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Microsoft said Friday it had hired a veteran
Wal-Mart executive, David Porter, to oversee the development
of brick-and-mortar retail stores. He will report to Kevin
Turner, Microsoft's COO, who also has ties to Bentonville.
Apple changed computer marketing with its hip
advertising. It changed the computer market with its nifty
devices, and it changed the computer marketplace with its
stores. Microsoft sees the writing on the wall, and these
hires underscore how serious Microsoft is about regaining
any of the ground it has lost to Apple. Porter and Turner
aren't show horses -- they're work horses. Wal-Mart executives
get things done fast and cheap, and they never lose focus on
the customer. That core competency will be vital to
Microsoft's retail execution. Here are four reasons I think
Porter's first step will be to engineer a merger with
software retailer GameStop (NYSE: GME).
1.
Microsoft Is Always on the Hunt for Deals.
Though the ill-fated Yahoo merger is the most well known,
Microsoft has put its vast cash hoard to work by acquiring
companies that have something it needs. Over the past two
years, MSFT's shopping cart has been loaded with search,
voice and advertising technology. Certainly Microsoft has
the human capital to develop new technologies on its own,
but it's cheaper -- and far faster -- to simply buy it. The
same is true with its stores.
And the fact is, Microsoft can quite literally buy anything it
wants. The Redmond company is one of seven U.S.
corporations to have a triple-A credit rating. It has cash
on hand totaling $8.3 billion, and it has no long-term debt.
2. GameStop Has a Huge Footprint.
GameStop has an international presence that
includes 5,264 stores. GameStop's stores tend to be in urban
areas, in shopping centers and strip malls. These aren't
destination stores like Wal-Mart; they are located where
people already eat, shop and work. This is precisely where
Microsoft will seek to extend its reach and build its brand.
A GameStop deal would give Microsoft an instant competitive
advantage over Apple, which has only 250 stores. Many of
GameStop locations are near existing Apple
stores.
3. GameStop Is Cheap.
GME is trading for only 12 times
earnings. As the chart shows, that's near the ebb. GME's two-year average earnings multiple is
27.
Though a dramatically reduced P/E usually signals concerns about
future earnings, GameStop doesn't have that worry.
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Sales continue to be brisk. It even did well
during the holidays, posting sales increases most
retailers would have killed for. GameStop's EPS has
never declined, and even in the current economic
climate, earnings are forecast to rise.
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4. GameStop Stores Meet Microsoft's Needs..
GME's relatively small stores -- already clean and well-lit -- are
ideal for Microsoft. They're less than crowded and could
easily make room for Microsoft products, display kiosks and
demonstration models. Maximizing store efficiency is
something that Porter and Turner learned at Wal-Mart, which
tracks revenue by square inch of shelf space. What's more,
GameStop existing staff would gel nicely. They tend to be
avid computer users, fluent in the lingo and up on the
latest products.
GameStop Will be Acquired at a Premium..
The vast majority of these shares are held by institutions, who
have held on through GME's -46% decline in the past year and
are unlikely to approve a merger that doesn't help make them
whole, especially from a company that absolutely can afford
to pay. GME's current market capitalization is roughly $4.3
billion. Microsoft would be getting a steal at $10 billion
-- the footprint it wants and a business that produces tons
of cash without any debt and doesn't have to burn cash to
develop products. An acquisition at $45 a share would
represent a +70% premium and still value the company at less
than its historical valuation.
Think that's too rich of a premium for GameStop? Consider:
Microsoft offered $31 a share for Yahoo last year when its
shares were trading at $19.18. Yahoo rejected the +61.6%
premium as too low, and after one of the strangest
negotiations in corporate history, Microsoft raised its
offer to $33 -- +72% over Yahoo's pre-merger offer price.
A Microsoft-GameStop deal makes sense financially for GME, MSFT
and investors. It achieves overnight a footprint that
otherwise would take years to build. And it marries two
compatible cultures: Apple users aren't gamers, but Windows
users are.
Here are the two ways you can play this,
depending on your risk tolerance:
1. Go Long.
Buy GameStop and hope for a takeover announcement that
includes a rich premium.
The upside: It happens and the stock skyrockets to the
takeover price.
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The downside: The
merger doesn't go through. What then? Well, it's not exactly
bleak! All that happens is you will own shares of a
successful earnings machine that you bought cheap yet is
continuing to post ever-improving results.
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2. Position Yourself for Huge Gains with Call Options.
A call option gives an investor the right to buy a stock for a
certain price during a certain time. A July 30 GME call
would allow its holder to buy GameStop for $30 a share until
July 18. If the price goes above that, the call will gain in
value. It can be sold to capture the gain, or it can be
exercised to buy the stock, which could then be resold for a
gain.
So assuming an investor were willing to bet on a $45 takeover
price, then an out-of-the-money call might suit his fancy. Here are Friday's prices of GameStop calls with a $30 strike
price:
|
Expiration |
Price |
100 Shares |
Downside |
Gain at $45 |
| 21 March |
$0.90 |
$90.00 |
$90.00 |
+1,900% |
| 21 April |
$1.70 |
$170.00 |
$170.00 |
+782% |
| 18 July |
$2.90 |
$290.00 |
$290.00 |
+417% |
As you can see, the upside is phenomenal and the
downside is modest. The question, of course, is timing. If the deal doesn't go through, the only chance you
have of coming out ahead is a +15% rally in GameStop shares
for an unrelated reason.
Is that possible? Sure. So is a merger. As to the degree of
likelihood and to whether it's a good investment for you
depends entirely on your risk profile.
-- Andy Obermueller
Co-editor
StreetAuthority Investor Update
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