IB Equity Research

June 27, 2014

GAMESTOPThesis OverviewGameStop (GME) is a global specialty retailer of video game hardware/software/accessories and mobile phone re-commerce (unlocking etc.). The Company derives a substantial portion of its gross margin (41%) from the purchase and resale of used games, typically from customers, but increasingly from liquidation closeouts and other retailers clearing inventory. The value proposition of GME starts (and ends) with the premise that gamers seek salvage value from their games, particularly those shiny new $60 ones. Salvage value serves as credit toward future hardware/software/accessory purchases without the headache/fees and two-step process of selling for cash into Amazon/eBay/Craigslist before outlaying the next purchase. The GameStop trade-in model is relatively seamless and allows the Company to maintain a negative working capital balance that outpaces any big-box specialty retailer.

Management has amply demonstrated to be a group of smart capital allocators within the business and the shareholder base. We estimate average sales per square foot of $900-$950 to outpace Best Buy’s $750-$800 despite GME possessing more than triple the store units (albeit at one-twentieth the square footage). GameStop’s latest store expansion plan is focused on the relatively young Tech Brands segment (where gross margins are not far off the used game segment) following last year’s tactical acquisitions of Apple and AT&T mobile phone resellers. Free cash flow after acquisitions has not gone below $380MM annually in over six years and management has returned all $1.7 billion (37% of market cap) of it to shareholders through dividends and buybacks.

The bearish thesis against GME has long been that either:

1. Some hyper-efficient retailer like WalMart will enter the used game market and take away significant share

2. Digital game copies (which have no salvage value) will replace physical discs and render the gamer value proposition obsolete

WalMart in the past tried a version of the used game model using a third party kiosk approach not unlike what it does today with Jackson Hewitt for tax preparation. The effort failed miserably after the partner went out of business, but now they seem back for more, this time without a third party. While this approach won’t likely have the same poor result, we believe that GME has a defensible market share based on

store network distribution (small units in strip mall locations, accessible to both urban/rural consumers);

supply chain efficiency;

Stock Rating BUYCatalyst Category ValuePrice Target $57.70

Price (6/26/14): $40.57Upside/(Downside): 42%Ticker: GMEExchange: NYSEIndustry: Specialty Retail

Trading Stats ($USD millions)Market Cap: $4,619Adj. Enterprise Value: $7,617Price / FY15E Free Cash Flow: 6.9xDividend Yield: 3%Price / FY14E EPS: 11.1xPrice / FY15E EPS: 8.4xAdj. EV / FY14E EBITDAR: 6.2xAdj. EV / FY15E EBITDAR: 5.3xSource: Company filings, analyst estimates

Price Performance52 Week range: $33.25 - $56.28

Analyst DetailsIB Username: Stilian MorrisonEmployer: Independent AnalystJob Title: Analyst

Analyst DisclosureGME Position Held: Yes

IB Equity Research

June 27, 2014

general brand ecosystem (staff members are typically avid gamers who are genuinely interested in chatting up and advising consumers)

As for digital, Microsoft tried a wholesale switch last year with the launch of its Xbox One, to which gamers responded with a vehement ‘NO’ prompting a swift (and embarrassing) turnaround. Gamers are a unique, informed subset of consumer group who hold major sway in an industry that has withstood a secular trend in the growth of the casual mobile game market.

IB Equity Research

June 27, 2014

Company OverviewGME expects to get to almost 7,000 total stores by the end of the current fiscal year as it expands its Tech Brands segment to roughly 8% of the store base. The average video game store is roughly 1,400 square feet vs. a range on tech brand locations of 900 to 2,600 square feet. Tech Brands represents the latest in a series of patient acquisitions into new verticals that started with digital/DLC for video games and moved into mobile/tablets, wireless, and the powerful Apple hardware ecosystem.

Source: 2014 Investor Day presentation

Recent Trading LevelsTrading Price: 40.57$ 52-week high 56.2852-week low 33.25Diluted Shares Outstanding: 113.858

Market Cap 4,619$ Long-Term Debt 79 Operating Lease Commitments 3,128 Cash and Equivalents (209) Lease-Adjusted Enterprise Value 7,617$

FY2014 FY2015Adj. EV / EBITDAR 6.2x 5.3xP/E 11.1x 8.4xP/FCF 14.3x 6.9x

EBITDAR 1,221$ 1,445$ EPS 3.64$ 4.81$ FCFPS 2.83$ 5.85$

Hstorical Trading

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IB Equity Research

June 27, 2014

Market OverviewVideo GamesThe video game market is somewhat asynchronous or acyclical with the macroeconomic business cycle in that the timing of new consoles tends to dominate any broader retail trend. This is not to say that GME shares did not suffer immeasurably in the dark days of 2008, but rather that operations held up well: sales still grew 3% and 4% in the 2008-2009 calendar years, with firm margin holds above calendar 2007 and over $800 million in free cash flow.

Far more important are console cycles: the launch of new (and more powerful) gaming hardware to replace the prior generation’s machines. There is a three-fold impact across the video game landscape:

1. New hardware sales experience a one-time surge along with greater software attachment as eager gamers add launch-day titles to complement their new systems. From GME’s perspective, this surge has typically lasted about one to two years (see FY07 which followed the November 2005 and November 2006 launches of Xbox 360 and PS3, respectively)

2. New software sales experience a more prolonged surge for two to three years as development cycles adapt to the capabilities and consumer reception of the new software

3. Used game/product sales, interestingly, grow and become more profitable through the refresh phase as gamers seek to trade in their older generation hardware/software to earn credit against the new. The margin improvement is indicative of GME’s ability to extract greater share of the salvage value from gamers as perceived obsolescence leads to more price compromises on the gamer’s part.

GME Historical Segment Sales Trends

$872

$1,471 $1,814

$2,270 $2,435 $2,538 $2,680

$2,652 $2,661 $2,709

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Industry watchers who were tolling the death knell of physical formats were probably surprised by NPD's May 2014 statistics in which gamers spent $274 million on physical software, 20% more than April and 57% more than prior year. The industry pipeline for new titles is expected to be considerably stronger next year and it appears that none of these major titles are being marketed as all-digital formats. Indeed, the console cycle’s sophomore expansion of new game supply is generally consistent with the prior game cycle. A prolonged new game cycle suggests a likely second wind for the used game refresh as gamers work through launch year supply before turning their attention (and trade-in credits) elsewhere.

IB Equity Research

June 27, 2014

IB Equity Research

June 27, 2014

In terms of distribution, GameStop’s highest spending gamers tend to be in smaller cities like Huntington, NY or Laredo, TX. Below is a map of Huntington with the locations of video game retailers relative to one another and the city center. Game Stop has four stores within a 14.5 mile perimeter right outside the official border of Huntington and across the East Jericho Turnpike. World Gamer Nation (WGN) and Play N Trade both have superior locations, but lack the footprint and larger scale of GME; WGN is a single store and Play N Trade appears to be a sub-$50 million business with just over 100 stores nationwide.

IB Equity Research

June 27, 2014

Tech BrandsAn aspect of the equity upside in GME is the Company’s expansive push in its Tech Brands segment. Management devoted a substantial portion of its most recent investor day to addressing the market potential herein. Indeed, the various sectors and sub-segments, most notably re-commerce, are capably positioned for robust growth as mobile phone cycles. Re-commerce, while a much smaller market, is growing rapidly and is very much analogous to the trade-in business model of the used game market, GME’s hallmark sector.

In targeting these verticals, management has sought to make Tech Brands at least 10% of consolidated earnings by FY 2016 through expansion to 1,000 stores. Excluding the Apple ecosystem (Simply Mac), whose (10% of Tech Brands) stores require ~$175K in capex, the majority of the segment’s units require on average half the capex dollars of GameStop video game stores. Contributions margins at the ATT (Spring Mobile), currently 75% of Tech Brand footprint, are relatively close in dollar terms to the flagship video game units.

IB Equity Research

June 27, 2014

ValuationVarious forward multiple methods are applicable to valuing GME, including P/E, P/FCF, and lease-adjusted enterprise value (AEV) to EBITDAR. The former are perhaps more applicable against the relatively sparse comparable universe with differing rent models among Big Box retailers. We arrive at a target price of $57.70 that is consistent with 12x FY15 P/E and 10x FY15 FCF.

The stock remains heavily shorted with the latest numbers showing 15 days to cover and 30% interest of float. A sustained earnings beat or spate of good industry news through the rest of the fiscal year might well trigger some manner of squeeze.

Base Case Annual Financial ProjectionsFY2011 FY2012 FY2013 LTM Apr-14 FY2014 FY2015 FY2016 FY2017 FY2018

Stores 6,683 6,602 6,675 6,980 6,980 6,980 6,980 6,980

Sales 9,551$ 8,887$ 9,040$ 9,171$ 9,380$ 10,601$ 11,070$ 11,441$ 11,828$ % growth 0.8% (7.0%) 1.7% 4.8% 3.8% 13.0% 4.4% 3.4% 3.4%

Gross profit 2,680$ 2,652$ 2,661$ 2,709$ 2,877$ 3,144$ 3,252$ 3,358$ 3,468$ % margin 28.1% 29.8% 29.4% 29.5% 30.7% 29.7% 29.4% 29.4% 29.3%

SG&A 1,842 1,836 1,892 1,924 2,069 2,120 2,173 2,228 2,283 % growth 8.4% (0.3%) 3.1% 9.3% 2.5% 2.5% 2.5% 2.5%

D&A in COGS 2 2 3 3 2 2 2 2 2 EBITDA 840$ 818$ 771$ 788$ 811$ 1,026$ 1,081$ 1,133$ 1,187$ % margin 8.8% 9.2% 8.5% 8.6% 8.6% 9.7% 9.8% 9.9% 10.0%

Rent 399 395 391 391 410 419 419 419 419 Rent/store 60$ 59$ 59$ 60$ 60$ 60$ 60$ 60$

EBITDAR 1,239$ 1,213$ 1,162$ 1,179$ 1,221$ 1,445$ 1,500$ 1,552$ 1,606$ % margin 13.0% 13.6% 12.9% 12.9% 13.0% 13.6% 13.5% 13.6% 13.6%

EBITDA 840$ 818$ 771$ 788$ 811$ 1,026$ 1,081$ 1,133$ 1,187$ Capex (165) (140) (126) (126) (160) (140) (140) (140) (140)

EBITDA-Capex 675$ 678$ 646$ 662$ 652$ 886$ 941$ 993$ 1,047$ Cash interest (25) (3) (3) (2) (3) (3) (3) (3) (3) Cash taxes (211) (246) (238) (186) (223) (295) (312) (330) (349) Stock comp 19 20 19 20 19 19 19 19 19 Provision for inventory reserve31 43 41 41 41 41 41 41 41 Change in NWC (22) (23) 179 9 (56) 22 9 8 9 Acquisitions (30) (2) (109) (137) (103) - - - - Other (6) (12) (5) (5) (5) (5) (5) (5) (5)

FCF 431$ 456$ 530$ 400$ 322$ 666$ 691$ 725$ 760$ FCF excl. acquisitions 461$ 458$ 640$ 537$ 425$ 666$ 691$ 725$ 760$ FCF/share 3.06$ 3.61$ 4.48$ 3.46$ 2.83$ 5.85$ 6.07$ 6.36$ 6.67$

EBITDA 840$ 818$ 771$ 788$ 811$ 1,026$ 1,081$ 1,133$ 1,187$ D&A (186) (177) (167) (164) (168) (179) (186) (186) (186) Interest, net (20) (3) (5) (4) (5) (5) (5) (5) (5) Tax expense (211) (225) (215) (220) (223) (295) (312) (330) (349)

Adj. Net income 423$ 413$ 386$ 399$ 415$ 547$ 579$ 612$ 647$ Weighted avg shares - diluted141 126 118 116 114 114 114 114 114 Adj. EPS 3.00$ 3.27$ 3.26$ 3.44$ 3.64$ 4.81$ 5.08$ 5.38$ 5.69$

IB Equity Research

June 27, 2014

FY2005 FY2006 FY2007 FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 LTM Apr-14 FY2014 FY2015 FY2016 FY2017 FY2018

Stores 4,490 4,778 5,264 6,207 6,450 6,670 6,683 6,602 6,675 6,980

SalesNew VG h/w 503 1,074 1,669 1,860 1,757 1,720 1,612 1,333 1,730 1,926 1,823 2,005 2,005 2,005 2,005 New VG s/w 1,245 2,013 2,801 3,685 3,731 3,969 4,048 3,582 3,481 3,338 3,318 3,883 4,116 4,239 4,366 Used VG 808 1,316 1,587 2,027 2,394 2,470 2,620 2,431 2,330 2,360 2,520 2,822 2,963 3,111 3,267 Other 536 917 1,038 1,234 1,197 1,315 1,271 1,540 1,499 1,547 1,719 1,891 1,986 2,085 2,189

Consol 3,092 5,319 7,094 8,806 9,078 9,474 9,551 8,887 9,040 9,171 9,380 10,601 11,070 11,441 11,828

Gross ProfitNew VG h/w 31 77 108 113 114 125 114 102 177 201 170 150 150 150 150 New VG s/w 267 427 582 768 795 820 839 786 805 784 774 854 885 911 939 Used VG 383 652 772 975 1,121 1,141 1,221 1,170 1,094 1,122 1,247 1,383 1,422 1,462 1,503 Other 192 315 352 415 405 453 506 593 585 602 686 756 794 834 876

Consol 872 1,471 1,814 2,270 2,435 2,538 2,680 2,652 2,661 2,709 2,877 3,144 3,252 3,358 3,468

Sales MixNew VG h/w 16.3% 20.2% 23.5% 21.1% 19.3% 18.2% 16.9% 15.0% 19.1% 21.0% 19.4% 18.9% 18.1% 17.5% 17.0%New VG s/w 40.3% 37.8% 39.5% 41.8% 41.1% 41.9% 42.4% 40.3% 38.5% 36.4% 35.4% 36.6% 37.2% 37.1% 36.9%Used VG 26.1% 24.7% 22.4% 23.0% 26.4% 26.1% 27.4% 27.3% 25.8% 25.7% 26.9% 26.6% 26.8% 27.2% 27.6%Other 17.3% 17.2% 14.6% 14.0% 13.2% 13.9% 13.3% 17.3% 16.6% 16.9% 18.3% 17.8% 17.9% 18.2% 18.5%

Consol 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Sales GrowthNew VG h/w n/m 55.4% 11.5% (5.6%) (2.1%) (6.3%) (17.3%) 29.7% 57.0% 5.4% 10.0% – – –New VG s/w n/m 39.2% 31.6% 1.2% 6.4% 2.0% (11.5%) (2.8%) (6.1%) (4.7%) 17.0% 10.0% 7.0% 3.0%Used VG n/m 20.6% 27.7% 18.1% 3.2% 6.1% (7.2%) (4.1%) (1.0%) 8.2% 12.0% 5.0% 5.0% 5.0%Other n/m 13.2% 18.9% (3.0%) 9.9% (3.4%) 21.2% (2.7%) (2.4%) 14.7% 10.0% 5.0% 5.0% 5.0%

Consol n/m 33.4% 24.1% 3.1% 4.4% 0.8% (7.0%) 1.7% 4.8% 3.8% 13.0% 4.4% 3.4% 3.4%Comp store sales 11.9% 24.7% 12.3% (7.9%) 1.1% (2.1%) (8.0%) 3.8% 6.0%

Gross MarginNew VG h/w 6.1% 7.2% 6.5% 6.1% 6.5% 7.3% 7.0% 7.6% 10.2% 10.4% 9.3% 7.5% 7.5% 7.5% 7.5%New VG s/w 21.4% 21.2% 20.8% 20.9% 21.3% 20.7% 20.7% 21.9% 23.1% 23.5% 23.3% 22.0% 21.5% 21.5% 21.5%Used VG 47.4% 49.5% 48.7% 48.1% 46.8% 46.2% 46.6% 48.1% 47.0% 47.5% 49.5% 49.0% 48.0% 47.0% 46.0%Other 35.8% 34.4% 33.9% 33.6% 33.8% 34.4% 39.8% 38.5% 39.1% 38.9% 39.9% 40.0% 40.0% 40.0% 40.0%

Consol 28.2% 27.7% 25.6% 25.8% 26.8% 26.8% 28.1% 29.8% 29.4% 29.5% 30.7% 29.7% 29.4% 29.4% 29.3%

Gross Profit MixNew VG h/w 3.5% 5.2% 6.0% 5.0% 4.7% 4.9% 4.2% 3.8% 6.6% 7.4% 5.9% 4.8% 4.6% 4.5% 4.3%New VG s/w 30.6% 29.0% 32.1% 33.8% 32.7% 32.3% 31.3% 29.7% 30.3% 28.9% 26.9% 27.2% 27.2% 27.1% 27.1%Used VG 43.9% 44.3% 42.6% 42.9% 46.1% 44.9% 45.6% 44.1% 41.1% 41.4% 43.3% 44.0% 43.7% 43.5% 43.3%Other 22.0% 21.4% 19.4% 18.3% 16.6% 17.8% 18.9% 22.4% 22.0% 22.2% 23.8% 24.1% 24.4% 24.8% 25.3%

Consol 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

IB Equity Research

June 27, 2014

Public Equity CompsValuation Operating

Adj. EV/P/E P/FCF EBITDAR Dividend Sales SSS % LTM Margins LTM

Company FY2014 FY2015 FY2014 FY2014 Yield Stores Avg sq ft per sq ft FQ2 FQ3 FQ4 FQ1 GM EBITDAR FCF

GME 11.1x 8.4x 14.3x 6.2x 2.9% 6,980 1,400 938$ (0.6%) 0.3% (1.2%) (1.9%) 29.5% 12.9% 4.4%BBY 13.3x 11.8x 16.4x 6.1x 2.5% 1,963 27,880 769$ (10.7%) 20.5% 7.8% 5.8% 22.1% 6.6% 1.5%WMT (1) 14.5x 13.3x NM 8.1x 2.6% 10,359 98,551 467$ (0.3%) (0.3%) (0.4%) (0.1%) 24.8% 8.1% (0.1%)

(1) Store statistics exclude Sam's Club

Risk FactorsDigital FormatWhile an industry-wide shift toward digital copies of games is highly unlikely, a more conceivable risk to the thesis is that more consumers migrate toward digital formats. The latest NPD numbers suggest that there is, as yet, no immediate danger in the face of a strong software pipeline. Meanwhile, management is ably positioning the Company to be an active player in digital formats by touting the application of its rewards programs to that subset of customers.

Secular DeclineBears see GME as the next Circuit City, Blockbuster or RadioShack, an aging brick and mortar specialty retailer that will die at the hands of the behemoth online marketplace. The flaw in that logic is that gamers have heretofore shown themselves to generally be a distinct animal from other consumers of specialty electronics, as evidenced by the Company’s sustainable top-line development through both console and macroeconomic cycles. This is not to say that there might not be a latent effect pending, but such observations have thus far failed to manifest. For now, GME’s store network and brand ecosystem have allowed it to hold serve as it explores newer growth verticals.

Used Game Disruption (WalMart effect)WalMart’s deft management of supply chain and powerful competitiveness will likely scare some shareholders off, but the truth is that any Big Box retailer lacks the network capability to hit the high dollar gamer markets in the same manner as GameStop. Square footage per store associate is 10x higher in a Big Box format vs. GameStop such that it is unlikely for gamers to have the same meaningful and efficient customer experience. Moreover, GameStop has the distinct advantage of having to only worry about a narrow (niche) category of inventory to effectively manage within overall working capital needs.

ConclusionGameStop is a nimble specialty retailer that has mastered the ability to effectively deploy capital into both real estate and inventory (the two critical assets on or off any retailer’s balance sheet), and in turn return capital to its shareholders. While the shares remain elevated from their 2010-2012 levels, valuations are definitively attractive ahead of a full new software calendar that should beneficially hit multiple parts of the P&L (notably, an extension of the trade-in phase to the console cycle). The Tech Brands segment is still de minimis, but management has outlined an ambitious, albeit achievable, store plan to make this vertical a credible aspect of the future company. In the interim, we are confident in the Company’s near-term ability to add further channels (buying from liquidation closeouts and retailer inventory purges) to bolster its flagship video game business.