What better way to escape the worries of the economy than by zapping a few baddies in a fantasy video game? And in a couple of months this experience is set to become much more realistic with the pre-Christmas launches of Microsoft’s Kinect and Sony’s Move state-of-the-art 3D motion-sensing consoles. And not to be out-gunned, Nintendo is also set to release its 3D version of the Wii system in 2011.
This giant leap in user experience will provide a huge tailwind for the industry. The only headache is that, with these new blockbuster systems on the verge of being launched, punters have been holding fire on purchases, waiting for the step-change in technology.
Worse still, this temporary air pocket in demand has been compounded by the slump, with Britain’s £3.5bn gaming market declining by 15% in 2009 and a further 17% so far in 2010.
So it’s hardly surprising that shares in Game Group, the UK’s largest specialist video games retailer, have crashed 75% from 2008’s highs of 300p. Results have been disappointing at best, with like-for-like sales in the first half of 2010 dropping by 10.9% and gross margins by 2.9%. That said, with the company accounting for roughly a third of the British market, together with strong positions in Europe, newly appointed chief executive Ian Shepherd is not about to throw in the towel.
Gamble of the week: Game Group (LSE: GMG)
Shepherd is cutting costs and working capital, and aims radically to change the 1,338-store portfolio over the next three years. On top of this, online sales are expanding and if there is a double-dip Game should benefit as cash-strapped families entertain themselves at home.
The City expects 2010 sales and underlying earnings per share of £1.6bn and 10.3p respectively, rising to £1.7bn and 12.3p in 2011. This puts the stock on a forward p/e ratio of less than seven, while paying a generous 8% yield. I would value the company on an eight-times EBITA multiple, which, adjusting for net debt of £63.5m, gives an intrinsic worth of around 100p a share.
So what are the possible hitches? Competition from the likes of HMV, the supermarkets, Amazon and eBay is intense, while longer term there is the danger of gamers downloading titles directly from publishing houses, such as Electronic Arts.
The dividend and borrowing levels also need to be monitored – although with a comfortable loan-to-EBITDA ratio of less than one, a further equity raising seems unlikely. With the fillip from the new console releases, together with an “eye-poppingly congested” release pipeline, Game looks a good bet and could be an outside bid target for arch-rival GameStop.
Recommendation: speculative BUY at 70p (market cap £243m)
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments