Sunday, March 13, 2005



GameStop Corp. (NYSE:GME) located in Grapevine, TX is the nation's largest video game and entertainment software specialty retailer. GameStop sells the most popular new software, hardware and game accessories for the PC and next generation video game systems from Sony ,Nintendo, and Microsoft. GameStop is the industry's largest reseller of used video games.

In addition, the company sells computer and video game magazines, strategy guides, action figures, and related merchandise to more than 30 million customers. The company operates 1,746 retail stores throughout 49 states, Puerto Rico and Ireland, primarily under the GameStop brand. The stores are located within shopping malls and strip centers. Complementing the retail stores, the company operates a website at and publishes Game Informer, one of the industry’s largest circulation multi-platform video game magazines, with over 1,500,000 subscribers. One visit to the web site is all it takes to appreciate the extent of the offerings available.

Since going public in Feb 12, 2002, GameStop has had an impressive showing over the last couple of years. Sales have exceeded projections each quarter. On Nov. 21, 2002 GameStop Corp. announced the opening of its 1,200th retail store. "While reaching 1,200 stores is an exciting milestone for GameStop, it is also just a step on the way to the continued rapid expansion of our company," said R. Richard Fontaine, Chairman & CEO. "We are on pace to open over 200 stores this year; and, given the growth of the video game business, and the success we have had serving very diverse demographics, we plan to grow even faster in the coming years."

Third Quarter 2004 was no exception. GameStop sales increased 28% to $416.7 million from $326.0 million. Video game software sales were exceptionally strong, growing 36%, with leading titles such as "Madden NFL 2005" from Electronic Arts Inc, "Grand Theft Auto: San Andreas" from Take-Two, and "Fable" from Microsoft, Inc. Video game hardware sales were robust with the launch of the newly redesigned PSTwo and the Xbox holiday bundle. Comparable store sales increased a strong 11.8% during the quarter.

On November 9th 2004, GameStop set a one days sales record when Microsoft released "Halo 2". "Halo 2" sold over 525,000 units in 24 hours. "Our initial projections for a strong holiday season seem to be justified by the exceptional acceptance of the video games released thus far in the season, and we are looking forward to an exciting few months and beyond", reported CEO Fontaine. Here is the BUT.

Depending on others for success can cause one to ask, "Why Do Bad Things Happen to Good Companies?" December sales were ready to surge but didn't. The headlines read- Hardware Shortage Impact Fourth Quarter Sales and Earnings.

Mr. Fontaine, commented, "After a very strong November, when GameStop's comparable store sales rose 23% driven by significant demand across all major platforms, we were well positioned for a strong holiday season. Unfortunately, severe hardware shortages of Sony's PlayStation 2, Microsoft's Xbox, and Nintendo's Dual Screen, have taken a toll. Not only did we lose the tie-in software sales that generally accompany hardware gifts, but due to the shortage affecting the total market, we lost the 'downstream' sales that historically have come our way regardless of where hardware is sold. In all of my years in the video game business, I have never seen shortages of this duration or magnitude. There is no question that there was demand for the product, but not hardware product to satisfy demand. As the season progressed, we expected hardware inventories to improve, and, as the season developed very late, we felt that much of the lost holiday sales could be rescued with more hardware in the last weeks of the season, but the shipments did not materialize."

He also said, "To put into perspective the impact of not being able to secure the hardware we needed, our December month-end inventory was $33 million lower than the previous year even though we had over 300 added stores. It became very clear as the month went on, and hardware shortages continued, that there was a significant effect on store traffic”.

"While we were frustrated by the supply shortfall, we view this as a temporary problem, as we know that our hardware manufacturers will aggressively work to expand the user base that is so obviously ready to purchase the product. Our disappointment at not having the product to sell is, to some degree, tempered by our enthusiasm for the fact that in the fourth and fifth holiday season for Xbox and PlayStation2, demand was phenomenal".

GameStop's numbers are sensational. The company has grown from 1,039 stores in 2002 to 1,746 stores; an increase of 707 stores in 2 ½ years. The industry is growing, the company is growing, but the supply problem zapped fourth quarter reults. The business is competiive with “big boys" such as Wal-Mart offering price pressur. The company does not pay a dividend.
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Selecting this company as the Stock of the Week, takes Moxie. (As the saying goes, a lot of Moxie). Selecting a company whose largest competitor is Best Buy (BBY), a company that sells a product that is a major category for the likes of EBAY and AMZN, a company that competes in an area where large firms such as Blockbuster Video have failed might prove to be foolish.

In other articles, I have written how "long-tailed" products are being distributed more and more through low cost online channels. Games at first appear to be "long-tailed" products. There are thousands of older games wasting away on shelves everywhere. Should NFLX enter the business, it might be able to squeeze more value out of old games. However, innovations continue to destroy the value of old games. The new Sony machine is expected to be a huge success and most of the old games will not play on the latest machines.

I have never suggested that NFLX would put movie theaters or producers out of business. People follow the crowd and buy what is "hot". Movie producers and game producers are addept at creating "hot products". Producers must collect millions of revenues to justify the costs required to make a movie. Producers win big on some and lose on others. A major part of their success comes from the DVD after-market but 100's of millions are made by making and promoting the "hot new product".

The game rental business and the movie business are similar. One can purchase or rent an old game or an old movie cheaply. Never-the-less, consumers go to the theater, pay $8 to see the show and spend almost as much on a box of popcorn and a large coke. The parents of young folks are willing to drop kids off at the mall to "hang-out". In flocks the kids go to the game stores to purchase the hot new game at a $40 price.

Note the difference in the purchase of a game and the rental of a video from Blockbuster. Blockbuster stores are normally located in a high traffic location but not inside high priced mall space. Games are bought spontaneously. After-all, the rental of a movie is likely to be made by someone who has a drivers license who drove to the store for the purpose of renting a movie. The point is that GameStop has identified a niche. Most of us do not go to the mall to buy ice cream, cookies or a game but many of us will not pass the smell of a good chocolate chip. GameStop stocks a high dollar inventory and turns it fast. The price to sales ratio is only .59. The forward P/E is under 15 times.

Bill Miller of Legg Mason Wood Walker, Sumner Redstone of Viacom and other very smart investors have invested in game stocks. My family owns shares in Electronic Arts (ERTS). Playing games on a privately owned machine is acutally relatively cheap entertainment. In the old days, game players spent one quarter at a time. In today's dollars, those quarters would be at least $1 at a time. Spending $40 on the latest game is the equivalent of 40 games. Some of the players play one game thousands of times.

After the design and production costs are covered, the manufacturing costs per game are minute relative to the sales price. To be successful, producers need a distribution channel to quickly convert the latest product to a "must have product". GameStop is the 800 pound gorilla that can make or break the latest edition.

Finally, the demographics are interesting. Gamers do not stop playing when they "grow up". Thirty and forty year old men and women who played Donkey Kong as kids now challenge players from around the world. They play new games or new versions of old games from the comfort of their living rooms. New technology allows gamers to carry on conversations or to "video-conference" with competitors from around the world. The situation reminds me of the "progress" made in personal computers over the years. A PC without an internet connection is nothing but a fancy typewriter. As soon as the latest innovation is on the market, all those old games are obsolete.

Should you decide to invest, you do so at your own risk. Should you invest, we suggest that you risk 5% or less of your capital on any one security.

Miller and Kupsky