Yahoo Finance GME Stock: 3 Levels of Gauging GameStop's Plan For Change
When you think of GameStop, you know what you're getting as a consumer. Video games.
While that hasn't changed, GameStop Corp. (GME) has also taken one of its premier offerings -- video game returns -- and turned it into a refurbishing powerhouse; sales in the unit account for 26 percent of GME revenues. It's with this expertise that GameStop is starting to plan for the future.
Physical video games have held on longer than many may have expected in a digital world. Since creators of the games don't like to discount their offerings, the appeal of going to a brick-and-mortar store has remained viable. But consumers are getting used to the idea of downloading new hits while consoles -- including Microsoft Corp.'s (MSFT) X-Box and Sony Corp.'s (SNE) PlayStation -- have gotten better at enticing players to download directly from the couch.
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That's leaving GameStop in a precarious situation, as its stock price has fallen 18 percent in the last year. How will the company respond?
GameStop's trade-in policy remains a key differentiator. GameStop has faced the impending decline of physical video game software to digital downloads for a few years. Since 2013, sales of new video game software have fallen 19 percent. But, as the largest player in video game retail, "they're going to dominate physical software sales for a while," says Michael Pachter, managing director in equity research for Wedbush Securities.
What keeps GameStop relevant is its trade-in policy. This allows users to take their old games, earn some store credit and buy other games in the store. That's why during the same time span, used game sales have remained fairly steady, only falling 2 percent.
This trade-in policy provides consumers with in-store currency that they can use to shop at Gamestop -- even though most customers think they're going to get more back than they will. The average trade-in is in the low teens, while customers expect to get nearly $20 back, Pachter says.
The issue, of course, is that if more people turn to digital downloads, there are fewer video games to resell. Once that starts cutting into GameStop's business, then it may not have many ways to maneuver on the video game front.
Refurbishing more than just games provides a path forward. When GameStop buys a used game from a customer, it's shipped to the company's refurbishment center -- an 182,000-square-foot facility that cleans and fixes the games before sending them to stores for sale. It's a tactic GameStop has used for years to increase its dominance in the video game market, and offers nearly 47 percent gross margins on the repurchase, according to Arvind Bhatia, an analyst for Sterne Agee.
Now GameStop has broadened the use of the refurbishing facility, using it to clean and repair unwanted smartphones and tablets that it buys from its customers.
It's also why it's bought 890 AT&T (T) branded stores, 76 Simply Mac locations and 70 Cricket branded stores. "They're really good retailers," says Bhatia, and "they have the capital."
By buying these stores, GameStop is using its retail knowledge, as well as its refurbishment capabilities, to resell more products.
"I think it's fair to compliment management," Pachter says. "They actually see that their core business will decline over time. Good for them to redeploy capital into something effective."
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Yet, if it continues to build a close relationship with AT&T, then the way forward may intricately link GameStop to AT&T's results and smartphone sales -- for good or bad.
Valuation depends on how you feel about its plans ahead. Whether or not you think GME stock is a buy hinges on how you feel about the video game sector, and whether you believe the company can improve its refurbishing efforts to counter a reduction in game sales.
Jeffrey Thomison, an analyst for Hilliard Lyons, values the company at 8 times 2016 earnings per share. That's about where the company is on average over the past five years, but below its 10.1 average over the past decade. Thomison says he's unsure about the future of video games and GameStop's efforts to diversify.
Pachter, on the other hand, believes the company's positioned well and doesn't think that video game sales will drop as dramatically nor as quickly as others expect. That's why, even though he has an estimate of 8 times 2017 EPS, he has a $36 price target, which is a 12 percent upside to its current pricing.
"The Street is not giving them any credit for the mobile business until we see it's growing," Pachter says.
That's where GameStop as an investment hinges. Will it take a large deal -- like potentially becoming the exclusive refurbisher of AT&T phones -- to get the stock growing? Or will the demise of the physical video game happen first?
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It's a battle that GameStop is trying to win. But it's unclear if it has discovered the way forward, or if it will have to hit restart.
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