Is GME undervalued by D Klein – 08/22/10

GameStop Corp. ( operates as a retailer of video game products and personal computer entertainment software. It sells new and used video game hardware; video game software; video game accessories, including controllers, memory cards, and other add-ons; PC entertainment software; and strategy guides and trading cards. The company sells its products through its stores, as well as through electronic commerce Web sites, including,,,, and As of January 30, 2010, it operated 6,450 stores in the United States, Australia, Canada, and Europe primarily under the GameStop and EB Games names. The company also publishes Game Informer, a video game magazine in the United States. GameStop Corp. was founded in 1994 and is based in Grapevine, Texas.

On 8/19 GME reported earnings. News articles reported headlines like : “GameStop 2Q profit rises but misses estimates…GameStop 2nd-quarter profit rises 4 percent; company cuts 3rd-quarter outlook, citing expenses” .  Needless to say the stock took a hit due to these headlines, after all, increasing expenses doesn’t sound very good.  The comments on the conference call point to the increased expenses as good news.  How? In part due to results from a pilot program called Rewards are exceeding expectations so they plan to accelerate a national rollout.  From the CC:

“After only 10 weeks in pilot, …PowerUp members are shopping at roughly twice the frequency of non-members, and 15% of members have shopped us five times or more in the last 10 weeks. We are also seeing a high level of trades in used sales from PowerUp members…Based on the success of the company’s new power of rewards loyalty program, an in-store DLC sales pilot, these two initiatives will be rolled out nationally during the third quarter. GameStop is adjusting its third quarter diluted earnings per share guidance…To account for incremental expenses related to these programs as well as for the upfront expenses in the Kongregate acquisition and investments in e-commerce.”

What about the longer term guidance that somehow was lost in the headlines:
we are maintaining our full year 2010 guidance of diluted earnings per share at the range from $2.58 to $2.68. Total sales growth of between 4% and 6%.

The company generates impressive free cash flows growing in excess of 10% over the past few years.  They plan to end the year with about a billion in cash and are developing a plan to return cash to shareholders through buybacks on an annual basis.

I understand one risk that spooked the market is there have been several big-box competitors who have launched used business,  but the company has seen zero impact to their results to date.  They seem to be well established and have a loyal and growing customer base.  Then again if the stock continues to fall they may become an attractive acquisition candidate which I’m sure they would fight given their financial results.  Maybe their annual buyback plans are a result of this fear, probably not.

I think the stocks fair value is about $26 but the market disagrees.  Current PE as of this date is about 8 and the forward PE about 7.  One thing I do not like is they do not pay any dividends and my gut tells me dividend paying stocks will be more attractive to investors going forward.  That said GME appears to be trading at a discount of close to 28%.

Some info used to formulate my opinion is at my data/calcs page:

Disclosure: No position as of this writing.

Comments welcome.

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