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GameStop Same Store Sales Crater and Admits Writedowns Are Coming

August 16, 2012 | About:
Todd Sullivan

Todd Sullivan

22 followers
Trainwreck.

Let’s start with yesterday. I said, “Take a look at GME’s balance sheet. They carry a shade over $2 billion in goodwill, which is just a shade under the company’s current market cap of $2.2 billion. That is a goodwill write-down red flag — a major one. The test for goodwill is what the asset could receive on the open market. What GME is telling you is the acquisitions they have made are worth what the entire company is being valued at. I call BS.

Put it another way, $GME is telling you their business except acquisitions is only worth $200 million (the difference between goodwill and their market cap).”

Then jump to the bold below under guidance:

Now, $GME is still maintaining fiscal year guidance despite the first and second quarters coming in worse than expected. The only way they can possibly accomplish this is to basically empty that bank account in buying back shares. That does leave a gaping hole next year.

GameStop Reports Second Quarter 2012 Results

Quarterly dividend increased 67% to $0.25 per share


New businesses account for 10% of gross sales and drive significant margin expansion

GRAPEVINE, Texas–(BUSINESS WIRE)–Aug. 16, 2012– GameStop Corp. (GME), the world’s largest multichannel video game retailer, today reported sales and earnings for the second quarter ended July 28, 2012.

Second Quarter Results

Total global sales for the second quarter of 2012 were $1.55 billion compared to $1.74 billion in the prior year quarter, a decrease of 11.1%. Consolidated comparable store sales decreased 9.3% compared to the prior year quarter. As expected, slow traffic due to a lack of new game releases caused sales of new software and hardware to decline sharply. While outperforming the new category as well as the overall market, pre-owned sales decreased 11.2%.

Other category sales, up 40.6% during the quarter, were primarily driven by new business channels. Digital receipts increased 27% to $134 million. Mobile sales, made up of tablet and pre-owned iDevice products, were $29 million, on track to reach the company’s 2012 forecast for mobile sales of $150 to $200 million.

Paul Raines, chief executive officer, stated, “We continue to see solid sales growth as well as strong margins in our new retail offerings and digital channels. We are focused on staying ahead of the curve as the competitive landscape evolves and we manage through the trough of the console cycle. Finally, the ongoing share buyback and increase in dividend demonstrate our confidence in the future of GameStop and our commitment to improving total shareholder returns.”

GameStop’s net earnings for the second quarter were $21.0 million compared to net earnings of $30.9 million in the prior year quarter. Diluted earnings per share were $0.16, compared to diluted earnings per share of $0.22 in the prior year quarter.

Capital Allocation Update

During the second quarter of 2012, GameStop repurchased 7.6 million shares at an average price of $17.96, or $136.4 million worth of stock, compared to $34.6 million in the prior year quarter. As of today, $301.0 million remains available for share repurchase under the current stock buyback authorization.

GameStop’s board of directors also declared a quarterly cash dividend of $0.25 per common share payable on Sept. 12, 2012 to shareholders of record at the close of business on Aug. 28, 2012. This dividend represents a 67% increase over the quarterly dividend paid in the first two quarters of 2012.

Earnings Guidance

For the third quarter of fiscal 2012, GameStop expects comparable store sales to range from -10.0% to -5.0%. Diluted earnings per share are expected to range from $0.28 to $0.36.

Based on the current number of shares outstanding, the company is maintaining its previously announced full year diluted earnings per share guidance range of $3.10 to $3.30. Full year comparable store sales are expected to range from -10.0% to -2.0%.

Given the recent decline in the company’s stock price, GameStop’s net book value of equity exceeds its market capitalization. As a result, the company is performing an interim impairment test of its goodwill and other intangible assets as required by the provisions of Financial Accounting Standards Board Accounting Standards Codification Topic 350. Management believes any impairment would be related to the company’s international reporting units, which have goodwill and other intangible assets recorded on the financial statements at a carrying value of $920 million. Any impairment charge resulting from this test would be material to the company’s financial statements. However, any such potential impairment charge would be non-cash and would not impact the Company’s on-going business operations, cash flows or financial condition.

Note: Current guidance only includes the effect of the shares purchased thus far in fiscal 2012.

Same store sales were down in excess of what was projected, SSS guidance for the rest of the year ratcheted down lower (again) than projections, cash is falling, current liabilities are not falling, etc.

Now, here is the key point. The main reason results aren’t materially worse is because of the buybacks. Buybacks added $0.02 to earnings in the current quarter and $0.06 year to date. Without them, earnings for Q2 would have been 14% lower and 9% lower year to date. Here is the problem with that: They are running out of cash to keep this up without taking on more debt. The company has made $0.71 year to date and expects $0.32 (middle point of guidance) in the third quarter for a total of $1.03. That means the fourth quarter must deliver $2.17 to hit the middle point of their annual guidance.

That will be quite a trick seeing as they made $1.61 last year. They are below results from 2011 year to date ($0.71 vs. $0.78), have guided the third quarter well below the $0.39 they earned in the third quarter last year but are magically going to grow fourth quarter EPS 35%. Anyone want to explain that to me?

gme-balance-524x420.jpg

That is a near $100 million drop in cash (lower AR also) year over year that has gone to share repurchases. Now, that is good for shareholders temporarily as it has buoyed the stock price and EPS this year. But, reality has to now hit and shareholders have to look and say, “What happens when they can’t buy more back?” The quick answer is EPS plummets. The company bought back $136 million in the second quarter. That matches what they have left in the bank. There will be a small amount of cash coming in during the third quarter as they still are profitable (by a bit) so they will actually have a bit more than indicated above. The key point is greater than $125 million a quarter in buybacks is coming to an end soon without the company adding debt to do so.

Let’s go a step further — sales and sales mix.

Remember the basic short thesis is the physical game model is going away (or nearly away). As it does, there will be fewer trips to $GME locations, and fewer trips to $GME locations means fewer used games sold, which is still the company’s bread and butter no matter what they say.

Here is the proof:

gme-sales-518x420.jpg

Used games still make up more than 35% of the shrinking sales pool. No matter what the company says about new initiatives and sales channels, people walking into the stores and buying used video games is still what drives sales and even more so, profit:

gme-profit-mix-502x420.jpg

While approximately 35% of sales, used video games are more than ever a bigger piece of the profit pie now at 47%. So, again as store traffic continues to dwindle, we can expect the used game segment to continue to fall. As more games move to digital, this segment will continue to fall. Thus the reason GME needs to wander into different directions (see yesterday’s post linked in beginning for more on that) in a desperate effort to find alternative revenue sources.

I'm going off on a tangent her,e but this is the reason you simply cannot run a stock screen and invest based on the ratios it spits out. By every metric GME is “cheap.” Book value, PE, etc., all say GME is a bargain. But, when you look at the direction the components of those ratios are going, they are going the wrong way. When profits are falling, today’s low PE goes up as the E falls. Today’s low P/BV goes up when massive goodwill writedowns (they will be here) wrecks the BV part of the equation.

Ratios and screens are a decent place to start — to start. You then have to dig. It's the only way.

About the author:

Todd Sullivan
GuruFocus - Stock Picks and Market Insight of Gurus

Rating: 4.0/5 (18 votes)

Comments

shaved_head_and_balls
Shaved_head_and_balls - 2 years ago
All this negativity and GME is up substantially for the day. Perhaps the author should move onto Salesforce.com for his tirades. Oh wait--isn't he one of the many shorts who've crowded into the CRM short-seller graveyard?

Perhaps it's time for the author to jump on the Barnes & Noble hatewagon--along with 300 authors on the Fool website who think they're being clever by pointing out over-dramatized long-term consumer trends.
Adib Motiwala
Adib Motiwala - 2 years ago
Hello Todd,

Let me begin by saying I appreciate you taking the time to analyze GameStop and posting this article. I have a slightly differing take on a few of the points you make. This reply is intended to have a discussion. I respect the other point of view and it helps me test my thesis.

Let me try to address a few points you make.

1) Good will write down is a non-cash event. It will not affect the cash flows or impair their balance sheet. Yes, the income statement will take a hit ( as it did in Q4 last year by $81m). As per what I heard on the call, this is an accounting rule where they need to test for and impair goodwill when the market cap is lower than book value (which is the case today). This is the least of my worries from your points above.

2) I agree that without the buybacks their guidance given in the Q4 2011 call would have been missed. Goes to show how difficult it is to forecast even one year sales and profits for anyone. However, I am more interested in FCF. More on this later.

3) Lets talk about SSS and the dropping top line which is what most people focus on. Most followers of the gaming industry would know that the current console cycle is 7-8 years old. That means almost everyone who wanted to buy a gaming console has bought one. What does that mean? Sales of hardware consoles declining. I am not sure if the game lineup is also soft causing this to drop or whether this means a permanent shift to alternative gaming/entertainment. Gaming consoles cost what $100-$300 a pop and software is $60 a game. So, that goes a long way in dropping top line and reducing SSS. Yes, an increasing top line is what every investor looks for. But, if the company can pull other levers to keep profitability during the low point in the cycle, it must be applauded. Gaming is a cyclical business. And Yes i noticed that used game revenue also dropped this quarter and I will have to keep an eye on that as well.

4) What no one talks about is the improvement in Gross Margins over the last 3-4 quarters due to the new businesses (DLC, Mobile, IOS device refurshment program). Just this quarter GM was 33.5% over 31.2% last year. That meant Gross Profits dropped only 4.5% v/s a 11% decline in Sales.

The company is now debt free so saves interest expenses. It has kept SGA flat in a tough sales environment. Unfortunately with falling sales, SGA as a % of Sales is higher and hence operating margins suffer. But, any investor will know that margins is part of the story. There is asset / inventory turns that are equally important. So, I focus on cash flows over the income statement.

5) As per GME press release from Q4, "Adjusted diluted earnings per share, excluding restructuring, impairment and debt retirement expenses, were in-line with guidance at$1.73, a 10% increase compared to adjusted diluted earnings per share of$1.57 in the prior year quarter. ". ( so it was not $1.61 but $1.73 but you are in the ball park). So, to meet the 2012 guidance GME has to do $2.17 as you rightly said in Q4. I am also not sure they will hit that but i am not so worried. The share count is lower by atleast 10% from last year so that gets you close to $1.9. If you notice Depreciation/Amortization is running lower by $2.5m/quarter due to lower capex. GME is now debt free and so has saved about $3-$4million a quarter over last year. About $6.5m savings a quarter over 2011. Thats 5cents a quarter. So that gets Q4 to $1.95 or so.

I think the difference is coming from WiiU release in Q4. That is my best guess. Management did say on the call that WiiU is baked in their full year results. They said its not aggressive but reasonable. I have no way to verify if they will get that or not. But, even if they hit $2.0 in Q4 and $2.9 for 2012, it would be pretty good in this tough environment.

6) The discussion no one has is about Cash Flows and FCF. It is more important v/s the EPS number. I am interested to find out if GME can achieve FCF of $400-$450 million they have averaged over the last 2 years. Remember, FCF is running ahead of Net Income. To present numbers,

In the last 3 years, GAAP Net Income was $340m, $408m and $377m

Cash Flow From Ops was $625m, $591m, $644m

FCF was $459m, $390m, $480m.

Clearly, the $80m write down in Q4 2011 had no material effect. What it did was to widen the gap between NI and FCF. I cannot remember a single analyst saying FCF/Share last year was $3.32 a share.

6) Valuation, Capital allocation and management: You hit the nail in the head that investing cannot be done purely by buying cheap looking stocks based on screening or valuation metrics. I focus on many aspects when considering a stock for an investment

(i) Valuation:

Share Price : $18

Shares : $130m

Market Cap: ~$2400.

Cash $130m

EV ~$2300m

At the average $400m in FCF that GME has done last two years, GME is valued at 6x P/FCF! On a P/E basis, at $3 in EPS, GME is also at 6x P/E.

(ii) Capital allocation. I give a lot of importance to this when evaluating any stock as the cash produced is no good if it does not go to shareholders return. So, lets take a look at what GME management has done with the Cash it has produced in 2010, 2011 and so far in 2012.

2010: Repurchased shares worth $381million, Paid back $200m in LT Debt. Dividends = 0. Total $581 million. FCF that year was $480 million.

2011: Repurchased shares worth $262million, Paid off all debt of $250m (debt free). Dividends = 0. Total $532 million. FCF was $390 million.

2012: Repurchased shares $260million In 2 Quarters, no debt, $40m in Dividends = $300million.

(Has used cash from balance sheet to do so)

(iii) Current dividend yield is $1/ Share annually. That is 5.5% yield at @$18. ! The dividend was raised from 15cents quarter to 25 cents a quarter. I guess no seems to care for that.

This company has returned 100% of its FCF to share holders for the last 2 1/2 years. in the Q2 call, management again said we will return 100% of FCF to shareholders. But, I guess no one cares for that. People only look at SSS, declining top line.

(iv) Management stake: Chairman and CEO are required to own 5x of their base salary in common stock, other execs 3x. Chairman owned 700k shares and CEO owned 540k shares as per recent proxy. That is worth $12.6m and $9.7m respectively. Their salaries were $900k and $1million respectively.

So to conclude you have

(1) A market leading company operating profitably (Net Income and FCF) in a tough environment at the bottom of the gaming cycle

(2) The stock provides a 15% FCF yield and a 5.5% dividend yield on a 30% payout ratio.

(3) The company has no debt and pays out 100% of FCF to share holders.

(4) Reasonable level of skin in the game.

Yes, there are headwinds being at the low point of the cycle, lower consumer spending, weak macro, alternative gaming distribution. But, GameStop has done everything a shareholder can ask for.

thanks

Adib

Disclosure: Long GameStop.

SapientInvestor
SapientInvestor - 2 years ago
Adib,

I agree the numbers are enticing. However, aside from the obvious threats coming from whole game download options and competition from amazon, which are enough for me to stay away, I see another negative long-term trend affecting the retail sales.

A lot of publishers and developers are refocusing and putting more money on fewer core titles that have add on's and subscriptions. I believe this is a strong secular trend that will intensify and is not just part of the current gaming cycle and affects both console and PC games. Fewer games are being released. Publishers are also even showing increasing willingness to offer free to play (initial game) for mega budget games and instead trying to sell premium services. For example, EA's Star Wars is going free to play and Activision is experimenting with Call of Duty free to play in China.

Any one of these things by themselves would not be much but taken together could be another story.

Gus

Disclosure: No position
superguru
Superguru - 2 years ago
GME - Value trap. Unless they are able to reinvent their business.
Gabriel Canelli
Gabriel Canelli premium member - 2 years ago
I don´t think amazon will supplant retail trade, this subject is totally exaggerated. I once heard that wal mart is in danger. We have to think about the GME costumers. They are teenagers and the main diference about the costumers of blockbuster is that the teens are waiting all week to go and see or buy the new products of GME. The mains costumers of blockbuster are people about 30, 40, 50, years old who prefer select some films on internet. I don´t think GME is in danger because its costumers love go there.
Cogitator99
Cogitator99 - 2 years ago
Looks like a value trap. I agree with SapientInvestor's comments. The rise of the "perpetual" game is a strong negative for GME.
Adib Motiwala
Adib Motiwala - 2 years ago
There will be a small amount of cash coming in during the third quarter as they still are profitable (by a bit) so they will actually have a bit more than indicated above.

Cash on balance sheet end of Q3 is $366 million after spending $75m on buybacks and $25m a quarter in dividends. (During the third quarter of 2012,GameStop repurchased 3.7 million shares of common stock at an average price of$20.59, or$76.8 million worth of stock).

So, looks like GME generated close to $300million in FCF in Q3. ( cash up from $130m to $366m and also bought back $75m worth shares). Stock at the time of my initial comment $18. Stock today $26.68.

Adib Motiwala
Adib Motiwala - 1 year ago
GME announced 2012 numbers today.

FCF $480million. Cash on balance sheet (no debt) = $635 million.

EV = $2.7billion.

Annual Dividend $1.1 a share or 4%.

100% FCF paid out in buybacks and dividends.

And this in an environment where sales were down 5-7% over last year. New console cycle is underway with WII U out and Sony PS4 in the Fall.

Disclosure: Long GME

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