This column was originally published on RealMoney on Nov. 23 at 2:01 p.m. EST. It's being republished as a bonus for TheStreet.com readers.
It's little wonder that video-game fans stood in line this week to buy the meager shipments of the Xbox 360 from
. Or that they will line up to do it again for
PlayStation 3 early next year. These are fantastic pieces of supercomputing hardware, each with components that take players to the edge of the possible.
Both companies sell their consoles at a loss, however, so the big near-term question for traders is which retailers will benefit most from this new wave of interactive entertainment devices. Investors have already made a big bet on video-game chain
, which reports earnings Tuesday, and initial indications suggest they will be rewarded.
Spun off by
Barnes & Noble
in November last year, GameStop has since rapidly grown to 4,200 retail stores after a merger with Electronics Boutique, focusing on strip-mall locations. It sells new and used gaming hardware, software and accessories, and it produces the magazine
, which reportedly has a circulation of 1 million. The company also operates the online outlet
. On Tuesday, it hosted Xbox debut parties at 1,600 locations.
This round of hardware releases represent a significant technological leap for the video-game industry. The previous generation of devices ushered in DVD movie capability when the stand-alone players were still pricey. Now they are moving farther ahead with a processing power that shames most business desktop computers, allowing game publishers to create incredible experiences that will pull even more eyeballs away from movies and television. The PlayStation 3 will be the cheapest way into a Blu-Ray high-definition DVD player. Sony and Microsoft both use high-end multiprocessor technology in their consoles, with Sony finally taking the wraps off of its highly touted Cell processor.
It's little wonder, then, that the nation's leading dedicated video-game retailer is selling at a premium itself, trading in the high $30s at a P/E multiple of nearly 27. With the stock trading sideways between $28 and $38 since June, traders have clearly been torn between the goal of buying ahead of the new wave of consoles and games and selling on their arrival. Citigroup analyst Elizabeth Osur says she expects shares to break out to $45 over the next six to 12 months, driven by what she thinks will be a 35% estimated five-year growth in earnings. She is looking ahead to the peak software growth year of this cycle in calendar 2007 and estimates earnings per share to be a whopping $2.85 for fiscal 2008.
Although hardware will drive sales during the coming year, it's a low-margin business for GameStop, so Osur expects a growth plateau in calendar 2006. If consumer sentiment is crimped by high heating bills this winter and Microsoft is able to get only 1 million Xbox 360s to market instead of the earlier projection of 2 million, gaming retailers would suffer.
Although these are legitimate concerns, Microsoft's lack of sufficient product for holiday 2005 does not pose as much a danger to GameStop as it does to Microsoft. Serious gamers, GameStop's target market, have already preordered their 360s if they are in the Microsoft camp, or are waiting for Sony's console. Casual gamers will no doubt continue using their existing systems until the racket dies down sometime in 2006.
This creates a rather large group of gamers looking for their fix in other places this holiday, and that means used games, GameStop's high-margin specialty. High energy prices could also drive consumers to satisfy their gaming urge with lower-priced used games. With
( BBI) and
( MOVI) both announcing moves away from in-store and stand-alone store video-game businesses, no doubt brought on by brutal competition in their primary movie rental business, GameStop just might be able to buy up inventories and market share from these two competitors and further its advantage.
Although GameStop faces competition from mainstream discount retailers for new hardware and software sales, it's the used software that will drive traffic of gamers into GameStop when this iteration of the video-game cycle really revs up. It's going to be a terrific and profitable product cycle, so traders should use the inevitable scares along the way to get in the game with GameStop.
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Anthony Mirhaydari assisted in the research of this article.
At the time of publication, Markman was long Microsoft, although positions may change at any time.
Jon Markman, writer of TheStreet.com Value Investor, is the senior investment strategist and portfolio manager at Greenbook Investment Management, a division of Greenbook Financial Services. Separately, he is publisher of StockTactics Advisor, an independent weekly investment research service. While Markman cannot provide personalized investment advice or recommendations, he appreciates your feedback;
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