* UK video gaming retail sales set to slow after record yr
* Game Group's low rating makes its vulnerable to bid
* GameStop of U.S. seen as likely suitor
By James Davey
LONDON, March 25 (Reuters) - Investors willing to take a bet on UK equities could do worse than the retail video gaming niche, where bombed-out valuations have made it a top tip as the next hotspot for consolidation.
Last year sales of video games hardware, software and accessories hit record levels while the rest of the UK retail sector succumbed to the economic downturn.
Yet market leader Game Group Plc, which trades from more than 1,340 outlets in nine European countries and Australia, has one of the lowest price to earnings ratios of the companies that make up the FTSE All Share General Retailers Index.
With manufacturers Sony Corp, Microsoft Corp and Nintendo Co Ltd unlikely to launch new generation consoles to replace Playstation 3, Xbox 360 and Wii, respectively, before 2011, gaming retailers' sales growth looks set to go into reverse.
Analysts think specialist retailers such as Game and HMV Group Plc may have to cut costs, curtail physical expansion plans and shift further and quicker to the Internet to limit any damage to profits.
Slower growth may also drive consolidation, with U.S. giant GameStop Corp seen as a possible suitor for Game, which trades on a prospective price earnings ratio of just 5.7 times, compared with a sector average of 10.7 times.
Shares in Game, which have lost a quarter of their value over the last three months, closed on Tuesday at 144.25 pence, valuing the business at 519 million pounds ($755.3 million).
"If profits hold on, I'm sure Game will get re-rated. If they don't, they'll get taken over by GameStop. It looks a great each-way bet to me," said Nick Bubb, analyst at Pali International.
2008 A VINTAGE YEAR FOR GAMING
Sales of games, hardware and accessories increased 23 percent to a record 4.03 billion pounds in 2008, according to the Entertainment and Leisure Software Publishers Association (ELSPA), outselling music and other video products for the first time and making them Britain's number one form of entertainment.
For the year to end-January 2009, Game, which has about a third of the UK video gaming market, is expected to achieve a 39 percent increase in pretax profit to 124 million pounds, according to a consensus of analysts' forecasts on Reuters Estimates. But profit is forecast to fall to 107 million pounds in the following year.
Despite the expected fall in profits, analysts at Numis Securities reckon Game "offers stand-out value".
They forecast Game's like-for-like sales will fall 7 percent and 10 percent in the years to end-January 2010 and 2011 as the gaming cycle turns, but they expect gross profit margins to improve 1 percentage point per year as its product mix moves to more profitable software.
"We also believe that an unprecedented third generation console line-up and a wider acceptance of gaming leave the group in a robust position as the gaming cycle moves into its software phase," they said in a research note.
Game, along with HMV, Home Retail Group Plc's Argos and the supermarket chains, will also benefit from the recent demise of Woolworths Group Plc and Zavvi, which has left a tenth of the UK retail video gaming market up for grabs.
David Stoddart, analyst at Altium Securities, recently upgraded his stance on Game to 'buy', because although he reckons it should trade at a discount to the sector, given the threat posed by the Internet, he believes the current discount is exaggerated for a company with net cash of over 40 million pounds. (Editing by Will Waterman)