Sales are plummeting at Game Group, but at least the shares are cheap.
Shares in Game Group (LSE: GMG) plunged on Tuesday morning, falling 6% to 99p against a broadly flat market.
Yet the reason -- its Christmas 2010 Trading Statement and its profit warning -- is about as shocking as Invaders from Space in a games arcade.
Game warned on 8 December that sales had fallen in double-digit percentage terms over the year, that supermarket price cuts were increasing competition, and that cheaper hardware from Sony and Microsoft wasn't making up the difference.
However it stressed that the last eight weeks of the year -- including the Christmas period -- usually represented 25% of its annual turnover, stating:
"While the wider economic conditions and prevailing video games market trends lead us to approach the critical Christmas period cautiously, the Board believes the Group is well positioned to deliver a solid outturn for the year."
Investors who looked to the positives and ignored the negatives got a rude awakening this morning:
"We now expect the Group profit before non-recurring costs and tax for the full year to 31 January 2010 to be between £87m and £93m."
Analysts were looking for near £100 million.
A very unmerry Christmas
So how bad are things at Game?
Even the low end of the board's expectations -- £87 million -- is a very decent profit for a company valued at £344 million. Indeed, it will be the second best profit in the group's history, much lower than 2009's £126 million, but up on 2008's £75 million, which followed the acquisition of its major High Street rival.
That was then, though -- this is now, when things are bad, and in my view are going to get worse.
Starting with Christmas:
- total group sales decreased by 12.1%. Like-for-like sales were down by 13.8%;
- in the UK and Ireland sales decreased by 18.0% (like for like down 17.5%); and
- international sales were flat, but down 5.9% on a constant currency basis.
For from bucking the trend of falling sales, Christmas continued the decline that was already in play.
Over the last 49 weeks, like-for-like sales have fallen by 15%, with international sales down 17%, ignoring currency effects.
Extra life
It's little wonder that Game's comparative figures look so bad -- calendar year 2008 was a record one for the whole industry, not just Game. And anyone investing in a video game retailer must expect wild swings in performance.
If buying specialist retailers is a lottery, because you don't know if their wares will go out of fashion, then buying a specialist video games retailer is more like playing Russian roulette. The cycle of boom and bust is institutionalised because of the way new games consoles are introduced every few years, making slumps inevitable.
While Game admits that revenues will drop further in 2010/11, it says new hardware -- such as Microsoft's Project Natal 'vision control' technology for Xbox 360, as well as new controllers from Sony and Nintendo -- will improve margins.
It also hopes upcoming games such as Mass Effect 2 from Electronic Arts, Splinter Cell: Conviction from Ubisoft, and Bioshock 2 from Take Two will power-up its performance.
Then again, there are always new games on the horizon.
Game over?
I think Game may do okay over the next 12 months -- not because of a new boom, but because the comparisons with its 2009 financial year will be replaced by softer figures. But anyone buying the shares even at today's prices must understand the challenges ahead.
Supermarkets are stealing sales of blockbuster games like last year's Call of Duty: Modern Warfare 2. Tesco (LSE:TSCO), which today announced its strongest Christmas period ever, has been increasing its game offer for years.
Specialist retailers like Game have instead grown reliant on secondhand game sales, but this hasn't endeared them to publishers, who see no profit when a used game is resold. Such ill-feeling can only accelerate the move towards digital distribution of software, which hardly bodes well for High Street stores.
It's true Game does have its own online presence, but the company here faces competition not just from specialist rivals but also the likes of Amazon.
Worse, some pundits argue that future games consoles might be based entirely around online connections. Delivering games this way protects the publisher from software piracy, as well as cutting out the middleman -- the retailer.
And that's even assuming there are future consoles. The most radical prediction is the hardware cycle is 'broken', with console entertainment being replaced by lightweight games that run in web browsers, or that use built-in TV hardware.
Just look at the popularity of games on Apple's iPhone, or the success of UK-founded PlayFish's casual games, which uses Facebook as the games platform -- PlayFish was recently deemed to be worth $400 million by industry giant Electronic Arts, who acquired it after barely two years of trading.
Insert coins?
Then again pundits are always making predictions, and investing in game companies during market lulls has delivered good returns before.
If you're inclined to throw away the crystal ball, then Game isn't without merit. Assuming profits at the low-end of expectations, the shares are on a P/E of just 4. Analysts were looking for a 5.5% yield; that may be trimmed, but 5% looks a reasonably safe bet in the short-term.
With debt of just £60 million as of September's interims, the company faces no immediate pressure. But with nearly 700 stores in the UK and Ireland and 1,362 worldwide, Game has a lot of mouths to feed.
If you're ever going to buy shares in a games retailer, now may be the time to buy cheaply rated Game -- its 99p shares cost £2 last May, and approached £3 back in 2008.
On the other hand, if the pundits are right then this window of opportunity may close for all the wrong reasons.
More comment on retail shares:
Owain owns shares in Tesco.
