Is Video Game Retailer GameStop in 'Play'?

In the video game world, there is no more direct line to the enthusiast audience than GameStop.

Gamestop store
Source: Gamestop
Gamestop store

The retailer, which has more than 6,200 stores nationwide, is a gathering spot for players, who flock there when big games are released. It has withstood numerous attempts by big box stores to encroach on the most profitable parts of its business model.

Its first quarter financial results were solid and the outlook is good for its second quarter report, scheduled on May 20. But because the stock continues to trade so cheaply, some on the Street have begun to whisper that GameStop could find itself a takeover target.

Right now, it’s nothing more than whispers. Analysts say they haven’t heard any solid chatter or seen activity that indicates anything is imminent. But because the stock is so cheap, it leaves a wide-open field for suitors.

GameStop is a company that could mesh well with a number of other retailers. The name that’s most frequently bandied about as a buyer, though, is Best Buy.

“The only company I could see buying them that makes sense is Best Buy,” says Michael Pachter, managing director of equity research for Wedbush Securities. “That’s because Best Buy is so determined to expand into strip malls with its Best Buy mobile business.”

GameStop has a market cap of over $3.5 billion. The stock, though, trades low, sticking in the $20-$25 per share range these days, but falling as far as $17.12 in the past year. Its price-to- earnings ratio of 10 is well below the average of 30 for specialty retailers.

That’s due, in part, to the company’s reliance upon the brick and mortar model. Many within the video game industry (as well as outside of it) expect digital distribution to become a significantly bigger sales force in the coming years—and GameStop is not currently well positioned to take advantage of that.

The company also is reliant on used-game sales to boost its earnings. Recently, though, publishers, including Electronic Arts and Take Two Interactive Software, have begun taking more proactive steps to discourage the resale of their games. Additionally, Wal-Mart is said to be considering a major step into the used game space—one that is far more involved than recent failed efforts.

Despite that, GameStop has a strong balance sheet, with $905 million in cash and $447 million in debt as of March 20 (compared with $292 million in cash and $447 million in debt in October).

“There are a lot of challenges for GameStop right now, but they are pulling in a lot of money,” says Billy Pidgeon, senior analyst of M2 Research.

Potential cost cutting measures, such as scaling back on store growth and revamping the company’s loyalty program, could make it an even bigger cash generator—and that could make it attractive.

“It might be a good time for them to sell, because retail is going to be declining,” says Pidgeon. “Big boxes are really getting a handle on software and console sales. We’re also hitting the part of the cycle that means [gaming] is a mainstream thing now and less of a specialty market. You’re going to get the shoppers who don’t go into specialty shops like GameStop. They’re going to be served just fine by the Wal-Marts and Targets.”

GameStop itself seems to be paying little attention to the takeover talk. The company gave strong initial guidance for 2010 during its last earnings report and has extended the contract of CEO Dan DeMatteo by two years to 2013.

That has some observers thinking that even if an offer is brewing somewhere, GameStop’s not interested.

“Management would downplay the stock if they were looking to sell the company,” notes Pachter.