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GameStop
GME - BUY
February 13, 2011
$20.28
$32.00 $25.75-$17.12 $3,070 151.4 3,928,509 $0.00 0.0% 2010E $2.67E NC 7.6x 2011E $3.02E NC 6.7x
Is There Smoke? - GME recently filed a brief 8K locking management into the
company in the event of a change in control. This release should fuel more conjecture over an LBO, as any financial buyer would need assurance that management will not leave. GME's management is talented as evidenced by the 38% increase in market share over the past two years. and the fact it added 6 million loyalty subs in under six months - a feat that is remarkable. This news should help support the stock, as short sellers (25% of the float) contemplate the potential for a large takeout premium, which is supported based on our LBO model (attached on the next page). LBO Analysis - Using a $30 takeout price (i.e. a 50% premium) at the end of 2011, we estimate a takeover would cost $3.9 billion after accounting for advisory and capital raising fees. Assuming a deal is funded with 40% equity ($1.6 billion) and 60% debt (consisting of 20% bank loans at 5% and 80% high yield debt at 8%), GMEs average annual post-LBO free cash flow of $436 million could easily pay the average annual net interest expense of $152 million and have excess cash to pay down $150 million in debt each year while paying a $200 million annual dividend (improving the deal's IRR). Using a 6.0x EBITDA (or 13.6x PE) exit in 2015 would imply a total net return of $3.8 billion after accounting for dividends. This would equate to a healthy 39.5% IRR, which we believe could move even higher as some of our estimates could be considered conservative.
FYE: Jan 2009A 2010E 2011E Revenue (M): $9,078A $9,459E $9,738E Quarterly Revenue (M): Q1 $1,981A Q2 $1,739A Q3 $1,835A Q4 $3,524A FYE: Jan EBITDA: 2009A 830.8A
Fear Creates Exit Opportunity Digital threats continue to be one of the biggest
overhanging issues for GME, as investors fear digital will eliminate GME's dependence on stores and packaged media. We believe these fears fail to appreciate: 1) GME's potential to arise as a major digital platform; 2) consumer preference for games on packaged media that is portable and retains residual value (i.e. can be traded); and 3) the FCC's new broadband policies (passed 12/22/10) that will change the way consumers pay for broadband, and in the process, will render big game downloads uneconomical. This fear may create an ideal LBO, as the elimination of these fears (e.g. investors/consumers realizing the new realities of downloading in a Usage Based Billing world) could create an ideal exit strategy while the core business remains sound and needs no significant capital commitment.
Q1 2010
Q2
Q3 2011
Q1
25 20 15 10 5 0 Created by BlueMatrix
Research Analyst Certifications and Important Disclosures are on pages 3 - 4 of this report
LBO M OD E L
Required Funding Current Price $20.00 Take Out Price $30.00 Reqd Premium 50.0% Shares 157.1 Purchase Price $4,713.0 Debt (End 2011) Cash & Equiv (End 2011) Enterprise Value Advisory Fees Fee % Debt Issuance Fee % Total Deal Cost $98.9 $945.5 $3,866.4 $11.6 0.30% $38.7 2.00% $3,916.6 LBO Cash Flow Analysis Adjusted EBITDA YoY Growth D&A Stock Comp Interest Expense, net GAAP Taxes Tax Rate Minority Interest Net Income +D&A +Stock Comp, Net of Tax +Chg in Inventory +Chg in BS & Other Operating Cash Flow YoY Growth Capital Expenditures Free Cash Flow YoY Growth LBO Debt Repayments % of FCF used for Debt Repay Dividends 2010 $883.2 5.5% $175.2 $39.3 $34.3 $224.2 35.3% ($1.5) $411.7 $175.2 $25.4 ($47.2) $80.6 $645.7 0.2% ($190.2) $455.5 -5.2% $0.0 0.0% $0.0 2011 $908.4 2.9% $182.2 $39.0 $12.7 $236.1 35.0% ($1.2) $439.6 $182.2 $25.3 ($21.5) $70.9 $696.5 7.9% ($190.2) $506.4 11.2% $0.0 0.0% $0.0 2012 2013 2014 2015 $985.5 $1,005.2 $1,025.3 $1,045.8 8.5% 2.0% 2.0% 2.0% $190.4 $194.2 $198.1 $202.1 $40.6 $41.4 $42.2 $43.0 $170.1 $162.6 $155.1 $145.7 $204.5 $212.4 $220.4 $229.2 35.0% 35.0% 35.0% 35.0% ($0.8) ($0.6) ($0.4) ($0.2) $380.6 $395.1 $409.8 $425.9 $190.4 $194.2 $198.1 $202.1 $26.4 $26.9 $27.4 $28.0 ($40.1) ($40.9) ($41.8) ($42.6) $39.7 $40.5 $41.3 $42.2 $597.0 $615.8 $634.9 $655.6 -14.3% 3.2% 3.1% 3.3% ($190.2) ($190.2) ($190.2) ($190.2) $406.8 $425.6 $444.7 $465.4 -19.7% 4.6% 4.5% 4.6% $150.0 $150.0 $150.0 $150.0 36.9% 35.2% 33.7% 32.2% $200.0 $200.0 $200.0 $200.0
Target Capital Structure Equity $1,566.7 % of Reqd Cash 40% Debt $2,350.0 Banks Loans $470.0 % of Debt 20% Interest Rate 5.0% Senior Notes $1,880.0 % of Debt 80% Interest Rate 8.0% Deal Metrics 2012 EBITDA 2012 PF Net Income EV/EBITDA (2012) P/E (2012) Debt/EBITDA EBITDA/Int Exp LBO Return Exit EBITDA Exit P/E Exit Enterprise Value Ending Debt Return on Sale Total Return w/ Divs Initial Invest. Total Net Return w/ Divs IRR
Debt/Cash Balance $985.5 $485.8 3.9x 8.0x 2.4x 5.8x Bank Loans Balance (BOP) - Paydown Balance (EOP) Senior Notes Balance (BOP) - Paydown Balance (EOP) Debt Balance Interest Expense Cash Interest Rate Interest Income Net Interest Expense
2010
2011
2012
2013
2014
2015
$1,002.4 $1,078.0 $1,172.8 $1,288.1 0.50% 0.50% 0.50% 0.50% $4.9 $5.2 $5.6 $6.2 $165.3 $157.4 $149.5 $139.5
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Definition of Ratings
BUY: Janney expects that the subject company will appreciate in value. Additionally, we expect that the subject company will outperform comparable companies within its sector. NEUTRAL: Janney believes that the subject company is fairly valued and will perform in line with comparable companies within its sector. Investors may add to current positions on short-term weakness and sell on strength as the valuations or fundamentals become more or less attractive. SELL: Janney expects that the subject company will likely decline in value and will underperform comparable companies within its sector.
Price Charts
Rating and Price Target History for: GameStop (GME) as of 02-10-2011
01/22/09 I:B 10/20/09 N 05/27/10 B
Created by BlueMatrix
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184 155 7
51 46 3
18 4 0
10 3 0
*Percentages of each rating category where Janney has performed Investment Banking services over the past 12 months. Other Disclosures
Investment opinions are based on each stock's 6-12 month return potential. Our ratings are not based on formal price targets, however our analysts will discuss fair value and/or target price ranges in research reports. Decisions to buy or sell a stock should be based on the investor's investment objectives and risk tolerance and should not rely solely on the rating. Investors should read carefully the entire research report, which provides a more complete discussion of the analyst's views. This research report is provided for informational purposes only and shall in no event be construed as an offer to sell or a solicitation of an offer to buy any securities. The information described herein is taken from sources which we believe to be reliable, but the accuracy and completeness of such information is not guaranteed by us. The opinions expressed herein may be given only such weight as opinions warrant. This Firm, its officers, directors, employees, or members of their families may have positions in the securities mentioned and may make purchases or sales of such securities from time to time in the open market or otherwise and may sell to or buy from customers such securities on a principal basis.Supporting information related to the recommendation, if any, made in the research report is available upon request.
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