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GameStop - Tadpoles in the Stew?



February 13, 2010 – Comments (12) | RELATED TICKERS: GME

We noticed that shares of GameStop Corporation (NYSE: GME) were hammered on Tuesday, down almost 4.5% from the previous day, on volume that was almost 2.5 times the norm.

While we don't have a position in GameStop, we think it is a fairly well managed company with reasonable financial metrics. So the price change and the volume increase certainly got our attention and made us wonder just what was going on.

Financial information related to GameStop Corporation, contained in this report, is based on the company's most recent Form 10-K filing for fiscal year ending January 31, 2009 as filed with the with the Securities and Exchange Commission on April 02, 2009.

What We Found
At the outset, the only reason we could find for the increase in volume and large price fluctuation was a single news article titled Critical Alerts for Yahoo!, DIRECTV, CIT, Toyota, and Gamestop released by Seven Summits Research.

Having seen things like this many times over the years, we decided to see what Seven Summits Research actually did.

As it turned out, Seven Summits Research is Seven Summits Strategic Investments, a company that according to Securities and Exchange Commission filings, employs NO registered representatives of a broker-dealer, and has NO assets under management.

The company is run by a Mr. Victor H. Schiller, who posts at a stock blog site and describes himself as an analyst with an attitude. Mr. Schiller also writes for Investors Observer, a site owned by Fresh Brewed Media.

While Mr. Schiller may indeed have an attitude, one thing he apparently is not is a CFA Charter holder, making him, in our opinion, just another web wannabe instead of the analyst he likes to call himself.

We did search the web in an attempt to learn a bit about Mr. Schiller and came across an interesting discovery. Mr. Schiller may be a patent holder.

According to information we found, a patent was apparently granted for:

"A method for generating natural language news-based stories directed to financial instruments named in a portfolio, the method comprising the steps of:selecting a portfolio of financial instruments using a computer interface; and offering a choice on the computer interface between creating a strategies page or a news stories page produced from each of the financial instruments in the portfolio,wherein the news stories page comprises a plurality of natural language news stories, each including a date of publication, a story rewritten in natural language using a template from a news brief, and a source of origin for the news brief."

We have no idea if Mr. Schiller of Seven Summits is the patent holder, hell we have no idea if Mr. Schiller is a real person, we just found it interesting that there is a patent for news articles directed to financial information, that Mr. Schiller's company issued a Critical Alert about a company we have on our watch list, and the daily trading volume for the stock of that company increased by 250% and the price fell almost 4.5%, on the very day the Critical Alert was released.

We also have no information, nor did we attempt to find any information, stating that Mr. Schiller, any of his companies, or anyone, or any entity that is currently or has ever existed in the solar system of which planet Earth may or may not be apart, derived any benefit, financial or otherwise, from the changes in price of any of the stocks mentioned in the Critical Alert.

In an attempt to keep from getting sued, we did continue to search the web for other possible reasons for the Gamestop volatility and final found several other articles posted, including a downgrade from Credit Suisse which may have contributed to the volatility in the stock price and the increase in trading volume on that day.

In The End

Having considered the information we found, not about GameStop but around news events surrounding Gamestop, we have to wonder if the common investor really did take it in the end?

Certainly we have no idea this happened, nor are we even remotely qualified or smart enough, to answer that question.

Instead, what we would like to highlight is that when it comes to individual equities, investors need to have a time horizon larger than a nanosecond. They need to ask themselves what they expect an investment in a specific company to do for them, and they need to be realistic in the length of time they are willing to allow an investment to work in order to achieve expectations.

Short-Term Investment
According to the trend line, the stock is in a clear downward trend, having moved recently from an over bought position to an almost over sold position, and based on the current MACD, this trend could continue for the next several weeks.

The stock closed recently at $19.17, with first resistance at $21.16, a 10% upward move from its recent close, and first support at $18.27, a 5% decline from its recent close, we simply don't think the 5% spread is enough to consider a short-term investment at this time.

Long-Term (5 Year Hold) Investment
We happen to think that a Reasonable Value Estimate for GameStop is in the $50-$55 range, and think the time to start a position in the stock will be right after the company announces fiscal 2010 earnings, which we believe will be closer to fiscal 2008 earnings.

While there is certainly room for improvement with some of the financial metrics we like to focus on, debt per share of $3.25 being the main metric that needs improvement, we do like the company's free cash flow, which for fiscal 2009 was close to $3.30 per share.

Assuming we are correct in our thinking, the price should drop a bit once fiscal 2010 earnings are announced, providing investors an opportunity to buy shares in a pretty good company at a price well reduced relative to our reasonable value estimate.


For the Wax Ink GameStop Raw Value worksheet, please click here.

12 Comments – Post Your Own

#1) On February 14, 2010 at 2:35 AM, checklist34 (98.57) wrote:

I have been looking at GME lately as well..  but $50-55?  That would be an apple or google-like multiple, which this stock just doesn't justify. 

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#2) On February 14, 2010 at 7:22 AM, wax (< 20) wrote:


You are quite right, the stock doesn't justify that sort of multiple, but the entire point of the post was to highlight what happens when a stock is purchased and held for at least 5 years.

So I guess I'm asking, what do you think will be the stock price of GME five years from now?


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#3) On February 14, 2010 at 2:09 PM, walt373 (99.86) wrote:

What is driving the price down? I would assume people don't like the fact that game distribution is moving online, cutting out the middlemen like Gamestop, including the used game market. They will be profitable for a while, but guessing when they will decline is tough. In 5 years, will their profits have risen enough and/or sentiment improved enough to raise their price up to $50-$55? Assuming they have today's P/E multiple, earnings must rise by about 23% a year on average. 

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#4) On February 15, 2010 at 5:24 AM, wax (< 20) wrote:


I think the price is being hammered because Wall Street knows this year's earnings are going to be closer to 2008 earnings, certainly that's where we think sales will be.

When earnings decline, even when it has been obvious to anyone with a pulse that they will, analyst issue downgrades and that is what is happening at the moment. It's called a top down approach to investing.

As to the P/E you mentioned, let's say we completely screwed up and that a more realistic price in 5 years is $40.

Based on a recent close of around $19, isn't that still more than a double if you held your investment for 5 years?

And that's the point. Regardless of what Wall Street does, if you have taken the time to understand what you are buying, and then determined what you believe is fair price, the longer you are able to hold an investment, the harder it should work for you.

Case in point is Gardner Denver, Inc. (NYSE: GD). We bought shares in October 2002 for $15.30 and sold them in March 2004 for $28.41. We sold them because we believed that the stock at that time, was fully valued, with little upward room left. The stock closed recently at $40.04.

The point is things happen, and if you have done your research and paid a fair price, then good things can happen to you.


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#5) On February 15, 2010 at 3:16 PM, walt373 (99.86) wrote:

I don't think earnings decline is the sole reason the stock is as cheap as it is today. There are very many companies with declines in earnings or losses in the past few years, yet many of them are rated buys by analysts. There must be more to their reasons for downgrades. I myself don't really follow Wall St. analysts that much, and it's clear that blindly listening to them is usually a bad idea, but ignoring them or even being a constant contrarian probably isn't a good idea either. When there is a fear of something by the market, I think usually that fear has a valid argument behind it - the risk is real. Whether the market is overreacting or not is another case. And when you bet against the market and the market is right, your investment proves to be a value trap.

Back to GME - even if earnings stay at 2008 levels, and if they could sustain that level of earnings with zero growth out forever, this stock would be an obvious buy at the current multiple. What the market is saying is that it believes there is a good chance this won't happen.

Like I said before, the business of selling games is directly affected by the quickly developing technology of online distribution. I have found that when a business is on the wrong side of technology, their profitability can fall surprisingly fast. There are also threats to its competitive position by powerful players like Walmart, Amazon, Ebay, etc. How their competitive positions look like in five years is anyone's guess. It is possible that Gamestop's revenues will be lower than where they are today in five years. In ten years, it's even more likely. If their business does deteriorate significantly, considering their operating leverage, their earnings will fall even faster than revenues. If their earning power is less than it is today, and it's clear that it continues to deteriorate, the stock price will probably be even lower than it is now.

That said, I personally believe Gamestop is a good bet right now. The stock is cheap, they have been growing tremendously in recent years, and I don't believe they will start to go into a permanent decline for many years - at the earliest, the end of the current console cycle. But I think it's always useful to look at every side of the argument, so I'm just playing devil's advocate.

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#6) On February 15, 2010 at 8:11 PM, wax (< 20) wrote:


Your comments add value to the discussion and I sincerely appreciate them. Thank you for taking the time.


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#7) On February 15, 2010 at 10:01 PM, walt373 (99.86) wrote:


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#8) On February 16, 2010 at 12:45 PM, aesir (< 20) wrote:

I think people over rate the threat of online games.  There will always be a strong need for physical media.  Just like movies went from VHS to laser disk to DVD to Blue Ray, games will continue to make the most use of these higher resolutions and capacities.  The need for physical media will also mean a strong market for used games.  Online is less of a threat than Walmart deciding to go into the used games market.

Disclosure: I'm in at ~$19 average.  This is a company which I believe has strong long term potential.  I'll likely buy a bit more when it looks like it's bottomed out over the coming month or two.

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#9) On February 17, 2010 at 5:03 AM, wax (< 20) wrote:


I happen to agree with your take, but with that said, I think Walt has very valid points regarding on-line distribution.

But it has always been our belief that you determine what to you is a reasonable value for the stock.

Then you determine an entry price, a price at which you would sell about half of your position, and a price at which you would close your position. As those price points arise, you execute your strategy.

We also like to set stops under our positions. So in addition to price point actions, we also utilize stops to take us out of position and help preserve our risk capital.

The idea is that you will allow the stock to run but only so far before you start to take some of your initial risk capital out of the stock, just as you will only allow a stock to fall so far before you move to preserve capital.

Managing your investments in this manner provides you options, much like the option to close a position in GameStop should on-line distribution become an issue, or should the cow actually jump over the moon.


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#10) On February 17, 2010 at 5:49 AM, baldheadeddork (26.88) wrote:

Regarding Walt's comment about online distribution - I don't think the brick and mortar stores aren't going anywhere for a long time. A modern game like Mass Effect 2 is 4-7GB even in compressed form. On the release day a big launch can sell 300K copies in 24 hours. Put those together and you're talking about an almost unimaginable amount of bandwidth from the distributor servers all the way down to local ISP's.

Playing on remote servers isn't a practical solution for most games, either. Online gaming now is really not doing much more than synchronizing remote systems and exchanging a small amount of information that each console uses to show what the other players are doing. You still need each system to run the graphics and gameplay physics calculations. Moving that to a central server would require a lot more bandwidth and a larger amount of computing power on each session server than in any individual console. 

Online distribution works with old and small games, and online play from a central server works with simple graphics and slow/no action games. For everything else, which is the part of the market where everyone makes money, selling a game disc via a retailer is the most cost effective way to sell and distribute video games.


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#11) On February 17, 2010 at 10:34 AM, walt373 (99.86) wrote:


I agree with you that I don't believe online distribution will replace physical distribution at least for a few years, but I think it is closer than you might think. Online distribution can easily take place now, where players download the content to their systems and run games from there. It is more of a matter of consumer preference, not technological feasibility. I think you underestimate how much traffic is going on the internet already. People download and upload millions of movies and songs every day, and I am guessing a normal day on Youtube alone would probably dwarf the bandwidth needed to release a popular game. Also, you mention playing games on a remote server - this is more along the terms of "cloud computing", not so much online distribution, and is another topic.

Just for background info, many PC games are already being distributed online. Popular games like Team Fortress 2, Counter-Strike, Half-Life 2, etc. have been distributed on Valve's Steam platform for many years now. I bought Half-Life 2 about five years ago this way, and it was pretty quick and painless. Blizzard's is also moving toward online distribution - you can now buy from and directly download World of Wacraft, the upcoming Starcraft 2, and their older games like Starcraft, Diablo 2, Warcraft 3, etc. Also, the infrastructure is definitely there in terms of bandwidth and computing power. Just look at WOW and how many concurrent players they support every day. They have a huge game world and there are constant updates, and for the most part it runs pretty smoothly.

I think the console game audience will undoubtedly be slower to adapt to online distribution than the PC gaming crowd, since there are more casual gamers among them, and they are on average less technically savvy.

But even if it takes ten years, you need to remember that stocks are worth all future discounted cash flows, not just those of the next few years. If you do a DCF analysis of GME, how much of the stock's value is in the perpetuity? What is a reasonable worst case scenario, and how would this affect the stock's value? Does today's price have a margin of safety to that value? I think these are the important questions.

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#12) On February 17, 2010 at 10:48 AM, walt373 (99.86) wrote:

Also, one point I forgot to mention: consider the incentives from both the publishers and consumers' point of view. Publishers make much fatter margins on games that they distribute online, since they cut out costs on things like packaging, DVDs, instruction manuals, shipping, etc., and don't have to give the retailers a cut of the sales.

Because of this, they can offer games at cheaper prices than retailers, and still make more profit. Cheaper prices, along with the fact that you can avoid long lines and crowds, can convince consumers to buy games online. The internet is getting faster rapidly (see the recent news about Google pushing out ultra high bandwidth internet), and in the future, it will be faster to download a game than to drive to the store to pick it up. So everybody is happy except the middlemen like GME.

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