As Game confirms its intention to float, it’s clear the retail IPO train continues to come at a pace after such a long drought.
As Game confirms its intention to float, the retail IPO train continues to come at a pace after such a long drought.
Leaving the question of valuation aside for a moment, we’ve seen the arrival of a number of much-needed growth companies come into the public markets, businesses delivering organic, long-term growth in the UK, online and across international territories.
These are exactly the types of businesses that investors target, operating in good or growing markets with prospects and usually a high level of cash generation.
We’ve also seen some less obvious IPO candidates over the past year, businesses which would not top anyone’s wish list, but which come out with a compelling enough yield and valuation to be of interest. So where will Game fit in?
There is no doubt that the business has been transformed operationally with a much leaner store base, lower operating costs and a less financially geared balance sheet.
There is however no escaping what drives the model, which is the console cycle. Game is a business that does not have control of its primary products, rather it relies on innovation from the console manufacturers and the games companies.
Looking back at how Game has fared since 2000 when I first started covering the stock, the console cycle has proved to be the main driver of performance.
The launch of a new major console is transformational for Game. Selling high-priced boxes at low margin, the group’s sales numbers will fly – double digit like-for-like gains. While margins are low in percentage terms, the cash margin is still attractive and the business generates strong like-for-like gross profit and sales as it dominates the market.
As the console prices come down and the initial excitement dies down (all consoles end up at £100 eventually) so Game’s sales mix will move back in favour of higher margin software and in particular the most profitable of all, pre-owned games.
So, while the like-for-like sales will likely turn negative at this point, the business is still highly profitable and cash generative, still making strong like-for-like gross profit gains.
The problem is the next bit, the gap that comes three years or so after the console launch when the high-octane years come to an end and the like-for-like gross profit starts to fall.
Historically, Game has delivered outstanding upgrades on the way up, often way beyond market expectations.
Similarly, on the way down, the speed of decline was equally surprising. Game successfully rode the console cycle three times before the gap between the Xbox and PS launches proved too great and the business went into administration, a process ultimately speeded up by a lack of support from suppliers.
Will it be different this time? The cycle has consistently behaved this way for the last 14 years before we even consider the switch to digital.
Game will continue to shift huge console volumes and accessories as the UK market leader, no doubt delivering stunning numbers. Over that time, Microsoft is likely to be trialling some of the new features built into the Xbox that were pulled at launch, particularly through digital channels, with Sony doing the same.
Building in the likely acceleration in the switch from physical to digital then the downswing is likely to be even more pronounced, particularly the impact it will have on the critical pre-owned market.
This time there is a reasonable argument to suggest that this is the last console cycle because it is the portal, rather than the box, that will become increasingly important, a gateway controlled by the likes of Sony, Microsoft, Apple, Google, Sky and the content providers.
Game is a much leaner and flexible business than it was two years ago. However, we still see the product cycle driving the company’s fortunes and not the other way around. Buckle up for a roller coaster ride.
- John Stevenson, retail analyst, Peel Hunt