Short Gamestop

The Fall of GamestopAs Presented by Reece Denzel

Thesis

As consumers of video games move toward online distribution platforms, sales from

physical retail and resale outlets will decline.

Trade: Short GameStop Inc. and hedge with a long position with the largest video game developers/publishers (GameStop’s main

products).

Overview of Industry (2013)

Size of Global Video Game Software Market: $50B

Expected Growth Rate: 9.7% YoY 2012-2013

Market Share of Top Three Third Party Publishers (EA, TTWO, and ATVI): 20%

Source: Hoovers

Exact data for the industry is hard to produce given the number of independent developers and smaller segments of large corporations involved, as well as the fluctuating definition of ‘video game’.

Both 2005 and 2012 saw a decrease in sales as new consoles approached release

Trends

Like most other industries, consumers of video games are increasingly adopting online distribution methods.

In a 2012 survey, NPD group found that ⅓ of gamers prefer digital downloads over physical discs.

Publisher Actions

Video game publishers are putting an increased emphasis on the digital market and direct sales via online portals.

Next Generation Announcements

In 2013 and 2014, Both Sony and Microsoft announced major changes to video game distribution methods. Microsoft will also lead the way in the sharing of digital content.

“We believe in a digital future on our box”

- Phil Spencer,Vice President of Microsoft Game Studios, speaking at the 2014 Game Developer Conference

“Every PS4 game will be available as a digital download” -Shuhei Yoshida, President of SCE’s Worldwide

Studios, in an interview with the Guardian

PlayStation Now

● In early 2014, Sony announced PlayStation Now, which will provide cloud processing and streaming for games on all current Sony consoles.

● Beta is already in progress with release expected for Q3 2014

● Users will pay to access content on a per-game basis or through a subscription

● Connection of 5 Mbps is recommended

Xbox One ‘Always Online’

● Original plans announced at the unveiling of the console at E3 in 2013 stated that the Xbox One would require a near-constant connection to the internet

● This would allow not only for the digital purchase but also the digital sharing and re-sale of games online

● Consumer outcry forced a reversal of this policy, but Microsoft still backs the idea and hints that it will be implemented in pieces throughout this generation

Digital Downloads as Percentage of Sales

2011 2012 2013

Take Two 8.9% 12.8% 21.1%

EA 23.2% 29.6% 43.8%

Activision Blizzard < 32% 32.0% 34.0%

Publishers are moving toward an online distribution platform. Since these numbers reflect sales on older systems, the next few years is

expected to see a dramatic rise in digital downloads as percentage of sales as new consoles are adopted by more consumers.

GME Company Overview

GameStop Corp. (GME) is a global, videogame consumer electronics and service retailer. The company includes 6,675 company-owned stores as well as several online distribution channels (not digital content).

GME Company Overview

● P/E has increased from 8.8 in 2010

● EBITDA margin has been stable at ~8% since 2010

● Market Cap has doubled since 2010 despite no growth in revenue or income

Sales To GME By Major Publishers

2011 2012 2013

TTWO19.2% 19.0% 23.8%

EA16% 15% 13%

AVT/BLZ12% 10% <10%

Trends indicate decreasing reliance on Gamestop to deliver content to consumers.

Release of Grand Theft Auto 5: Large download size discouraged digital distribution

GME Company Overview

Poor Earnings Results, Lowered Guidance

Increase of Dividend

Positive Earnings, Announcement of New

Consoles

Quarterly Results, Optimism

GME Income Statement

Revenue BreakdownBoth new software and used products will be at risk as the digital trend continues. Small bump to hardware comes from new generation of consoles released in late 2013.

New Consoles

The Effects of Console Launches

Xbox 360

PS3 WiiPS4

Xbox One

Wii U

New consoles = new excitement and increased demand for new systems and games. The buildup preceding launches in 2013 likely comes from the increased importance of pre-orders and greater anticipation of sales compared to 2006.

GME Geographic Breakdown

Revenue % By Region

GameStop operates in countries that, for the most part, have sufficient infrastructure to support the digital distribution of games.

Average BandwidthsUS: 7.4 MbpsAustralia: 4.7 MbpsUK: 10.1 Mbps

Source: Thompson ONE Banker Source: Techspot (2013)

Where GameStop’s Games Come From

Over 75% of GameStop’s purchases of new products come from console producers or the three largest software publishers.

Sony, Nintendo, Microsoft and EA all have their own digital distribution channels (direct competition with higher margins).

Balance Sheet

● Inventories rapidly depreciate, require quick sales

● Not enough cash to substantially diversify in a short amount of time

Balance Sheet Cont.

What Edge do we have?

As the world’s largest exclusively-video game retail outlet, GameStop has many strengths from a financial perspective: advantageous pricing, name recognition, high sales volume, etc.

However, investors are failing to see just how out-of-date GameStop’s business model is. Even with strong current financial performance, GameStop can’t avoid the downfall of the physical gaming industry - which is happening very rapidly.

As the target demographic, we can recognize the benefits of a switch to digital content - including convenience of purchases, saving money, and content accessibility.

Hedging

● Growth is and may continue to take place in the big-budget gaming industry (GameStop’s main products)

● Mitigate risk that comes from overall growth in the market

● Top publishers of the goods that are resold by GME → EA, Activision-Blizzard, Take-Two

Overview

Overview of Software Developers/PublishersMk. Cap Price P/E P/B D/E Dividend ROE

EA 8.85B 28.60 - 4.45 1.14 - (1.8%)

TTWO 2,08B 21.20 7.55 2.53 1.42 - 59%

ATVI 14.3B 20.12 21.28 2.16 1.12 1% 11%

Video Game Publishing is a highly volatile market that depends largely on the release of games that have been in development for 2+ years. Some years will have losses due to lack of content entering the market. By hedging with all three of these developers, we can cancel out much of that risk, as these products are in direct competition for consumer dollars and their combined performance is an indication of the big-budget gaming software market as a whole.

Video Game Stocks vs. The Market

Take-Two

TTWO is more heavily invested in consoles than its competitors, amplifying the impact of the pre-new console slump

Electronic Arts

Activision-Blizzard

Revenue Breakdowns

All three companies derive 100% of their revenue from software sales, licensing, publishing, and related services (indicators of market as a

whole). Activision Blizzard Electronic Arts Take Two

Balance Sheets

Take-Two

EA

Balance Sheets Cont.

Activision Blizzard

Note: More expansive balance sheet information available on 10Ks but too large to fit on slides

Proposal

Pair Trade

Short (50%)GameStop

Long (50%)EA, Activision-Blizzard, and Take-Two (equally split)

Risks

● Digital content takes longer to catch on (Bandwidth Constriction, Consumer Preference)

● GME is able to substantially diversify very quickly

● Lack of new products encourages purchasing of old/used products

Sourceshttp://www.statista.com/chart/1180/computer-and-video-game-sales-in-the-united-states/

http://www.gamesindustry.biz/articles/2014-02-20-ea-digital-revenues-to-overtake-physical-in-two-years

http://www.forbes.com/sites/greatspeculations/2013/08/20/gamestop-faces-headwinds-but-digital-sales-will-help-earnings/

http://www.superdataresearch.com/blog/us-digital-games-market/

http://www.gamesindustry.biz/articles/2013-03-29-digital-game-sales-growing-33-percent

http://www.gamasutra.com/blogs/BryanCashman/20140103/207997/2014_in_Video_Games_The_Year_of_Digital_Acceptance.php

http://www.gartner.com/newsroom/id/2614915

http://investor.gamestop.com/phoenix.zhtml?c=130125&p=irol-SECText&TEXT=aHR0cDovL2FwaS50ZW5rd2l6YXJkLmNvbS9maWxpbmcueG1sP2lwYWdlPTk1MDcyOTUmRFNFUT0wJlNFUT0wJlNRREVTQz1TRUNUSU9OX0VOVElSRSZzdWJzaWQ9NTc%3d

10K of Electronic Arts Inc., Take-Two Inc., GameStop, and Activision Blizzard Inc.

Questions?(and maybe answers)