Booking Profits from the Video-Game Boom

As the No. 1 game software retailer, Barnes & Noble stands to benefit from the launch of new platforms -- and its shares are attractively valued

By William Donald

Standard & Poor's Focus Stock of the Week is Barnes & Noble (BKS ), which was recently raised to 5 STARS (buy), S&P's highest investment rating. Barnes & Noble is the largest U.S. operator of book stores, and the world's largest operator of video-game and PC entertainment stores.

Based on Standard & Poor's belief that Barnes & Noble's prospects are far greater than those of retailers in general, its shares are currently trading at a discount to its peers by several measures. S&P expects Barnes & Noble to earn $1.74 for fiscal 2002 (ending January), up $0.68 from $1.06 earned in fiscal 2001. S&P sees another 26% advance to $2.20 for fiscal 2003.

Barnes & Noble operates more than than 900 Barnes & Noble and B. Dalton bookstores and 978 Babbage's, Software, Etc., GameStop and Funcoland video-game and entertainment-software stores. It also has a 36% interest in (BNBN ).


  Standard & Poor's is projecting a 3.5% to 4.5% gain in same-store superstore sales for the full year in fiscal 2002. Nevertheless, same-store comparisons are expected to be weaker in the second fiscal quarter, estimated at 2-3%, reflecting the difficult comparisons related to last year's Harry Potter phenomenon. Although its absence will be felt this year, the fifth book in the Potter cycle could be released sometime in late 2002, providing additional fuel to fiscal 2003 revenues and earnings.

Gross and net margins at book retailing are improving sequentially and year over year, reflecting management's corporate-wide scrutiny of 50 cost items designed to add $30 million to net income in fiscal 2002.

One important growth area for Barnes & Noble: video-game sales. This is an unprecedented time for the video game industry. For the first time there will be three game platforms available. So business should come roaring back after a dismal year in calendar 2000 when the U.S. video-game industry saw a 5.8% drop in sales of video-game machines, software and accessories such as joysticks, to $6.5 billion from $6.9 billion in 1999.

The fall-off reflected a generally slower economy, a shortage of Sony's PlayStation 2 machines and a wait-and-see attitude from consumers anticipating the new game machines. Sales of consoles, including the older PlayStation machine, Dreamcast and Nintendo 64, declined more than 21% to $1.1 billion from $1.4 billion in 1999, as the number of units sold fell 31% to 8.2 million from 11.8 million. Sales of game software fell 2.6% to $4.09 billion from $4.20 billion.


  This year, as well as fiscal 2003 should prove differently. Microsoft is entering the video game hardware business for the first time with the November 2001 launch of its much-anticipated Xbox game console. Microsoft plans to have between 15 and 20 games initially available. Nintendo's new GameCube is scheduled to hit store shelves on November 5 with a full roster of its popular software. The Sony PlayStation 2 launched in November 2000.

We expect each to pull out all marketing stops in the upcoming holiday season. Unlike last year when Sony underdelivered, the heated competition means no one can afford to disappoint with availability this year. Another positive is the June 2001 launch of a new Nintendo GameBoy.

All of that spells good news for Babbage's. Company management hopes to far outperform its projections. The company expects same store comps to advance 35%-40% in fiscal 2002, and foresees at least 25% gains in same-store sales on average the next several years. The company will have opened 80 new stores by the end of the year.


  For fiscal 2002 we expect consolidated earnings of $1.74. By segment, we expect Barnes & Noble bookstores earnings to rise 7% to $1.98 from $1.85. Babbage's should report profits of at least $0.09, versus a loss of $0.16. The company's share of the online unit's losses should decline to about $0.31 from $0.55. Losses from other equity investments should decline to $0.02 from $0.06.

In fiscal 2003, we expect consolidated earnings of roughly $2.20 to include $2.17 of bookstore earnings; $0.30 from Babbage's; online losses of $0.25 and other losses of $0.02.

At its current $32 price, Barnes & Noble provides solid value. Its forward price-to-earnings (p-e) ratio of 18 times our fiscal 2002 estimate and 14.5 times our fiscal 2003 estimate is near the bottom of its average p-e range over the past four years. It is selling considerably less than one times its anticipated earnings growth in fiscal 2002 (65%) and fiscal 2003 (26%). In addition, we believe Barnes & Noble provides protection against further economic softness in the retailing sector given that most of its anticipated growth will come from an unusually strong product cycle at Babbage's, relatively stable growth of same-store sales at the bookstores, and declining Internet losses, mostly through cost-cutting.

Our 12-month target of $46 represents a multiple of 21 times projected fiscal 2003 earnings, which we consider conservative.

Donald is an equity analyst following advertising and publishing stocks for Standard & Poor's

Before it's here, it's on the Bloomberg Terminal. LEARN MORE