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Geoff Gannon
Geoff Gannon

Game Group (GME): Is This Time Different? Or Is It Barnes & Noble (BKS) All Over Again?

September 21, 2011 | About:

Someone who reads my blog sent me this email:

I read your BKS analysis. I just want to give you a hint… The problem with books is you can easily download them to an electronics device and the e-book is not tied to special hardware.

I think video games are another story completely (I won't recommend GameStop (NYSE:GME)). You need a special device for games, games and their hardware are completely interwoven. The data volume is much larger than for books — no easy download and especially not via mobile networks. Last but not least some companies have a used games business that seems very immune to competition (despite several tries, no one succeeded).

Of course used games is GameStop. I think GameStop has a much higher probability to survive than Barnes & Noble. The short ratio at 31% is nearly as high.

Here comes the clue: In the UK there is a mini version of GameStop, The Game Group. Roughly one-sixth the size, with 1,300 stores, 600 in the UK. Additional problems are the euro crisis in Spain and a retail war in the UK. Due to Tesco et al, prices in the UK are the lowest in the EU for video games. Game is the market leader in used games sales.

The figures speak for themselves: micro cap, 21 pence share price, 347 million shares, 150 million pounds in cash, 150 million pounds revolving credit facility, 350 million current assets, 320 million current liabilities, a couple dozen millions in long term liabilities.

Price to sales is 0.043

Earnings not so long ago 17p, last year reported 4.5p. 8.5p FCF last year according to my calculations.

What do you think? That's 8x or so cheaper than GameStop based on sales.

I think there is a risk here but that price seems extremely low.

Best Regards,


You’re right. There is a risk here. And the price is extremely low.

I had heard of The Game Group (GMG:LN). Richard Beddard wrote about it awhile back. I agree it is cheap. However, I do not agree with your reasoning when it comes to video games. You overstate the importance of technology. Customer behavior is more important.

What are the customer routines? Will they change?

Those are the key questions.

The issue with Barnes & Noble (NYSE:BKS) was not the shift to digital books itself. The issue was the amount of capital spending and operating losses Barnes & Noble was willing to endure making the shift. I actually think Barnes & Noble and Amazon (NASDAQ:AMZN) had much stronger positions in print books and a better future in digital books than anyone in the video game space. This is because of the industry structure.

Customers interact with video games differently. Distribution is different. Amazon and Barnes & Noble were the point of contact for book buyers. In video games the point of contact is really the console. The thing in your living room. Microsoft (MSFT), Sony, and Nintendo are the real point of contact between video games and customers. And they have already been welcomed into the home. This is very different from the book business. In the book business Amazon and Barnes & Noble have a very strong blocking position that keeps them closer to the customer than anybody else in the industry.

So there was a clear channel of distribution. They had big advantages. Whether e-books will be profitable for Amazon and Barnes & Noble is another question. But their competitive position relative to other potential e-book sellers was strong.

I do not believe this is true of video game retailers. As you explained, a large part of the video game retail business is used games. A shift to digital will crush the used game business. Video game retailers are in a much weaker position than the book retailers were. They're not as close to the customer. You can get around them. That's a big problem.

Regarding data volume, you have to remember that people can connect their consoles to the Internet by wire. This is how my own Xbox is connected. Ethernet in the house is fast, so download speeds are really driven by the cable entering the house.

More importantly, you have to assume that at least some voracious readers are not big Internet users. I'm not sure this is true of video game buyers. They have to have at least some familiarity with electronics. And with the importance of multiplayer games I assume they spend a lot of time on the Internet.

Video game buyers are not necessarily that young anymore. I don’t have data on the UK. But in the U.S. the average video game buyer is the age of the average American. There’s no bias towards youth when you ignore the issue of who buys the most games and just look at who buys games. But regardless of age video game buyers came up in an environment where they probably used electronics heavily. These people know a lot about computers. They're comfortable with them. I think the move to digital download may be a lot faster than you assume.

I can tell you my personal habits. I prefer both digital download of games and reading of e-books. That sets me apart from much of the population. Will it permanently? Or am I just an early adopter?

I don't know. When I bought Barnes & Noble stock I had not been in a bookstore in a very long time. That's not entirely true. I went to Barnes & Noble stores to research the stock. But I never went there to buy books for myself. I always bought print books at Amazon. And once I had a Kindle I stopped buying print books altogether.

A lot of people assume that people read e-books rather than print books because they're cheaper.

For me, price is definitely not the appeal of e-books. It’s convenience. I buy more e-books than I would print books. A lot more. It’s an issue of inertia. Inertia is the enemy of every business. It is the reason the infomercial business exemplifies good marketing better than any other business. It’s one thing to sell someone a bottle of wine in a wine store. Any advertiser can do that. The real difficulty is not in getting someone who is actively searching for a product to settle on yours. The far greater challenge is getting someone off their butt and over to the phone. Or out the door and into a store. Or out to a movie theater. That kind of marketing is tough to do successfully and is very expensive. It’s also uneconomical to reach certain groups. One reason why so few movies are marketed to folks over age 30 is that it’s too hard to get them all in one place, exposed to your ads, and chattering amongst themselves ahead of the opening weekend. They are too socially isolated. You can’t get a bandwagon going. The friction is too great.

E-books reduce friction. If I hear about a book on T.V., I can buy it this instant. When I see a book cited in a book I’m reading, I go straight to Amazon and check if that book is available on Kindle. Would I remember to check for this cited book the next time I was in a bookstore? Hell no. That sale would never happen in a bookstore. It only happens because I have a Kindle. Because a Kindle allows for frictionless movement from the moment of interest to the moment of purchase.

I can’t tell you how many e-books I’ve bought because they were cited in a book I was reading. It’s a very high number. And what about books by the same author? Also a very high number. E-books make it very easy to gorge on a particular subject or author. All because they reduce friction. I can quickly go from having the spark of interest appear in my head to having the book in my hands. That’s impossible in an offline world except for the few moments where you are actively browsing the shelves of a bookstore.

This is the real appeal of e-books. And it will be equally appealing in games.

The other appealing part – and I realize this is only a concern to a tiny fraction of the population – is that I don’t need shelves. I had filled several rooms with printed books. Now Amazon can keep the books for me and I only see them when I need them. Lovely.

So the Kindle has become my bookstore. In fact, it’s become much more than my bookstore. It is my bookstore, my personal library, and a friend who suggests new titles to me much better than any bookstore employee ever could.

Bookstores bring book buyers and publishers together. This is true whether the bookstores are online or off-line. Think of the analogous matchmaker in games. Is it the video game store? Or is it the console?

I say it's the console.

The console can easily become everything to gamers that the Kindle is to readers. So I don’t agree that video game retailers are more insulated from downloads. I think they're less insulated than booksellers were. You may find The Game Group’s business can change very quickly. The only thing stopping people from downloading video games en masse is the attitude of video game companies.

This was once true in books as well. E-books were not something the public was clamoring for. Just as tablets were not something the public was clamoring for before the iPad. E-books were pushed on the public by Amazon. Then Barnes & Noble followed. Whether a product is adopted or not does not depend on customers alone. Sometimes it does not even depend on customers primarily. Companies try to anticipate needs. Companies can mold customers. Creating a customer is one of the biggest jobs of any company. Amazon moved first. Barnes & Noble followed. The two of them together set the agenda in books.

The agenda in video games will be set by the publishers and the console makers. Primarily the console makers. Of course the console makers are dependent on the publishers for substantially all of their economic profit. Consoles do not sell themselves. Games sell consoles. If both publishers and console makers think they can make as much money off downloads you will see the download business snowball very fast. The appetite is there. The distribution system is there. The consoles are already in people's living rooms.

Distribution is easier than in e-books. The situation in video games is actually much more accommodating to quick change than it was in the pre-Kindle book business. So I disagree with you on the difference between the threats digital poses to video games and the threats e-books posed to bookstores. The only difference we’ve seen is that in books Amazon decided to push e-books on an as yet unwilling customer. Barnes & Noble followed. That unprompted push is the only thing lacking here. Video games are every bit in danger of change as e-books were.

You mention the used game business. I doubt this is very instructive. But I can tell you a little bit about my own experiences here. As a kid I actually sold used games to people. l only sold computer games. Not working at a store. Just dealing in used games myself. Selling my own games at first. And then buying games off people and selling them to other people for a nice profit. Why does this work?

Really, you're not a used game retailer — you’re a dealer in used games. There’s a difference. All that is necessary to make a market in used games is to be a place where gamers congregate. That's it. A person can do it. A store can do it. But it’s hard for a general retailer to do, because they know retail but they don’t know gamers. They’ve got it backwards. Knowledge of retail isn’t important. Knowledge of gamers is.

The reason it's hard to sell used games anywhere else is because you need to have buyers and sellers — the people who are making the actual trades — come together around you for you to make a market.

I think download presents disastrous problems for used games.

The games I would sell people fell into two categories. One category was old games. You could call these golden oldies. They were once hits. But they were no longer being published. They were well known but tough to find. Download kills that business. You put the backlist on download. You make more money. It's like reprinting a book. It's very easy to do. It makes perfect sense to do digitally. The economics of backlist publishing are excellent.

The other category of games that were profitable to sell was what we’ll call cult classics. If you knew someone liked RPGs you could sell them Arcanum. Arcanum is not a great game. It’s a great idea. But it's unevenly executed. Kind of annoyingly buggy in places. It’s a standout B title. Nothing more. However, there are a group of people who will buy it. And they will love it. You can sell War Along the Mohawk to people who like that kind of strategy game. Again, War Along the Mohawk is not a great game. In fact, it’s nowhere near as good as Arcanum. But it appeals to a certain kind of person. Someone who can't get enough of a certain kind of game.

There’s a market for bad horror movies. There's a market for bad science fiction. There’s a market for bad romance books. Where there are niches that people want to see filled and not enough new material being published in that niche you can sell B grade content in that niche and make money. You just need to know the folks who live in that niche. You need to be the place they come to.

Finally, you can make money selling used goods anywhere you have buyers who are perpetually short of cash. There is a market for used games in the same way there's a market for rent-to-own furniture. There are people out there who just don't have cash and can’t get credit. So used cars and used video games and pawn shops exist. They exist because some people have things and need cash and other people need things but have no cash.

Those are the three ways you make money in used products: moving product from old owners to new owners, selling backlist titles, and accepting product instead of cash.

The question I ask myself when I look at a business in danger of becoming obsolete is: If this business didn't exist would someone create it?

Could you create this business today and be successful? Is there a need for it? Or is it just a relic of business evolution? A vestigial organ? I would say video game retailers will become a vestigial organ of the video game industry.

Once you have consoles and the ability to download games to those consoles, the need for brick and mortar stores is basically nil. A computer or console is connected to the Internet. Your game-playing friends are connected to you through that console. You can interact with them better at your console than in a store. So the need for brick and mortar stores in the video game business seems low to me. I don't think anyone would imagine starting one if they didn't already exist.

There's a bigger issue here. The Game Group just isn’t the kind of stock I normally buy. I don't normally buy retailers. And I don't normally buy companies that are so inflexible they depend on a very specific distribution system that could be rendered obsolete by changes in customer behavior. Barnes & Noble broke both those rules. My investment in Barnes & Noble was a mistake. In part it was a mistake because it broke those rules. The rule breaking was a necessary but not sufficient reason for the investment to fail. When combined with the actions that management took it ruined the investment for me.

I will not try to dissuade you from buying The Game Group. It's a very cheap stock. And when buying a cheap retailer works out well it works out very well.

Retailers are outside my circle of competence. So personally I have no interest in buying shares of The Game Group. But there's no doubt that the stock is cheap. And there's no doubt it has plenty of upside potential.

Let's take a look at their operating margins. I'm taking this from Sharelockholmes, going from the furthest past to their most recent year we see operating margins were: 6.9%, 5.8%, 5.6%, 5.7%, 1.7%, 4.1%, 5.5%, 6.8%, 5.4%, 2.7%. That's very similar to the kind of operating margins you see at places like Barnes & Noble.

In fact it's very similar to the kind of operating margins you see at grocery stores. Think about the moat around your local grocery store and think about the moat around The Game Group. The moat around your local grocery store is much wider. The risk of volumes fluctuating in the grocery business is low. The risk posed by online sales of groceries is very low. Online grocery sales simply cannot be done at the same low prices as brick-and-mortar grocery sales. If there were no grocery stores today I have no doubt people would be building grocery stores as we speak. Online sales of groceries is not cost competitive with going to the local grocery store yourself. Online groceries are a logistical nightmare.

I don't see anything like those kinds of competitive advantages – the kind enjoyed by an established grocery store – in an established video game retailer. I really don't think there would be any need for them to exist if the only way to buy games was by downloading them to your console. I honestly think that is how people would buy video games if there were no retailers. And they wouldn’t think twice about it.

So I think these stores are a vestigial organ of the video game industry. That doesn't mean they won't survive. That doesn't mean they can’t be jerryrigged into serving some other purpose. You see that kind of adaptation all the time in business. It's natural. We build on the material we have it hand. New things are built from old capital. Businesses transition. The original business Western Union was in doesn't exist anymore. Western Union still does. It evolved.

Evolving is hard for a retailer to do. Retailers are specific. They are prone to extinction. Retailers are often so fit they can’t survive anywhere but in the specific place and time where they grew up. They are built to suit an environment. When that environment changes, they die.

Retailers have a lot of leverage built into the business. They have operational leverage in the sense of low operating margins. They have financial leverage in the sense of leasing stores. You can see this in the balance sheet of a retailer.

There’s nothing wrong with The Game Group’s balance sheet. But it’s not the kind of balance sheet I’d like to see if I were buying a net-net. It’s not the kind of balance sheet you want if you need to transition into something else. Liabilities are too high. There’s cash. But not enough net cash to buy time. There are much more attractive stocks from a pure balance sheet perspective. So an investor who buys The Game Group is buying the stock for its sales.

I think the risks to The Game Group are real. And they're really quite high. But, as you said, the price to sales ratio is low (0.04). You are getting $25 in sales for every $1 you spend on the stock. I agree that The Game Group is a better buy than GameStop (NYSE:GME). GameStop is just better known.

But it really comes down to this. I agree with the points you made about the cheapness of The Game Group. I do not agree with the points you made about the defenses of video game retailers against the threat of downloaded games. I think the threat is at least as great as the one posed by e-books. In fact I think it's greater. We just have to agree to disagree on this point.

I don't see technology as the biggest impediment in the switch to digital distribution. The established routines of customers are usually a bigger hindrance to rapid change than the technical limits of companies. And I see the possibility of routines being altered as at least as likely in the video game space as in the book space.

I do however agree with you about The Game Group’s cheapness. It’s a very cheap stock. I think this is a risky bet. I think it has a lot of upside. I think it has a lot of downside. That’s not the kind of bet I want to make. It may be the kind of bet you want to make.

But I think it's much more similar to the bet I made on Barnes & Noble than you are willing to admit.

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About the author:

Geoff Gannon

Rating: 3.9/5 (23 votes)


Adib Motiwala
Adib Motiwala - 5 years ago    Report SPAM
Game Group looking for a buyer. Ironically, GameStop may be interested.

"_ I agree that The Game Group is a better buy than GameStop (GME). GameStop is just better known" ---- Just buying cheap stocks is not enough...there are other things at play. GameGroup did not turn out to be a better buy even it was cheaper 8x on a P/S basis.

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