GameStop Bears Streaming in With Profits Poised to Fall

Bearish options traders and short sellers are betting on more misery for GameStop Corp. after the video-game retailer slumped the most in five years.

Contracts hedging against a decline in GameStop shares are the most expensive versus bullish wagers since September 2011, according to data compiled by Bloomberg. Shares have tumbled 23 percent this year, heading for the worst three months since the end of 2008, as analysts estimate GameStop will post an 11 percent drop in fourth-quarter profit tomorrow, the data show.

GameStop is facing rising competition from rivals both online and in stores. Sony Corp. said in January it would test a video-game streaming service, and Wal-Mart Stores Inc. said it will offer store credit for used video games. Earnings at the Grapevine, Texas-based company will fall this year for the first time since 2010, analysts’ estimates compiled by Bloomberg show.

“Gamers are more willing to look at content from digital sources as opposed to physical,” Michael Hickey, an analyst with Benchmark Co. in New York, said by phone. “Wal-Mart just announced a used-games program, Sony’s being aggressive about streaming, there’s the rise in mobility. It’s one thing after another, and it’s all aggregating to create a very bearish profile for GameStop.”

Cutting Forecasts

The gaming company plunged 29 percent in January after cutting its quarterly earnings forecast, while Sony said it will offer a service that would allow users to download titles from the Internet. Shares lost 3.4 percent on March 18 after Wal-Mart said customers who trade in games will receive credit that can be used on any kind of merchandise at the world’s largest retailer and Sam’s Club locations, as well as the chains’ websites.

About 27 percent of GameStop’s revenue last year came from its used video-games business, while new software accounted for 40 percent of sales, and hardware including consoles for 15 percent, data compiled by Bloomberg show.

Concern over competition is outweighing optimism that GameStop will benefit from the releases of Sony’s PlayStation 4 and Microsoft Corp.’s Xbox One last November, their first consoles in seven years. The video-game industry is facing a shift in consumer preference toward social and mobile games. From 2008 to 2012, the market for consoles shrank 32 percent, according to researcher NPD Group Inc.

Shorted Stock

After soaring 96 percent last year, GameStop is the most-shorted stock in the Standard & Poor’s 500 Index after iron-ore producer Cliffs Natural Resources Inc. Short interest for the gaming company climbed to 25 percent of shares outstanding on March 24, up from a low of 11 percent in September, according to London-based Markit, a financial-data provider.

GameStop options with an exercise price 10 percent below the shares cost 5.8 points more than calls betting on a 10 percent jump, according to one-month implied volatility data compiled by Bloomberg. The price relationship rose to 8.7 on March 18, the most since September 2011.

The options market is implying a one-day move of 8.2 percent following the earnings report, data compiled by Bloomberg show. That’s more than the average gain or drop of 4.7 percent following the past eight releases.

Joey Mooring, a spokesman for GameStop, declined to comment on the options trading.

Cheapest Shares

The declines this year have left GameStop as the fifth- cheapest stock out of consumer discretionary companies in the S&P 500, according to data compiled by Bloomberg. Shares trade at 11.5 times reported earnings, compared with the average of 30 for those in the group, the data show.

GameStop’s 33 million-member loyalty program will allow it to fend off competition, while flexible lease terms for its stores and aggressive stock buyback programs will help lift the shares, according to Matthew DiFilippo and Nicholas Westrick of Stewart Capital.

“Those members have a lot of loyalty towards GameStop,” Westrick, who helps manage $1.2 billion at Stewart, said by phone of GameStop’s PowerUp Rewards program. “It gets people in the doors.”

The company, which operates about 6,500 shops in 15 countries, said in January that holiday same-store sales rose 10 percent amid demand for new consoles. Profit will jump 24 percent to a record $3.77 a share next year, according to the average analyst estimate in a Bloomberg survey.

Dividend Increase

On March 4, the company boosted its annual dividend by 20 percent to $1.32 a share. GameStop’s stock repurchases, debt buybacks and dividend payments have totaled more than $2.1 billion since 2010, according to the company.

“They’ve done a very good job at managing the business for profitability,” said DiFilippo, chief portfolio strategist at Stewart. “GameStop has a strong balance sheet and cash earnings. They’re very well-positioned for the new gaming cycle. They manage inventory at the store level. It’s going to take a while for their competitors to replicate that.”

The Chicago Board Options Exchange Volatility Index, the gauge of S&P 500 options prices known as the VIX, fell 7.1 percent to 14.02 yesterday. Its European counterpart, the VStoxx Index, lost 5.2 percent to 17.32 at 9:44 a.m. in London today.

The ratio of outstanding puts giving the right to sell GameStop shares versus calls to buy has jumped 36 percent this year to 1.13-to-1 on March 24, data compiled by Bloomberg show. Contracts hedging against a 13 percent decline to $33 by April had the largest ownership, according to the data.

Crimped Profitability

GameStop’s profitability may be crimped as it tries to compete with Wal-Mart’s prices in the used video-game business, according to David Schick, an analyst at Stifel Nicolaus & Co. in Baltimore. Inc., the world’s largest Web retailer, may also enter the console market this year, and it probably won’t sell games through third-party retailers, he said in a March 18 note.

“We do expect some growing pains as Wal-Mart rolls out the business,” he said. “GameStop may be facing higher competition from two industry behemoths on both sides of the business (new and used) by holiday 2014.”

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