Who Does GameStop Think It's Kidding?

GameStop (NYSE: GME  ) shares may have opened slightly higher this morning, but that doesn't mean that today's quarterly report is at all comforting.

Total global sales fell 3% to $3.58 billion at a time when analysts were holding out for a marginal uptick.

Thankfully, a plunge in hardware sales -- the category where GameStop scores the lousiest profit margin -- is the culprit. Adjusted earnings for the fiscal fourth quarter managed to squeeze out a 0.3% gain. GameStop's feverish share repurchases over the past year are propping up profitability on a per-share basis 10% to hit the $1.73 a share that analysts were expecting.

How convenient. GameStop can disappoint on the top line, but still buy its way out of a bottom-line disappointment.

File that tactic away for now, because things are about to get even more unappetizing.

Gamers are just flat-out disappearing
The small-box retailer sees comps plunging by 7.5% to 9% during the current quarter, with sales essentially following suit. Wall Street was settling for flattish sales growth. However, GameStop's projected profit of $0.52 to $0.55 a share is well short of the $0.59 a share that analysts were expecting.

This is the kind of bleak near-term forecast that would send many stocks plummeting, but GameStop's holding up because its outlook for the entire new fiscal year is far more encouraging. Sales will climb 1% to 5%. The midpoint of its comps guidance is actually slightly positive. Earning $3.10 to $3.30 a share -- as it expects -- would be a reasonable 8% to 15% growth spurt.

However, what about the fact that GameStop expects to close more stores -- 150 -- than the 100 it is hoping to open this year? What about the fact that we're talking about "adjusted" earnings for the recently concluded holiday quarter because a series of charges include costs to exit certain international markets? This isn't a charge; it's a retreat.

If that's not enough to temper your expectations, how about the fact that GameStop slashed its same-store sales target three times during the course of fiscal 2011 -- yet still managed to come up short. A year ago GameStop was proudly aiming for a 3.5% to 5.5% boost in comps. That figure was worked down all the way to a negative 1% to 2% showing in same-store sales as of two months ago. The final snapshot calls for a 2.1% decline!

How confident can you be now that the same thing won't happen again? Take a mental photograph of this morning's guidance. It probably won't age well with every quarterly adjustment.

The new hardware is coming
This should be a year of new blood on the hardware front, but last month's debut of Sony's (NYSE: SNE  ) PS Vita obviously can't be going well given the negative comps that GameStop is targeting for the current quarter. There is heartier hope for Nintendo's Wii U revolutionary console upgrade this summer -- and consoles are holding up better than portable gaming systems -- but shouldn't the hardware refreshing be stinging margins?

On the software end, Activision Blizzard (Nasdaq: ATVI  ) shareholders have May 15 -- the day Diablo III hits the market -- circled in red. Obviously, there will be a new Call of Duty installment out before the crucial holidays. These may seem to be encouraging signs, but -- then again -- why is GameStop going to close 50 more stores than it opens this year?

GameStop's been using its money to keep shareholders around. It's been pumping up profits on a per-share basis through buybacks for some time, and it initiated a generous dividend rate last month. GameStop also retired the last of its senior notes during fiscal 2011. I'm a cynic, but I have no problem applauding its cash-management moves.

My concerns are with the model itself. Best Buy (NYSE: BBY  ) and Amazon.com (Nasdaq: AMZN  ) have been getting more aggressive about competing against GameStop's high-margin trade-in program. Best Buy mentioned that it was "pleased" with the progress of its trade-in volume during last year's second quarter conference call. Amazon even covers shipping costs for those looking to trade in their used games.

Then again, don't we need new sales to fuel the pipeline of future trade-ins? Digital delivery is going to crush this model before long. Yes, GameStop's made some decent headway to grow in digital. If it weren't for digital sales, fiscal 2011 would have seen total sales decline. However, digital is still less than 5% of GameStop's total revenue mix. If it ever grows to be a material factor, the retail model is probably dead.

I'm sorry, GameStop. I'm not impressed with guidance that I know will be tweaked lower. Your money can buy back shares and debt. It can even cut fresh dividend checks. It can't buy out my skepticism.

Digital future
Even though the next trillion-dollar revolution will be in mobile, it may not involve GameStop's digital initiatives. A free special report will get you up to speed.

The Motley Fool owns shares of Best Buy, GameStop, and Amazon.com. The Fool owns shares of and has written calls on Activision Blizzard. Motley Fool newsletter services have recommended buying shares of Nintendo, Amazon.com, and Activision Blizzard. Motley Fool newsletter services have also recommended writing covered calls on GameStop and creating a synthetic long position in Activision Blizzard. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Longtime Fool contributor Rick Munarriz calls them as he sees them. He does not own shares in any of the stocks in this story. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.


Read/Post Comments (7) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 22, 2012, at 11:00 AM, GentleGiant42 wrote:

    Obviously Rick doesn't understand the video game industry and how big releases drive stock. And there are plenty of new releases in the next couple of months along with new hardware launches to help gaming companies (even retail) strong!

  • Report this Comment On March 22, 2012, at 11:15 AM, Selfeduwha wrote:

    We are not disapearing, we are just flat out disappointed. Look at the trash on the horizon, an out of placed assassin fighting in the civil war, call of duty, aka $60 map packs and the one saving grace with all the hype in the gaming world has signs of issues. Of course I'm talking about blizzard's diablo 3. When a major contributer is let go two months befor release, something is wrong. My theory is the 10 years in the making game is unfinished. I hope I'm wrong because that is not blizzards MO, but activision may have applied a little pressure. Boy I hope I'm wrong.

  • Report this Comment On March 22, 2012, at 12:30 PM, KingOfPizza wrote:

    Who needs GameStop when I can buy and sell used games on Ebay from the comfort of my couch? They're just a middleman. I don't need their teenage "experts" to tell me what to buy - I've been playing video games since before they were born.

  • Report this Comment On March 22, 2012, at 2:45 PM, itconsultant wrote:

    Rick,

    All you chose to harp about is SSS and next quarter guidance, closing of stores, the non cash charges.... How about you talk about the following

    1) Capital allocation: Debt free, Buying back shares, paying dividends at only a 20% payout. Returned $1 billion to shareholders via shares and debt buyback in last 2 years! For a $3.2 billion market cap company!!

    2) Balance sheet: GME has $570m in CASH on the balance sheet accounting for buybacks in Q1 of $75million. They can easily and most likely will buy $300-$400m of stock this year. That is adding value to share holder by increasing their ownership in the business. Despite flat top line growth in a tough environment.

    3) Valuation: Produces $400-$450m in Free Cash Flow. Enterprise Value is $2800 million (accounting for Cash). That is less than 6x Free Cash Flow.

    4) ROIC is getting better.

    5) Participating in growth in digital space and leading in most parts.

    6) Constantly ready to evaluate what is not working and what is working and move in that direction. If UK stores are not doing well, they close them. Would you prefer they lose money ?

    7) Not doing outlanding acquisitions.

    8) Gaining market share. Check their numbers to what NPD is putting out.

    9) You are not just a skeptic. You are biased in your negative views.

    10) They are closing stores..because they may be they over built and/or their EB acquisition had overlapping stores.

  • Report this Comment On March 22, 2012, at 9:07 PM, jasjfarrell wrote:

    Bought GME stop around $27 and added to my position as the share price dropped. Luckily sold off today and cut my loss to less than $100. Oh happy day.

  • Report this Comment On March 23, 2012, at 5:13 PM, FoolSolo wrote:

    @IT Consultant

    All nine points are great points (except #9) and very germane to the value of the company. However, Gamestop's current business model may be a bit outdated in the current digital world. One of the challenges I see, and I think others do as well, is the digital revolution is making it much easier to eliminate the middleman, and avoid the retail channel all together. ATVI is already offering a lot of DLC directly to consumers, and future distribution will be much less dependent on physical media.

    Taken in context with the increased competition and the store closures, it's hard to see a compelling growth story in this murky picture. While there may be good value in the current company, as an investor I am looking for growth and future appreciation 1, 3, 5 years out. I just don't see a solid plan for growth that would compel me to invest in GME with these prospects. Perhaps if GME can lay out a more detailed and comprehensive growth story they would be able to entice me to invest, but right now I just don't see it.

  • Report this Comment On March 28, 2012, at 3:06 AM, itconsultant wrote:

    FoolSolo,

    Yes 9 was not a good point. :) i got a bit sick of this kind of 'journalism'.

    here are my points

    1) GME is not priced as a growth story. hell its not even treated as a reasonable company. I see Debt filled companies also with business models under threat also at 8x - 10x , ignoring debt. GME is 6x excluding cash.!

    2) I agree this is not a 5 year time line investment. Not every investment is the same kind. not all are growth. not all are value. not all are Apple . not all are 10 year stories. some are intermediate. Market only does not reward 10 year winners. if you are right over 2-3 years, while market is pricing death, you will WIN and win big.

    3) with 40% short, a dividend, that balance sheet, that FCF. shorts are playing with fire. any of these can happen

    a) rapid buyback quarter after quarter. complete the $500m in 3 quarters and announce another using the FCF from Q4

    b) one time special dividend of $2-3 a share.

    c) private equity buyout for the cash and free cash flow. its a perfect candidate. I have seen worse companies acquired at 8x EBITDA. This is at 3x! Anyone reading !!

    d) DiVidend payout increase to yield 5% from 2.5% ( I think this is the best option) . Combine strong buybacks+ strong yield. Let the shorts suffer and effect a short squeeze.

    e) I am not even saying take on debt and go crazy with buybacks coz i hate leverage.

    Any of these could happen before things go south...and those are hypotetical...the FCF / Sales / margins do not indicate that !!!

    f) Streaming games + Impulse + Used I devices are free options...Those can catch the fancy of share holders / investors/ customers ...who knows what happens...

    The new age social companies going public do not have 1/10th of the FCF of GameStop and are valued 3x (LinkedIn, Groupon, blah and blah). No one in the world mentions that they have weak competitive positions or someone will kill them ( like Google )...anyways. eventually it will work out.

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