game group

7/29/2019 Game Group

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BackgroundThe 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.


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Geographic analysis

Table 2. Geographic Analysis

(000) Turnover Turnover(%) Profit

Profit

(%)

Profit

Margin

UK and Ireland 1072,698 60,52% 321,402 65,23% 29,96%International 602,556 34,00% 155,183 31,50% 25,75%

Global Online 97,104 5,48% 16,107 3,27% 16,59%

Total 1772,358 492,692 27,80%

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 2007 2008 2009 2010

Exchange

differences (000) -666 -3,571 9,663 17,55 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.


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Historical Data analysisTurnover and Profit analysis

Table 5 Financial

performance 2006 2007 2008 2009 2010 MeanPBIT 11,198 32,965 82,34 130,881 94,789 70,4346

Capital

Employed 170,012 189,233 270,074 330,583 365,511 265,0826

Revenue 645,118 801,306 1491,914 1968,604 1772,358 1335,86

Profit Margin 1,7% 4,1% 5,5% 6,6% 5,3% 4,7%

ROCE 6,6% 17,4% 30,5% 39,6% 25,9% 24,0%

Table 6. Acquisitions

2006 2007 2008 2009 2010

Acquisitions 7,768 9000 80,941 6,804 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 salesrevenue 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.


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Profitability ratios

Table 7. Profitability ratios

2006 2007 2008 2009 2010 Mean

ROCE 6,6% 17,4% 30,5% 39,6% 25,9% 24,0%

Profit Margin 1,7% 4,1% 5,5% 6,6% 5,3% 4,7%

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

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.

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

2006 2007 2008 2009 2010

ROCE

Profit Margin


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Diagram2

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.

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

2008 2009 2010

ROCE

Activity rate


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Corporate financeLong 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 2007 2008 2009 2010

Interest Cover 4,01 9,13 10,09 15,21 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 2007 2008 2009 2010 Mean

Total debt (mln) 49,24 47,66 95,85 58,17 41,27 58,438

Total Assets (mln) 332,29 364,76 640,32 728,92 655,36 544,33

debt ratio 14,82% 13,07% 14,97% 7,98% 6,30% 0,114262


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Table 10 Debt ratio vs Net gearing ratio

2006 2007 2008 2009 2010

debt ratio 14,82% 13,07% 14,97% 7,98% 6,30%

net gearing inc, intangibles 13,53% 28,45% 20,62% 0,40% 3,45%

Diagram 3 Gearing ratios

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

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

2006 2007 2008 2009 2010

debt ratio

net gearing inc,

intangibles


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Diagram 4

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.

-80.00

-60.00

-40.00

-20.00

0.00

20.00

40.00

60.00

80.00

100.00

120.00

2006 2007 2008 2009 2010

Net Increase/Decrease

In Cash

Purchase of Property,

Plant & Equipment

Net Purchase of

Intangible Assets

Borrowings


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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

Current Ratio 0,892987 0,917989 0,90963 0,949554 1,071213

Quick Ratio 0,460244 0,436084 0,517886 0,49129 0,463843

Diagram 5

(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.

0

0.2

0.4

0.6

0.8

1

1.2

2006 2007 2008 2009 2010

Current ratios

Current Ratio Quick Ratio


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Investors ratios

Table 12 Relative P/E ratio

2006 2007 2008 2009 2010

actual actual actual actual actual

PE Ratio 41,40 21,20 12,50 5,50 4,60Co/FTSA 3,16 1,68 1,18 0,31 0,32

co/sector 2,17 0,90 1,15 0,76 0,27

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 2007 2008 2009 2010

actual actual actual actual actual

Divident yield 3 2,1 2,2 3,8 6,3Co/FTSA 0,980392157 0,726644 0,477223 1,141141 1,987382

Co/sector 0,961538462 0,843373 0,455487 0,517711 2,333333

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


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RecommendationsThe 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.


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Appendix ATable 4. Turnover and Profit

2005 2006 2007 2008 2009 2010 MeanRevenue 576,586 645,118 801,306 1491,914 1968,604 1772,358

%change 11,89% 24,21% 86,19% 31,95% -9,97% 28,9%

PBIT 29,796 11,198 32,965 82,34 130,881 94,789

%change -62,42% 194,38% 149,78% 58,95% -27,58% 62,6%


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Appendix BDebt 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 non-

cash 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


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Appendix C

game group

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