Games drive growth, new retail strategy

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Two reports out this week speak of a bright and profitable future for both the game industry and investors over the next few years.

The first: Best Buy's first-quarter financials, released on Tuesday. The nation's biggest electronics retailer shocked Wall Street with quarterly profits that pulled significantly ahead of last year's same-quarter tally. On strong-selling categories that included games (along with MP3 players, digital TVs, digital cameras, and notebook computers), the company reported an 85 percent spike in profits.

On the same day, Piper Jaffray analyst Tony Gikas issued the second positive report--not tied to quarterly earnings per se, but indeed part of the overall positive picture for sellers of either game hardware or software.

Citing discussions with leading video game retailers, Gikas pegs calendar year 2006 as the year for shelf space devoted to games to increase dramatically at the nation's top retailers.

"We estimate video game category square footage will increase between 50-55 percent by 2007 driven by the launch of new hardware platforms ... and complementary software products. Of our increase, we estimate 26 percent of the growth will occur in CY05, 54 percent in CY06, and 20 percent in CY07."

Gikas believes Best Buy and Target will lead in-store expansion with "increases in footage of nearly 50 percent during the CY05-CY07 period." Wal-Mart and Circuit City are "likely" to follow suit with similar increases, Gikas says.

Gikas expects EB Games and GameStop, specialty stores that already allocate 100 percent of their square footage to games, to squeeze out an increase to shelf space as well, due to "new fixtures, merchandising, and a focus on slightly larger sized strip center (versus mall) expansion."

When it comes to actual investment of dollars and cents, Gikas says "we advise investors to add to positions before September and maintain holdings for a period of at least two years. We view sector growth as strong during the second half of 2006 and 2007 and think video game publisher stocks will significantly outperform relative to broader market indices."

Commenting specifically on the business practices of Best Buy, Gikas and Piper colleague Mitchell Kaiser believe that Best Buy has made the decision to expand gaming shelf space not only due to strong growth projections for the sector, but also "as a replacement for CDs, which have been a declining category for the last couple of years." Gikas added that entertainment software, including video games, DVDs, and CDs, represents approximately 21 percent of Best Buy sales.

"More importantly," he added, "these categories are strong traffic drivers to the stores with 50 percent of transactions having an entertainment software attachment."

As well, Piper believes Best Buy will expand the diversity of gaming inventory "more aggressively this fall" via the "Buzz" segmented store (part of its "Consumer Centricity" initiative, or stores converted to focus on specific customer groups, such as suburban housewives or small-business owners).

The "Centricity" initiative was announced last summer after a year of planning. The company plans on implementing the business model in 150 to 200 stores by the end of it current fiscal year.

Of its 68 California stores that conform to the new model, Piper says 11 reflect the Buzz format--aimed at affluent professional men between the ages of 30 to 60.

"Best Buy has committed to 150-200 new Centricity stores in FY06. We believe the second and third waves of store expansions will have several Buzz format stores," the Piper report concludes.