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The GameStop store in Westminster, Colo. (RICK WILKING/REUTERS)
The GameStop store in Westminster, Colo. (RICK WILKING/REUTERS)

TECH

After 20% drop, GameStop is worth buying Add to ...

Investors hoping to cash in on their video game addiction may want to turn their sights on retailer GameStop Corp., which several analysts are calling a buying opportunity after a massive selloff on Tuesday.

Shares of the world’s largest retailer of new and used video games and consoles sank 20 per cent after the Texas-based company reduced its guidance for the crucial fourth-quarter holiday period.

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It expects earnings to come in between $1.86 (U.S.) and $1.95 a share in the quarter, down from a previous guidance of $1.97 to $2.14 a share. Analysts had expected $2.14 a share, according to S&P Capital IQ.

GameStop blamed a bigger-than-expected 22.5-per-cent decline in sales of new games for the older-model Microsoft Xbox 360 and Sony PlayStation 3 consoles. Selling those games is a lucrative business, with about 22-per-cent profit margins: Those sales represented about a third of GameStop’s revenue in the nine-week period ended Jan. 4.

Investors bailed from the shares despite a 10-per-cent jump in same-store revenue that was driven by strong sales of the next-generation Xbox One and PlayStation 4 consoles. The new hardware division, which encompasses the consoles, accounts for about a third of GameStop’s sales, but has profit margins of only about 5 per cent, analysts say.

Some see the lower software numbers as a signal that GameStop’s bricks-and-mortar business model, which includes 6,488 stores across 15 countries, is being threatened by growing competition from digital downloads. Others believe it’s just a shift to a new generation of games that will eventually benefit GameStop.

“These transitions are always unpredictable,” said Sean McGowan, an analyst at Needham & Co. “It’s turning out to be, from a gross-profit standpoint, an unfavourable tradeoff, but one that you would probably happily make for the future.”

Mr. McGowan is one of 13 analysts with a “buy” rating on GameStop, while seven say “hold” and two say “sell,” according to Thomson Reuters IBES.

“While we are never pleased with a guidance reduction, we believe there is a major ‘silver lining’ in GameStop’s results and would be buyers on weakness today,” Anthony Chukumba, an analyst at BB&T Capital Markets, said in a note Tuesday.

GameStop’s issue is that there is too much demand for the next-generation consoles, which is negative for the company now, but could be positive down the road, says Tony Wible, an analyst with Janney Montgomery Scott LLC.

“Selling more razors means you’ll sell more razor blades in the future,” said Mr. Wible, who has a “buy” recommendation and $63 price target on the stock.

GameStop shares fell $9.01 to $36.31 on the New York Stock Exchange Tuesday, a six-month low. The stock has fallen about 37 per cent from a six-year high of $57.74 reached in November.

Before Tuesday’s slump, GameStop shares had nearly doubled over the past year, as investors anticipated the new consoles that Microsoft Corp. and Sony Corp. introduced late last year.

Morningstar Inc. analyst Liang Feng said the new products are expected to generate demand for additional hardware and software and bring more products into the stores for resale, but “investors were getting far too bullish.”

He lowered his “fair value” estimate on the company’s stock to $34 a share from $37 on Tuesday. “The industry landscape is evolving rapidly and introduces numerous risks to GameStop’s business model,” he said in a note.

Long-term challenges include faster Internet speeds that will make it easier for enthusiasts to download video games from home and the growth of digital gaming platforms that could take market share away from consoles.

Jeffrey Thomison, an analyst at Hilliard Lyons, has a “sell” on GameStop, in part because of the risk of a digital revolution in delivering video games.

“In a worst-case scenario, customers don’t need to go to a GameStop store in the future … that’s not a prediction, it’s a risk, meaning it could happen,” he said.

Investors may continue to hang on to GameStop for its healthy 2.4-per-cent dividend yield, which is rare in the video game business. It compares to 1.8 per cent for Best Buy Co. Inc., which also sells games, and 1 per cent for game developer Activision Publishing, Inc., producer of the popular Call of Duty series.

GameStop trades at about 14 times earnings, which is in line with Activision, but cheaper than Best Buy at 15 times and game maker Electronic Arts Inc. at 17 times.

Follow on Twitter: @BrendaBouw

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