming companies got the chance to tap my pockets for $50 every three or four months.

But now gamers have the option of purchasing used games, game makers aren't seeing the revenue they expected, expected being the key word.

Nintendo's Robotic Operating Buddy

My generation, the Nintendo Entertainment System (NES) generation (NTDOY), are grown ups, with real jobs, disposable income, and some of us are still paying video games. We have money to purchase new game after new game after new game if we choose. However, Game Stop convinced many of us to purchase used games over new games. From my experience, when I'd go to the counter at Game Stop and asked for a game that was a few weeks old, they gave me the used game. Never did they ask if I preferred a new or used game, they would just sell me the used game.

Source: Nintendo

The Empire Tried to Strike Back

During the developmental stages of Sony's Playstation 4 (SNE) and Microsoft's Xbox One (MSFT) there were talks of encoding game disc to systems. Once a game was purchased and played on the purchaser's system, that game would only play on that system. This idea was discussed and explored with the intent to put a halt to the used game business.

PlayStation 4 and Xbox  One Logos

But gamers spoke out, loudly, and neither Sony nor Microsoft ever discussed that plan again. If you're a gamer you understand why that idea was a bad one, even if you didn't buy used games. If you're not a gamer, then ask one why that was a dumb idea.

Technology Waits For No Man

Gamer's saved Game Stop once, but they won't be able to do it again. Technology waits for no man and the technology is here to really get Game Stop out of the way. Video games, like music now comes in a digital format and can be purchased and downloaded directly from the game maker. No need for a disc anymore; and hard drive space is as cheap as it's ever been, so lack of space no longer presents an issue for gamers.

Then there is the downloadable content or DLC. If you're not familiar, this is where a game sells items within the game. Item's like maps, uniforms, dance moves, special weapons, extra levels, more game content, etcetera are all available for purchase, and these purchases occur within the game.

Game Stop Annual Report 2017

Source: Game Stop Annual Report 2017

A look at Game Stop's 2017 annual report and you'll notice Pre-owned and value video game products declining in revenue. If we look at Take Two (TTWO), Electronic Arts (EA), and Activision's (ATVI) last annual reports, we'll see their downloadable / digital content revenue increasing.

Video Game Digital Sales from the Three Majors

Source: Take Two 10K, EA 10K, Blizzard Activision 10K

We've only discussed half of the competition so far. Game Stop still has to contend with Walmart, Target, Amazon, Ebay, and the mom and pop game shops.

A Win by Default is Still a Win

Game Stop was a great company with a great business model, but it seems like its day in the sun is coming to an end. The gaming industry didn't win because they did something right, technology was on their side. In 2019 we've all become use to downloading and streaming, why have boxes of video game discs cluttering up the living room, when you can have the games digitally stored on your gaming device?

Maybe there is hope for Game Stop. Maybe less locations, smaller inventory of software, and they become the go to place for gamers to purchase gaming hardware and accessories. Maybe a pivot, a new business model away from video games all together. I can only assume the private equity firms considering purchasing Game Stop have a long term plan in place.

We've Seen This Story Before

Game Stop is Blockbuster Video and Tower Records and the rest of the gaming industry is Netflix and Apple Music, we know how those stories ended. Game Stop is an Avoid right now and for the foreseeable future. Technology isn't on the side of Game Stop. Digital downloads will take Game Stop out of the game buying experience. Don't be seduced by Friday's stock price rise, the road ahead for Game Stop is a bumpy one.

I love the video game industry, and I believe if you can buy a company within the industry at the right price you should get on it. I recently reviewed Electronic Arts (EA), and felt that it was a buy after it sold off with the rest of the markets.

This is where I leave you, with an Avoid on Game Stop. Thanks again for checking out In Focus, and may your next investment be your best investment.


What is the Seville Report

The Seville Report is our attempt to bring world class investment research to people who feel world class investment research isn't available to them. We also want to demystify the stock market for people who wouldn't think of putting their money in the stock market. Our research comes quarterly via our newsletter, The Seville Report. We use the website and this blog to share thoughts and ideas about the markets and different companies.

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#Stocks #Investing #InvestmentEducation #FinancialEducation #GameStop #GME #VideoGames #VideoGameStocks #EA #TTWO #ATVI #ElectronicArts #TakeTwoInteractive #BlizzardActivision

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