Questions Remain on Merger of Electronics Boutique and GameStop

Analysts were surprised by the announcement but agreed the merger would give the combined company a stronger position in the videogame market, in time for launches of next-generation game consoles later this year and in 2006. Harris Nesbitt analyst said he was surprised by “the actual announcement” but not “that they were considering merging.” Wedbush Morgan Securities analyst Michael Pachter said the deal seemed to surprise EB executives as much as it did him. Noting that EB CEO Jeffrey Griffiths and CFO James Smith sold off thousands of shares of EB stock March 28 at only about $44 and $45 per share, Pachter said “if they knew about the merger, they would have waited” but EB didn’t respond to a request for comment by our deadline.

Shares in both companies jumped after the announcement Mon. In late afternoon trading, EB shares were up 32.51% at $54.49 while GameStop shares were up a more modest 8.70% at $23.49.

Questions left hanging Mon. were what roles Griffiths, Smith and other EB executives will have in the combined company, and how many stores will close as a result of the merger. GameStop Chmn. Richard Fontaine told analysts in a conference call “we certainly think there’s going to be a role for all these people” but “exactly what it is and what position is yet to be determined.” However, he said, “it’s my intention to keep as much -- if not all -- of the talent” in the combined company “as we have right now.”

The companies said that after the merger Fontaine will remain in his existing roles; GameStop COO-Vice Chmn. Daniel DeMatteo will keep his titles as well. The companies said “other key positions are under discussion and will be announced as the integration process moves forward.”

GameStop CFO David Carlson said the number of new store openings probably will drop this year compared with what each company had planned -- domestically, anyway. But Fontaine said the number of U.S. store closings “won’t be dramatic.” He stressed that it’s “still going to be a rapid growth company,” especially abroad, predicting “tremendous international opportunities.” Fontaine said decisions about U.S. store closings will be based partly on lease schedules; about 52 stores’ contracts soon face renewal. But he indicated that even if EB and GameStop stores are in the same mall, closings won’t be automatic. In some cases there’s room for 2 videogame retailers in the same development, he said. “Both companies have been successful” despite the growth in store openings for each over the past few years, Fontaine said.

Also unclear was whether all stores eventually will be named GameStop. “I don’t anticipate any significant branding changes per se” this year and any name changes on stores there are “will begin to roll out in 2006,” Fontaine said. He said store branding isn’t “an immediate priority.”

Fontaine said “this is a great time to bring these 2 companies together” -- with the industry on the brink of more growth, the impending arrival of new game systems and each firm fiscally robust. The merger is being made “from a position of strength” and it “will enable us to enter new international markets and allow us to compete more effectively in the highly competitive U.S. videogame industry,” he said.

EB has grown substantially over the past few years, Fontaine said, noting that GameStop -- “laser focused” on U.S. growth -- has lagged overseas. The combined company will have stores in all 50 U.S. states, Washington, D.C., Puerto Rico, Australia, Canada, Denmark, Germany, Ireland, Italy, New Zealand, Norway and Sweden.

Griffiths said the merger was in “the best interests of both of our companies” and will allow the combined company to be “very well positioned” for future growth. He said the merger “makes a tremendous amount of sense from an operational, cultural, and synergistic perspective.” Griffiths said his company “will now be in an even better position to broaden our reach and generate further efficiencies for our business and our customers.”

Asked if the combined company will consider buying U.K. retail chain Game Group, Fontaine declined to comment specifically but said “if there is an opportunity we will continue to stay open” to them. Game Group recently revealed it was “in discussions which may or may not lead to an offer for the company” (CED April 8 p4). After a long legal battle, EB had ended a services agreement with Game Group in the U.K.

In 2000, when GameStop was still owned by Barnes & Noble, it battled EB to buy U.S. used game retailer Funco. GameStop eventually won that battle but since then both companies have built up strong used game businesses. Neither, however, break out used product results from their new product sales.

As part of the merger deal, EB shareholders will get $38.15 cash, plus the equivalent of 0.78795 shares of GameStop Class A common stock for each share of EB stock. Based on the closing price of GameStop’s Class A common stock of $21.61 April 15, the stock component of the per share merger consideration is $17.03. The total merger consideration per share of $55.18 represents a 34.2% premium to the closing price of EB’s stock April 15, the companies said. GameStop intends to fund the cash portion of the transaction via the issuance of $950 million in senior bonds and excess cash.

The merger is “expected to be significantly accretive to GameStop’s fully diluted earnings per share in the 2nd half of fiscal 2005,” as well as fiscal 2006 and beyond, the companies said. The combined company expects to realize “meaningful pre-tax synergies beginning in fiscal year 2006,” they said, noting that both firms’ boards unanimously approved the deal.

But the companies said the merger is “subject to approval by the shareholders of GameStop and Electronics Boutique, clearance under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, and other customary closing conditions.” James Kim and affiliates, who own about 47% of EB’s voting shares, and Leonard Riggio and affiliates, owners of about 16% of GameStop’s voting power, each agreed to vote their shares in favor of the transaction, the companies said.

In an SEC filing late last week, GameStop said Fontaine will be paid a $598,500 bonus for fiscal 2004 while DeMatteo will get a $493,500 bonus. The filing also said their base fiscal 2005 salaries will be $650,000 and $535,000, respectively.