GAME can play the videogame cycle

The recent news that videogames have helped push consumer price inflation up to 1.3% came soon after GAME Digital (GMD) released its interim results, showing an impressive 17% growth in year-on-year revenue.

This is a far cry from their direct ancestor, GAME Group, which entered into administration in April 2012. Of course, the financial crisis is history and the domestic economy is growing fast, but the videogame market has grown by 14% this year and some are beginning to question whether this meteoric rise is sustainable.

A study published earlier this year doesn't think so. It says that videogame "sales tend to be correlated with releases of new consoles, producing a cyclical sales pattern". This 'circularity' in the market certainly seems to make sense. The year following the completion of the last set of consoles (Sony's Playstation 3 and Microsoft's Xbox 360: the third generation) hitting the market saw GMG experience a 67% increase in pre-tax profit. Peter Lewis, the chairman at the time, admitted the consoles were the "principal drivers" of the increase in sales.

The current situation for GMD also seems to fit this pattern - the fourth generation of consoles was released last year, with Sony introducing the Playstation 4 and Microsoft unveiling the Xbox One. Incidentally, this was the first time that the two main competitors in the videogames market released consoles at the same time (generation three consoles were released two years apart), and has helped cause the spike in both the videogames industry and the entertainment sector as a whole.

The acceleration of sales has been reflected in the share price for GMD, with a high of 364p recorded on the 12 November. A similar increase occurred the year after the generation three console release, with a record for GMD following a 56% surge over three months.

As for shareholder returns, Liberum analysts are refusing to update their forecasts on any dividend, arguing that "until the company has traded through the peak season and management has a clearer view of the capital requirements of the business", they would be unable to provide accurate estimates. They state that there is a "clear upside risk to [their] dividend forecast", as it was based on guidance of £50 million year end net cash for 2014, when the reported amount actually came to £84 million. It's no surprise they maintain their 'buy' rating.

Cyclical disappointment

Yet, looking back to the GMG days, the second year of the 'console cycle' was a massive disappointment. According to the annual report for 2009-2010, year-on-year sales fell by 10%, with pre-tax profit falling by 28.2% from £117.4 million to £84.2 million. Perhaps the most surprising fall was in cash inflow, which dropped from £118 million to £13.1 million.

The company attributes this to more payments taking place in December rather than after the year end, although they do concede that the trading performance was weaker than the previous year. However, with statistics like that, it was no surprise that the share price gradually fell from its record high to the point that GMG went into administration two years later.

The drop could be attributed to several factors. When a product such as a videogame console, typically a one-off purchase, is released into the market, its high demand immediately causes a retailer's sales to increase. But once the market is saturated with the product, demand and sales for the hardware will fall dramatically.

This is obviously anticipated by developers and retailers alike, and they expect the slack in hardware sales to be picked up by demand for the videogames themselves. However, it failed to cover the difference for GMG. Clearly, during the last 'console cycle' they failed to plan for slack software demand in the lead up to the next console release. With consumers planning for their next big purchase, along with the knowledge that their money could soon be spent on a better product, sales slumped.

GAME 2.0

So can the market expect another drastic drop in sales for stores like GAME? Will the share price start to deteriorate again? It seems unlikely this time round, as the current manifestation of GAME has a much smoother look. In their own words, GMD has "successfully completed a significant restructuring and [has] implemented a number of initiatives designed to position the company for sustainable long-term growth".

This improved financial structure seems to be paying off for the company, as videogame suppliers are actively investing in improving the customer's in-store experience. This is a far cry from 2012, when suppliers such as EA understandably refused credit to GMG due to concerns about the firm's ability to pay up.

This smart structuring seems to be doing them good. Their share of the videogames market in 2013 was 33% in the UK and 35% in Spain. With the market across both countries estimated to be worth £4.7 billion, GMD seems poised both for consistent revenue with room for further growth.

Market researcher Kantar Worldpanel estimates that, combined with Amazon, the two retailers hold a 52% share of the videogame market. If you follow the Entertainment Retailers Association's statistics for 2013, the videogame industry was the largest section of the entertainment industry in the UK (outselling both the video and music sectors) with 41% of the market. It's no wonder that GAME's specialised knowledge is proving successful.

Who sells the rest?

But how is the popularity of videogames affecting other companies? 67% of videogame sales take place away from GAME, therefore many companies should, in theory, be benefiting.

The main competitors for GAME are not industry specific. The most comparable rival is HMV, which deals exclusively in the entertainment sector, more so in the past few years as CD sales shrink. The increase in videogame popularity has benefited them though, as, along with other traditional 'high-street' stores, they are stealing back the entertainment sector from the supermarkets, such as Tesco and Asda.

However, it is Argos, owned by Home Retail Group, which seems to be benefiting most from the increase in game popularity, with an increase in their entertainment market share of 42% to 2.6% across the whole sector. That's a remarkable increase, and they attribute a lot of their success to videogame sales. In their second-quarter results, for the 13 weeks leading up to 30 August, they noted that "growth was driven by increased sales of electrical products as a whole, principally as a result of strong sales performances in TVs, video gaming and white goods".

If you look back to their third-quarter results from the last financial year, Argos credited videogames for its greater increase in sales. This all contributes to the theory that videogames are helping to drive the success of these companies.

Unfortunately, this has not benefited the share price of Home Retail, largely because of the weak performance of Homebase.

Think tank IDATE recently released a study forecasting that the videogame market will see steady growth until 2016 before levelling out in 2017. Looking back to the previous 'console cycle', it was in the fourth year that significant problems started to arise for videogame retailers.

This time around, at least in IDATE's opinion, the future seems more secure.