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The Game group plc is the largest UK based retailer of entertainment software and hardware, including game consoles and computer games. It has been established in 1999 at the present form after a round of acquisitions by Electronic Boutique company. Their operations are mainly done via more than 1300 its outlets, and recently have started to move into worldwide online sales. Its website has proven to be 2nd most popular game website by UK residents in 2010 (Annual Report 2010). Another side of Game's business is the retail of preowned games. They sell software for the majority of game consoles, which include Playstation 3, Xbox 360, Nintendo DS, PSP etc. and they accept previously owned discs with points based reward system for depositing the used items (Official website). Besides home activities Game also operates in: Portugal Spain Czech Republic Sweden Norway Denmark Finland France Iceland Republic of Ireland The main strategy for market penetration in these countries has been through leveraged buyout of the main players in the industry. (Datamonitor 2009). The latest acquisition of Game station has made Game group the monopolist in the UK market. However the strategy of Game group was not to amalgamate this brand, but to keep and distinguish it from Game stores as shop for dedicated gamers and their community (Campaign 2009) The main rival could possibly be HMV, because it also sells game software, and Game Stop – a US based entertainment hardware and software retailer. The first one is not exactly in the same industry, because it does not sell consoles or preowned goods, and arguably the choice is often limited since its specialization is music and movies. The second one does not operate in the UK, although it has presence in some countries where Game operates. (Game Stop official website). Therefore Game group plc has a strong presence in the niche.
Current Year analysis
Table 1. Divisional analysis Divisions Hardware software New hardware and software Preowned Other Total Turnover (£000) 433,748 730,8 1164,548 374,485 233,325 1772,358 Profit Turnover(%) (£000) Profit (%) Profit Margin
65,71% 21,13% 13,16%
257,362 156,007 79,323 492,692
52,24% 31,66% 16,10%
22,10% 41,66% 34,00% 27,80%
Game group plc. (the company) has 3 general classifications of divisions. These include New hardware and software, preowned hardware and software and other sources of revenue. The first one summarizes proceeds from sales of new game consoles, new computer games and other new software products. It is the greatest contributor to sales, new hardware and software division is almost twice as big as two other divisions put together. However it is the most costly division according to profit margin indicator – 22% The next segment is preowned hardware and software. In reality it is mainly preowned software that is mentioned, because Game outlets do not generally accept returned game consoles. Although the per cent of profit reaches only 31,7% out of total profits, it is leading in Profit margin indicators – 41.7% (See Table 5). This implies that the cost of selling a preowned product is much less than a brand new one. This is true in spite of the fact that the price of preowned good drops dramatically after it is returned. Thus profitability of preowned items is greater than of brand new ones. The last is the 'other' division which sells peripheral goods, that may complement game experience of the customers. Its sales are extremely low, but the Profit margin ratio is also high, probably this is why the company sells merchandise.
Geographic analysis Table 2. Geographic Analysis Profit (%) 65,23% 31,50% 3,27% Profit Margin 29,96% 25,75% 16,59% 27,80%
(£000) UK and Ireland International Global Online Total
Turnover 1072,698 602,556 97,104 1772,358
Turnover(%) 60,52% 34,00% 5,48%
Profit 321,402 155,183 16,107 492,692
The company operates in three main segments. Firstly, UK and Ireland have traditionally been the main priority for Game group. Evidently, this region contributes the most in terms of sales revenue, profit and profit margin. Secondly, international segment, particularly Sweden, Denmark, France, Spain, Portugal and Australia, This segment is vastly developing (Annual report 2010) According to Cash flow statements for the past 5 years, the company has spent a considerable amount of cash on acquisitions activities. Company report (ibid) pinpoints that M&A is the main strategy for expansion. Profit margin is relatively low, probably due to high overheads. Table 3 Exchange differences on translating foreign operations 2006 Exchange differences (£000) -666 2007 -3,571 2008 9,663 2009 17,55 2010 3,92
One may argue, that the effect of cheap pound had positive effect on the income figures. Thus Percentage turnover and profit margin do not reflect the exchange rate effect for the past 5 years. Lastly, online shopping is supposed to be impressive in terms of profit margin, due to low overheads, however the picture is more bleak.
Historical Data analysis
Turnover and Profit analysis
Table 5 Financial performance PBIT Capital Employed Revenue Profit Margin ROCE
2006 11,198 170,012 645,118 1,7% 6,6%
2007 32,965 189,233 801,306 4,1% 17,4%
2008 82,34 270,074 1491,914 5,5% 30,5%
2009 130,881 330,583 1968,604 6,6% 39,6%
2010 94,789 365,511 1772,358 5,3% 25,9%
Mean 70,4346 265,0826 1335,86 4,7% 24,0%
Table 6. Acquisitions 2006 7,768 2007 9000 2008 80,941 2009 6,804 2010 0
The revenue or turnover is the key indicator of assessing company performance (Appendix B). Game group has expanded dramatically over the last five years representing a two fold increase. The increase was fluctuating throughout the years. The greatest increase happened between 2007 and 2008 where it has acquired its competitor Gamestation in the UK thus adding 217 new outlets to their chain. (Annual report 2009). Moreover there were rounds of acquisitions globally, which added 116 net more stores globally. Table 5 shows that it required the company to spend a considerable sum of money. This had to be leveraged by long term borrowing. The problem with that can be seen in the turnover numbers of 2010, whereby the sales deteriorated by almost 10 % (Appendix A) Since turnover and profits are interconnected, then the same dynamics can be seen in a PBIT index (See Appendix A). This variable is calculated by subtracting expenses associated with running the business from the sales revenue. The problem for Game presently is that due to acquisition of a large share of both domestic and international markets it has increased overheads, thus a drop in sales revenue was not immediately followed by a proportionate drop in overheads. This resulted in 27% drop in PBID index. Analyzing profit and turnover ratios by type of activities, it is evident that the new software and hardware has diminished from 73,3%of total revenue to 65,7% for the last 3 years, whereas preowned products started to bring relatively more revenue. Profits have followed this trend. Game group has massively expanded into the market of brand new goods, however the this segment contains considerable overhead expenses, whereas preowned market on contrary has a high Profit margin due to little overheads associated. 4
Profitability ratios Table 7. Profitability ratios 2006 6,6% 1,7% 2007 17,4% 4,1% 2008 30,5% 5,5% 2009 39,6% 6,6% 2010 25,9% 5,3% Mean 24,0% 4,7%
ROCE Profit Margin
Return on capital employed (Appendix B) - ROCE shows how well the company is managing its capital in terms of profit generation. We can see positive figures throughout five years and a general increase from 6,6% to 25,9%. However as it was mentioned before, there was a significant drop in Returns after 2009. One could argue that profit margin is similar to ROCE in a way that it also shows profitability. Nonetheless ROCE is different because it reflects upon efficiency of capital acquired. Software and Hardware retail arguably does not employ capital as extensively as in construction for instance. As it was mentioned above, the profit margin started to decline after 2009 due to increased operating expenses. It generally follows the pattern of ROCE. Diagram 1
45.0% 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 2006 2007 2008 2009 2010 ROCE Profit Margin
As the diagram 1 suggests the pattern is very similar, but ROCE has greater dynamics because of M&A strategy that company has been employing between 2007 and 2009. Vast amount of capital has been acquired but its efficiency in terms of profit generation has started to fall. Activity rate shows how much of turnover is generated by the division that brings the largest proportion of revenue. In the company's case it is only feasible to regard the last 3 years of company's activity, because before the acquisitions it operated in a slightly different market, i.e only brand new software and hardware.
80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% 2008 2009 2010 ROCE Activity rate
Activity rate has been steadily diminishing despite peaks and troughs of ROCE. Moreover correlation coefficient (Appendix B) is rather weak – 66% compared to Profit margin 99%. The idea is that Game's strategy is to move into preowned software retail (Annual report 2010), therefore Activity rate has been falling even when ROCE was high. One can conclude, that it is profit margin that contributes the most to the ROCE trend, since both measures are using operating profits, and capital employed in this industry is rather small to cause a considerable difference.
Long term Finance Solvency ratios intend to show how much is borrowed compared to the equity of the firm (Appendix B) The idea is the higher the ratio is, the more volatile company is considered. In software and hardware retail such as Game group plc, it is important to include intangible assets in calculation of the asset since property rights are essential for online trading. Interest coverage ratio shows the proportion of earnings before tax (EBIT) to total interest expense. In other words it shows whether the company can service its current liability (interest expense) with its earnings. The lower the ratio, the more it has to service its debt Table 8. Interest Cover 2006 4,01 2007 9,13 2008 10,09 2009 15,21 2010 19,94
In case of Game group it is evident, that they can service their debt, and the trend is increasing. In terms of solvency the company becomes more and more stable. Comparing net borrowing and earnings one can see that despite a drop in 2010, Gross borrowing (mostly long term loans) were matched by more than proportionate increase in Earnings. Thus the company reinforced its position in the market Another measure of exposure of the company to solvency risk is gearing ratio. There are a number of ratios available. This paper will regard only two: Net gearing (including intangibles) and debt ratio (see Appendix b) Table 9 2006 49,24 332,29 14,82% 2007 47,66 364,76 13,07% 2008 95,85 640,32 14,97% 2009 58,17 728,92 7,98% 2010 41,27 655,36 6,30% Mean 58,438 544,33 0,114262
Total debt (mln) Total Assets (mln) debt ratio
Table 10 Debt ratio vs Net gearing ratio 2006 debt ratio net gearing inc, intangibles Diagram 3 Gearing ratios
30.00% 25.00% 20.00% debt ratio 15.00% 10.00% 5.00% 0.00% 2006 2007 2008 2009 2010 net gearing inc, intangibles
2007 13,07% 28,45%
2008 14,97% 20,62%
2009 7,98% 0,40%
2010 6,30% 3,45%
From the diagram 3 one can see that both ratios indicate that the risk has fallen since the proportion of borrowed funds either to total assets or earnings before interest and tax is diminishing. The general conclusion is that Game group has become less volatile, since it started to pay off its debts in 2008. During economic downturn, high gearing ratio is rather dangerous for the company, thus during 2008 crisis it decided to pay off a large share of its debt and not to incur any new borrowing. Cash flows In this section it will be discussed whether the company is facing solvency risk, with respect to cash flows it is generating or absorbing
120.00 100.00 80.00 60.00 40.00 20.00 0.00 -20.00 -40.00 -60.00 -80.00 2006 2007 2008 2009 2010 Net Increase/Decrease In Cash Purchase of Property, Plant & Equipment Net Purchase of Intangible Assets Borrowings
The diagram above shows what proportion of cash generated is spent on investment activities, i.e. purchase of plant and equipment as well as purchase of intangible assets. The graph suggests that Game group has been absorbing cash in recent years. There was a peak in 2008, when it borrowed £80mln to acquire its competitor. However ever since that acquisition, the company has been losing cash. As it can be seen from "Borrowings" line the company mainly spent its cash reserves in order to reduce the debt. It goes along with decrease of gearing ratio, even the positive change of trend between 2009 and 2010 can be explained by net increase in borrowing.
Short term finance Short term analysis is concerned with the proportion of total current assets with current liabilities. In this paper, there will be used to most popular ratios: current ratio and its improved version – quick ratio. These ratios can also be called liquidity ratios, because they assess how easily can a company generate cash. Table 11 2006 2007 2008 2009 2010 0,892987 0,917989 0,90963 0,949554 1,071213 0,460244 0,436084 0,517886 0,49129 0,463843
Current Ratio Quick Ratio
1.2 1 0.8 0.6 0.4 0.2 0 2006 2007 2008 2009 Quick Ratio 2010 Current Ratio
(For further calculations see Appendix D)
At the beginning of 2006 the company was not in good financial health because it would be able to pay its current liabilities if they were due. Current ratio of 0,9% suggests that. However the situation gradually improved after 2009. This coincides with company's debt repayment. Inventories of Game group, mainly game cds and dvds are difficult to turn into cash over a short period of time. Therefore, one can see, that the company in reality has not improved its liquidity, on contrary, it has slightly deteriorated due to fall in sales revenues in 2010. Game shows pessimistic prospective both in short term – quick ratio and long term debt ratio. This is likely to discourage risk averse investor from including these shares in the portfolio. However if cash outflows are cut due to full repayment of the debts, then both indicators are likely to improve. 10
Investors ratios Table 12 Relative P/E ratio 2006 actual 41,40 3,16 2,17 2007 actual 21,20 1,68 0,90 2008 actual 12,50 1,18 1,15 2009 actual 5,50 0,31 0,76 2010 actual 4,60 0,32 0,27
PE Ratio Co/FTSA co/sector
P/E ratio is the key in assessing current value of stock, (See Appendix C). It is evident, that at the beginning of 5 year period the company has outperformed both the market and the sector. However after 2008 the company has been in downturn. Arguably, just as other indicators this was a result of net expenditure on borrowing, i.e. the debt-leverage acquisition has had a significant pressure on P/E ratio. that Game group is a value stock because in the longer run this underperformance can be compensated by increased sales and therefore net income. The forecast (Appendix C) is based on ex poste growth figure, however one should be cautious applying this approach, because certain assumptions such as constant nature of growth. Also the mean would change The sector according to London Stock Exchange is general retail. Arguably it a very ambiguous segmentation, since there more than 20 companies which sell children's wear, stationary, dvds etc. This sector is quite diverse and both p/e and dividend yield figures can be misleading. Average P/E for this sector is 15,7 (Appendix C)
Table 13. Dividend yield 2006 actual 3 0,980392157 0,961538462 2007 actual 2,1 0,726644 0,843373 2008 actual 2,2 0,477223 0,455487 2009 actual 3,8 1,141141 0,517711 2010 actual 6,3 1,987382 2,333333
Divident yield Co/FTSA Co/sector
Dividend yields reflect how much of the share price is paid out in dividend. Although it may seem simplistic to assess share price solely on dividend yield, but it is a fundamental tool in comparing performance of the company to the industry and to sector. Game group has generally underperformed compared to the whole market. However in recent years the values of 1,41 and 1,99 have been achieved. This roughly means that it outperformed the 11
market by 14% and 99 % in 2009 and 2010 respectively. Most noteworthy is the latest leap. It was reflected in the company to sector index as well. In Company to sector Game group has generally underperformed, but in the last year dividend yield has massively increased. This implies that shares are considered risky (gearing ratios imply on that) and the company had to increase dividends paid. Yet again the problem of prospective dividend yield is that constant growth is used to predict the future. Consequently the farthest point 2015 is most difficult to predict. Risk analysis This section of analysis will elaborate on diversifiable risks, i.e specific risks to the company and market risks that cannot be diversify. To do so regression analysis is used (See Appendix D) Table 14 Game FTSA 0,007317 0,001925 0,142294 0,048205 0,404529 1,194115 0,163643 0,084732
Average Std.Dev Correlation Beta R-Squared Specific Risk
This regression was estimating the effect of FTSA return shift on Game return shift. Beta in this case shows what proportion of volatility in the market, i.e. systematic risk is imposed on the total risk of the company. Beta showed more than proportionate magnitude of 1,19. Thus if the market return increases by one pound, then the share return would move by 1 pound and 19 pence. However the Beta of General Retailers sector is 1,20, therefore sensitivity of the company to systematic risks is common for this sector. R-squared statistics shows how well the Beta explains total fluctuations in returns. The Rsquared is very low, 16% of all movements in returns. Therefore this model describes only a portion of the volatility. Standard deviations were taken as proxies of risks for the market and Game group. (See Appendix B). The result showed that specific risk of the company is relatively low – 8,4%. This figure is also implied by Sector Beta 1,20 which suggests that the company is within sector boundaries in terms of risk structure. However one could be skeptical of this result because R-squared is quite low, thus some of the factors which affect company's risk were not taken into account.
Valuation of shares In this paper there will be applied a Constant perpetual growth model, whereby the intrinsic value of a share price is estimated by adjusting dividends to discount factor and a growth rate. (Jordan 2010). In order to do so, there was calculated a sustainable growth ratio, however one must bear in mind that this ratio is assumed to be constant throughout the periods, which is not very feasible for a long period The second component was the discount rate. (See Appendix E) The problem with this component could be that the interest rate is assumed to be stable over the whole period. But as we know, that is a rather unrealistic assumption. Besides that Beta of Game albeit very high, does not reliably explains the changes in the company's prices. Its R2 is very weak – only 20%. Table 15 Constant growth model Payout ratio Retention ratio Roe Sustainable growth stock beta Risk free rate Market premium rate dividend year 2011 P estimated 0,33 0,67 0,1823 0,0474 1,194 0,04 0,09 6,054 60,515
The estimate of the value of a share price is by a fraction lower than the actual price for 25 February 2011 (the date in question) which equaled £60,05 This suggests that the stock is not mispriced.
The overall recommendation for the investors is to Hold, because the shares are correctly priced at the moment, plus the statistical data such a Beta and specific risk state that It moves within the market boundaries. The main problem remains the debt repayment which absorbs a great deal of cash reserves. Another dimension of debt issue is gearing which suggests that the company has become relatively volatile in recent years. This indicator may deter risk averse investors, however there has been a positive trend in short term liabilities, whereby quick ratio has shown positive dynamics in recent years. The negative signs such as falling profit margin on the main activity or turnover downturn can be explained by fluctuations in the sector in general, where there has been a relative drop in revenues. Arguably in the longer terms this trend will be reversed, however a prudent investor should consider buying the company's stock with long term prospects, rather than short term returns. Christopher Bell CEO of Game group outlined that the company is looking ahead in the long run perspectives and increase its presence in vastly developing spheres such as digital sales. (Game Annual Report 2010) Also he implied that due to a well established niche in the sector, the company has the capacity to reboost its sales. This is probably true, since there are not too many UK competitors in this industry left after M&A rounds.
Darby I, (2008). VIDEO games industry. Campaign (UK) issue 18, p2-2, Datamonitor, 2008. Game plc Company profile [online] retrieved from datamonitor.com Datamonitor, 2009. Game plc Company profile [online] retrieved from datamonitor.com Datamonitor, 2010. Game plc Company profile [online] retrieved from datamonitor.com Digital look: Game group plc. Historic prices [online] available at: http://www.digitallook.com/cgibin/dlmedia/login.cgi?username=salikhalid&url=security.cgi%3Farea%3Dprofit_loss%26action %3Dfinancials%26csi%3D10169%26data_set%3Dgeo%26sub_action%3Dfundamentals&msg= company [accessed on 14 Aprill 2011] Ft financial times: market data (software): [online] available at: http://markets.ft.com/markets/sectorsAndIndustries/industries.asp?s=571422&ss=WSODIssue& encodedName=Software [accessed on 14 Aprill 2011] Game group plc (2009) Annual report [PDF]: available at: http://ir3.quartalflife.com/data/game/igb_html/download.php?bericht_id=1000001&lang=ENG [accessed on 14 Aprill 2011] Game group plc (2010) Annual report [PDF]: available at: http://ir2.flife.de/data/game/igb_html/index.php?bericht_id=1000003&lang=ENG [accessed on 14 Aprill 2011] Game plc official website [online] available at: http://www.game.co.uk/ [accessed 20 April] GameStop official website [online] available at: http://www.gamestop.com/ [accessed 20 April]Investopedia (2011) Interest Cover ratio [online] available at: http://www.investopedia.com/articles/basics/04/040804.asp [Assessed on 15 April 2011] Jordan,B.andT.Miller(2010).Fundamentals of Investments: Valuation and Management(5thEdition). New York: MCGrawHill/Irwin. Moneyterms.Co.Uk (2011). Interest cover [Online]. Moneyterms. Available at: http://moneyterms.co.uk/interest_cover/ [Accessed 17 March 2011]. Morningstar: Game group plc. Fundamentals [online] available at:
http://tools.morningstar.co.uk/uk/stockreport/default.aspx?Site=uk&id=0P00007OC8&LanguageId=enGB&SecurityToken=0P00007OC8]3]0]E0WWE$$ALL [accessed on 14 Aprill 2011]
Table 4. Turnover and Profit 2005 576,586 2006 645,118 11,89% 11,198 -62,42% 2007 801,306 24,21% 2008 2009 2010 Mean 1491,914 1968,604 1772,358 86,19% 31,95% -9,97% 28,9% 130,881 58,95% 94,789 -27,58%
Revenue %change PBIT %change
32,965 82,34 194,38% 149,78%
Debt Ratio - A ratio that indicates what proportion of debt a company has relative to its assets. The measure gives an idea to the leverage of the company along with the potential risks the company faces in terms of its debt-load. Profit Margin - A ratio of profitability calculated as net income divided by revenues, or net profits divided by sales. It measures how much out of every dollar of sales a company actually keeps in earnings. ROCE - A ratio that indicates the efficiency and profitability of a company's capital investments. EBIT/(total assets – current liabilities) Current ratio – Current assets/current liabilities Quick Ratio = (Current Assets – inventories)/ current liabilities P/e – A valuation ratio of a company's current share price compared to its per-share earnings. Debt ratio - A ratio that indicates what proportion of debt a company has relative to its assets. The measure gives an idea to the leverage of the company along with the potential risks the company faces in terms of its debt-load. Solvency ratio - The solvency ratio measures the size of a company's after-tax income, excluding noncash depreciation expenses Gearing - Gearing is a measure of financial leverage, demonstrating the degree to which a firm's activities are funded by owner's funds versus creditor's funds. Correlation coefficient - A measure that determines the degree to which two variable's movements are associated. Interest cover - Interest cover is a measure of the adequacy of a company's profits relative to interest payments on
its debt. The lower the interest cover, the greater the risk that profit (before interest) will become insufficient to cover interest payments.
Beta - Beta is calculated using regression analysis, and you can think of beta as the tendency of a security's returns to respond to swings in the market. A beta of 1 indicates that the security's price will move with the market. A beta of less than 1 means that the security will be less volatile than the market. A beta of greater than 1 indicates that the security's price will be more volatile than the market. For example, if a stock's beta is 1.2, it's theoretically 20% more volatile than the market. Discount rate - The interest rate used in discounted cash flow analysis to determine the present value of future cash flows