Playing at GameStop

 | Nov 26, 2013 | 11:30 AM EST
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I was bullish on the shares of GameStop (GME) at the end of May. Since then, the stock is up 57%. I said investors would buy the stock ahead of the holiday season and with Black Friday at the end of this week and Christmas right around the corner, I decided I would update my thesis. 

There's no denying that GameStop in on a roll. Last Thursday. GME reported better-than-expected third quarter fiscal 2013 results.  Revenue rose 18.8% to $2.11 billion. Same-store sales rose a staggering 20.5% driven by demand for recently-released games such as Grand Theft Auto V. New software sales grew 43.1%. Hardware sales surged 15.3%, driven by sales of Nintendo 2DS and 3DS gaming systems. Analysts believe Game Soft's software market share grew 5% and its hardware share tacked on another 7%.

The stock declined sharply when management lowered guidance. The company projected fourth quarter earnings per share of between $1.97 and $2.14 vs. the consensus estimate of $2.16. Management said it thinks same-store sales are expected to range between 2% and 9%. Analysts were estimating 13.5%.

It's difficult to reconcile management's dim view of the holiday quarter with the company's performance. GME's loyalty program -- PowerUp Rewards -- just passed 26 million members. Management said that according to its surveys, two-thirds of its Rewards customers were planning to upgrade to either a Sony PlayStation 4 or an Xbox One.

Investors have been concerned that gaming was going entirely digital, thus cutting the chain out of the gaming business. But GameStop has a secret strategy to stop that from happening. GameStop allows Rewards customers to trade in their old hardware and software. 

Customers get a discount when they make a new purchase. With the price of new gaming consoles between $400 and $500, GameStop's trade-in program builds loyalty and drives sales. In fact, on the call, management said an aggressive trade-in program last quarter was responsible for the better-than-expected same-store sales.

I believe the company is being overly conservative. Microsoft (MSFT) said it sold more than 1 million Xbox One consoles in less than 24 hours, smashing its previous record. The PlayStation also sold 1 million units in a day. Neither of these consoles has been upgraded in a few years. The demand is clearly there to drive a strong holiday quarter.

The selloff in the stock is a buying opportunity. Gamers will turn out between now and Christmas to stock up on fresh hardware and software. Back in 2007, there was a big upgrade cycle and the stock peaked at $61. I think GME can get back to the low $60s.



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