Analyst Upgrades GameStop On Strong Game Sales

Market analyst firm Wedbush Morgan Securities has upgraded stocks of major U.S. video game retailer GameStop from "buy" to "strong buy", with a 12-month price target of $55, citing "stronger than expected" video game hardware and software sales in May and June as the reason for the shift. Wedbush analyst Michael Pachter commented that the firm has been “pleasantly surprised” with sales of both video game hardware and software, with hardware up a considerable 38 percent for the combined months of May and June, and software sales up 3.4 percent as well. Pachter also added that the firm expects that these strong sales will continue for the remainder of 2006, assuming that the economy remains stable and both Sony and Nintendo ship the promised number of next-generation consoles on time. He commented: “Our full-year estimate presumes year-over-year Q4 hardware sales growth of 50% (around $175 million on a same-store basis), meaning that GameStop will have to sell approximately 250,000 PS3 hardware units, 300,000 Wii hardware units, and around the same number of Xbox 360, Nintendo DS and Sony PSP units as it sold during last year’s Q4.” He continued, commenting that the firm believes that its estimates are “exceedingly conservative”: “In order for GameStop to meet our estimates, the company will have to sell only 12.5% of the number of PS3s expected to be delivered to the U.S. market, and only 20% of the number of Wii hardware units expected. Given that GameStop has approximately 22% market share in the U.S. and is likely to receive an allocation greater than its market share at holiday (we believe close to 25%), we think that it is in a good position to substantially exceed our comp estimate for Q4.” However, Pachter was quick to point out that these estimates depend strongly on Sony and Nintendo being able to deliver the new hardware on time, noting that “it is possible that Sony and Nintendo will have manufacturing issues, and that a lower number of next generation consoles will be delivered into the U.S. market at launch.” Wedbush also feels that in order to extend the retailer's presence in the UK, it will purchase Blockbuster’s Game Station business in that region, which represents approximately 200 stores. Currently GameStop only maintains a very limited presence in the UK, with just around 25 stores in Ireland, and the firm predicts that GameStop could open up as many as 1000 new stores in the UK over the next several years. Adding to this, Wedbush feels that Blockbuster may be looking to sell off its Game Station stores, and could consider letting them go for “around 50% of sales, or around an estimated $70 million.” Rather than building stores from scratch, the firm believes that this is the most logical alternative for the retail chain. The firm noted that it feels that both companies will announce a transaction around the October time frame. Turning to GameStop's business of buying and selling used games, Wedbush noted that the business continues to be lucrative for the retailer, despite recent speculation that Sony may introduce a new technology with the PS3 that could limit or otherwise restrict the ability to play previously owned or rented games on the new console. Sony's Europe branch has denied such intentions, however, and Wedbush noted that it feels that it is unlikely that Sony will restrict the resale of PS3 titles. Regarding GameStop’s merger with Electronics Boutique, Pachter noted that the firm feels the “final synergy” from the merger is close to $100 – 115 million per year, and that the combined company expects around $70 million in synergies in 2006. Wedbush also feels that some additional recognition of synergies could be seen in “2007 and beyond.” Pachter concluded: “With size comes the ability to deliver operating leverage. The GameStop model is working brilliantly, and we believe that the company can grow operating margins from 6% in FY:05 to 7.6% in FY:07. As the company grows revenues in FY:08 and beyond, we expect to see operating margins continue to grow...At yesterday’s close, GameStop shares offer approximately 45% upside to our price target. Given the near term catalysts of earnings upside, upward revisions to consensus estimates, the potential acquisition of Game Station stores from Blockbuster, and the death of the PS3 used game ban rumor, we think that GameStop shares will appreciate rapidly over the remainder of the year, and we believe that an upgrade is warranted.”