RTOB: Is GME a Best Buy?

Random
Thoughts
Of Brilliance

Could Best Buy (BBY), the country's premier consumer electronics superstore, one day be tempted to acquire dominant videogame retailer Gamestop (GME)?

I believe a deal would make great strategic sense for BBY (or ANY other similarly large + deep-pocketed retail company that doesn't mind spending for growth) given GME's dominant marketshare in the BOOMING video game consumer market. We've now just reached the beginning of the high margin $oftware phase of the 'video game upgrade cycle' as hardware (console) sales rose to $18 Billion in 2007 (up 43% over 2006!). Now that the next-gen console base has been built up retailers can sit back, relax + expect their margins to rise as sales on much higher-margined (more profitable) video game software titles start to account for a MUCH larger piece of the revenue pie. Best Buy's NOT stupid...they see the potential in this still emerging entertainment category. During their 3Q08 earnings conference call, Best Buy identified the video game category as a major growth focus area for the company. If Best Buy were to buy Gamestop then they could potentially become a one-stop paradise for video game enthusiasts looking for games, consoles, HD cables, surround audio and of course high definition televisions.

Regardless of the fundamentals though, I see this proposed combination facing some rather significant headwinds given a host of factors including:

1.) WEAK CREDIT MARKETS + FINANCING --> According to BBY's Dec 2007 quarter, the company exited the qtr holding about $1.3 Billion in cash. Given today's tight credit market environment, BBY would probably have a difficult time raising money + financing the rest of the deal.

2.) TIMING OF ACQUISITION --> On a P/E valuation basis Gamestop shares are almost 2 times more expensive than the average S+P 500 stock (mind you, this company is also growing MUCH faster than the average S+P 500 stock...on its investor relations site GME quotes its 5 year compounded annual EPS growth rate at 75%). Also, in terms of timing, this potential deal could be deemed as too risky for Best Buy considering Gamestop is trading at 'only' a 15% discount to its all-time highs of $64/share. Lastly, given the recessionary state of today's domestic economy, BBY could be 'playing conservative' when it comes to spending new capital on U.S.-focused growth (most of GME and BBY's retail locations are inside the U.S.).

3.) SIZE OF ACQUISITION --> On a markcap basis, GME is about 1/2 the size of Best Buy. Best Buy would be taking on a whole lot of risk onto their balance sheet if they were to go through with a takeover.

4.) BBY's INTERNATIONAL SITE DIVERSIFICATION FOCUS --> For the forseeable future, BBY is probably too busy + focused on its own strategic prerogative of diversifying its store count abroad (and away from the the U.S.) in countries like China, Canada, Mexico, Turkey, India, etc. Such an undertaking is probably a gigantic in scope and would leave little time + resources to give a takeover of GME a fair 'shake'/evaluation.

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*For my own edification, here's a quick look at some interesting numbers:

P/E:
*BBY --> 14
*GME --> 38

FORWARD 2008 P/E:
*BBY --> 14
*GME --> 21

MarketCap:
*BBY --> $18 Billion
*GME --> $9 Billion

2007 Annual Sales:
*BBY --> $36 Billion
*GME --> $7.1 Billion

2007 Annual Profits:
*BBY --> $8.8 Billion
*GME --> $1.8 Billion

2007 Gross Profit Margin:
*BBY --> 24.4%
*GME --> 25.4%

Full Disclosure: I own shares of GME.