The soon to be launched new video game consoles from Microsoft Corporation (NASDAQ: MSFT) and Sony Corporation (ADR) (NYSE:SNE) should provide a nice sales and traffic boost for retailers such as Best Buy Co., Inc. (NYSE: BBY).
Sony will be releasing its PlayStation 4 video game console on Nov. 15 with a retail price of $399, while Microsoft's Xbox One will hit the market on Nov. 22 with a retail price of $499.
Prior console launch volumes were somewhat subdued for a couple reasons, which led to slower initial traction from the release for a retailer like Best Buy. Notably, there were shortages of certain components for the Xbox 360 at launch, which restrained its initial uptake.
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"We think the upcoming console refresh cycle will exceed volumes achieved during the seventh generation launch (though, some supply might be constrained at the outset to create additional "buzz" from the scarcity)," UBS analyst Michael Lasser wrote in a note to clients.
Both Sony and Microsoft have become better at predicting consumer demand, which should lead to a better supply / demand match this time around. Sony is targeting to sell 5 million PS4 units between its November 15th U.S. launch date and the end of the company's fiscal year on March 31st. Microsoft expects to sell 1 billion units over the next five years.
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For Best Buy, the stabilization of its domestic entertainment business is key for driving comp. Best Buy's domestic entertainment division includes video gaming hardware and software, DVDs, Blue-rays, CD's, digital downloads, and computer software.
While the segment only accounted for 12 percent of its fiscal 2013 total domestic revenue, it declined at a 16 percent CAGR from fiscal 2009 through fiscal 2013, accounting for about an average of 180-200 basis points (bps) of the company's total domestic comp decline over the last three years.
"Assuming that the gaming category achieves a 30 percent growth rate & BBY can sustain its ~17% market share, it should contribute 150 bps–200 bps to its domestic comp in the next several Qs," Lasser noted.
For the fourth quarter, Best Buy is expected to generate 16 percent growth in new video console and game sales growth. If Best Buy holds share, there should be about 145bps benefit to its fourth quarter comparable sales from video games. If Best Buy achieves 20 percent in total video game market share, it would see a 300bps benefit to its comps.
Best Buy is well positioned to capture more than its historic share of the gaming market. Its closer relationship with Microsoft means that it is in a better spot to get a preferential inventory allocation. Plus, its improved operational efficiency should give the vendors greater comfort that it will manage its allocation well.
While consoles have a margin rate that is well below Best Buy's average, software is closer to the mean. Thus, the profitability impact will depend in part on the company's ability to cross-sell accessories, warranties, and other products to the hearty traffic that should result from the gaming resurgence.
"Using our sales estimates from the analysis shown above, we estimate FY'14 video game hardware and new software sales of $2.4B for BBY. Assuming a 5% gross margin on the hardware sales and 18% on software sales, this leads to a gross margin rate of 12%, well below the company average," Lasser said.
That said, the excitement surrounding the new video game console launches is going to be a significant driver of traffic, and Best Buy is well positioned to cross-sell higher margin products. The obvious add-on would be video game accessory products (controllers, memory cards, headsets, etc.), which carry much more attractive gross margin rates at around 30 percent.
"We assume a 30% attachment rate for video game accessories and hardware sales. This alone raises the gross margin rate from 12% to 15%. Further, the gross profit contribution from BBY's total gaming (incl. hardware, software, and game accessories) business, should more than triple from 2013 to 2014," Lasser added.