Position Update: GME

(Click to Enlarge - Above Sterne Agee Estimates, Below Goldman Sachs Estimates)

After the big selloff on Thursday, it is clear that many analysts have different views on Gamestop. I have read 3 analyst reports and 2 remain very bullish, both keeping price targets above $30. One of those firms, Sterne Agee, kept the $35 price target and said the selloff was overdone - which I agree with. Goldman Sachs on the other hand, kept their neutral rating and lowered the price target from $27 to $24. Goldman believes the firm should earn $2.73 per share and $2.62 per share next year. Sterne agree believes the firm will earn $2.90 a share this year and possible grow 15% EPS next year (which takes it to about $3.25ish). So what brings the wide seperation?

Sterne Agee: They argue that the guidance is very conservative and reflects extreme (overdone) weakness in Europe and Wii Sales. In addition, they believes that Gross Margins improved dramatically in Q1 (which they did) and even though in Q1 the firm missed revenue targets, they crushed EPS estimates because of strong cost cutting measures. Lastly, they believe used games will remain to perform well, growing strong, and will provide stronger margins (around 50%) which will post EPS growth.

Goldman Sachs: GS has a variant view to say the least. GS believes that is the beginning of a business model flaw because "they believe" that current product cycle continues to taper off, which double-digit declines in same-store sales declines in software will provide headwinds for earnings. Secondly, GS claims that Gamestop continues to "lose share on a same-store basis, by our measure, with Gamestop's SSS tracking light on industry numbers". Well, I flat out disagree with that and it shows that they don't listen to the conference call (or the analyst was playing solatiare). The CEO said (not quote for quote) "our share grew while the industry sales declined, showing the Gamestop stayed reslient in a tough economic climate". The first comment is a fair statement, that I can respect.

So, enough of the gibberish, here is my take. I believe long-term Gamestop is going to face serious headwinds because of the new online model that allows gamers to download content off MS live or whatever portal they choose. Many bears believe Gamestop will end up like Blockbuster but I view it a little differently. I think Gamestop's management is one of the best in the biz, plus Blockbuster never had a true profitable segment, like that of used-games for Gamestop. It is true that Gamestop faces strong challenges with Amazon and new disruptive technologies; however, I am a believer - at least for a trade. Here is why:

1. Hardware sales- The segment that is killing Gamestop, more than any, is hardware. The CEO of Gamestop said on the conference call that the only way Nintendo or Sony will make their hardware sales numbers is to cut prices on the consoles. I totally agree because this seems to be the longest time period, where a manufactuer has not cut prices. Therefore, I am "betting" that Sony and/or Nintendo will cut prices on their consoles, which will boost sales and help Gamestop's numbers. However, note this: GME's 2Q numbers do NOT reflect any hardware prices cuts BUT 3Q/4Q DO reflect hardware price cuts. Therefore, no price cuts, could lower the 2nd half of the year's estimates. I believe we will see price cuts within the next 45 days.

2. Multiple Valuation - One could argue that PE multiples are dumb in an environment that like this and I somewhat agree but would you rather me bust out EV-to-projected EBITDA in relation to market cap numbers? I will save that for another day but the valuation on Gamestop really comes down the the last half of the year and the EPS projection for next year. If they hit numbers and guide higher, the stock should easily see $30. I believe that Gamestop should deserve a 10x multiple, which is conservative compared to the past. In 2007, the stock carried a 12-13 multiple, while last year it had a 9.5x multiple (in a strong bear market). I think 10x is conserative but I rather be conservative than agressive. Regardless, Gamestop has this year's FY estimates of about $2.83-$2.93, which solely rely on a strong second half. If they can hit those numbers, the stock is worth $28+. If not, I will need to see how bad the estimates come out and the guidance for next year but I think worst-case scenario is depicted by Goldman. Goldman has a $24 price target on it.

In conclusion, I like the name for a trade. Over the long-term, it is a risky bet with new technology and new industry trends. I am willing to quadruple my position if the stock dips below $19 and until then, will probably keep what I have or add small.