Is Gamestop a Good Private Equity Target?
Rumors circulated this morning claiming that Blackstone (NYSE: BX) and The Carlyle Group may be considering buying out Gamestop (NYSE: GME) for $5.1 billion. Operating in a large, overgrown industry, Gamestop may or may not appear to be the best investment for some people. Many analysts on Wall Street believe that Gamestop's business model will eventually be overrun by digital downloading capabilities. If this happens, then it would not be a lucrative investment at all for private equity giants.
To learn more about Gamestop and the possibilities of a financial takeover, Benzinga reached out to Wedbush Securities' Michael Pachter, a research analyst covering the entertainment software publishing and retail sector.
According to Pachter, who has an Outperform rating on the stock, "The market is undervaluing Gamestop primarily because it thinks that it will follow the footsteps of music. As we've seen, many people are now downloading music instead of purchasing it, and they're translating this trend to video games. This is simply wrong, especially so for Gamestop, which is definitely operating a sustainable business."
Apart from music, movies and television based entertainment fell prey to digital downloading and piracy. A prime example is Blockbuster. Pachter claims that "Blockbuster failed because of Netflix (NASDAQ: NFLX) and Redbox. These services physically gave the content directly to customers for a cheaper price. Naturally, as they became more popular, Blockbuster started to fade away. Digital downloading also played a role in Blockbuster's demise, but it was not nearly as effective as Netflix and Redbox."
Ultimately, Pachter believes that Gamestop will not face the same fate. In fact, a lot of the thinking stems from the average investor's way of thinking. The average investor is wealthy enough to be able to purchase content online. However, the premiums associated with the convenience of purchasing movies online is not a luxury everyone can afford. As such, the average investor has a skewed view of how content is commonly delivered to retail customers. According to Pachter, "people have been physically purchasing music from stores and have been going to movie theaters for the experience. This activity has increased over the past couple years, and may be a clue to how Gamestop will do going forward."
Some investors may still be wary of Gamestop after witnessing the slow degeneration of Radioshack (NYSE: RSH). Pachter contends this, stating that "Radioshack is a bad company with a bad product. It is a specialty retailer which is continuously selling irrelevant products, and its aging client-base will eventually stop purchasing its products. Gamestop does not operate with the same business model. It provides customers with the latest and greatest in video games, catering to young and old gamers in the process."
Regarding the possibilities of a private equity takeover, one must remember that financial buyers pretty much have one reason to purchase any given company: to directly make money from it. Whether it is harvesting cash flows during the holding period or levering up operations and re-selling it after significant growth, private equity companies are looking primarily for targets with impressive cash flows.
One thing that Blackstone and Carlyle could do, should they purchase Gamestop, is to essentially repackage the company to be lucrative for a strategic buyer. Pachter mentioned that Best Buy may be a good strategic buyer of Gamestop, primarily because of the synergies gained from entering the video gaming entertainment market.
"Best Buy does not currently recognize that Gamestop could be a very lucrative investment for them," Pachter states. "Apart from gaining dominance in the video game market, Best Buy could use the retail space. Think about the Apple (NASDAQ: AAPL) stores. Their customers simply go in and pick from a variety of devices in a somewhat condensed environment. Best Buy could convert many Gamestop stores into small hubs that advertise the hottest products from a variety of brands."
From whichever perspective, it appears that the private equity giants may find a good investment in Gamestop. While its growth has been haltering in the last few quarters, there are several things that can be done to revitalize growth. Finding a strategic buyer could be an extremely lucrative path that the financial buyers can pursue. Contrary to popular belief, Gamestop may not be as vulnerable as some of its competitors to digital downloading and online piracy. Only time will tell what will happen to Gamestop, whether it is taken private or whether it will remain as an independent, public entity.
Gamestop is currently trading at $25.30, up over 10.5% for the year.
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