GameStop (NASDAQ: GME) stock slumped today after earnings, tracking at just above $18 a share during Friday morning trading. That’s nearly a -10% drop since Wednesday, and an almost -34% drop from their $28.52 high in the past year. What happened?
Well as for GameStop earnings, it all comes down to a single penny. GME missed earnings projections for their second quarter, which ended on July 31, by just one cent. Analysts were predicting $1.82 billion in sales and a rise of 27 cents a share in earnings. But despite the shortfall, Gamestop reported $1.8 billion in sales and earnings that rose +4.2% over last year.
The recent troubles of GameStop prompt fears among some investors that GME Gamestop is on track to be the Blockbuster of the game industry. That is, an old entertainment business model that worked really well before the digital shift sunk it.
Gamestop has added 99 new stores during 2010, bringing its total number of stores up to 6,549 over 17 countries, and while the company’s sales and profits are up, it’s questionable how long Gamestop can hold onto their piece of the video game space with the emergence of digital markets. Physical video game sales account for nearly all of Gamestop’s revenue, and 31.4 percent of those sales are of used products. Gamestop is able to pull in $2.8 billion, as they did in the first quarter of 2010, thanks largely to their retaining all profits made on used game sales.
How can Gamestop keep their used game business alive when customers stop buying physical copies of games though? A July report from Ipsos MediaCT found that 64% of video game shoppers preferred physical discs of the games they buy, a surprisingly low number considering that digital distribution of home console games has only been a market factor for five years. The number is doubly discouraging considering Ipsos MediaCT director Ian Bramley’s conclusion that customers only find value in a physical game’s resale value. “I believe the preference for physical discs amongst next gen gamers reflects the potential value they derive from the pre-owned market, which is holding up the preference for physical.” In other words, Gamestop’s business model is keeping itself on life support as the games market moves towards digital distribution.
An unnamed PiperJaffray analyst also sees a troubled future for the brick-and-mortar Gamestop business. In a report filed after Gamestop’s second quarter earnings were announced, the analyst wrote, “We expect the swift shift from off-line to on-line digital entertainment will continue as the current video game cycle continues to decline during the next few years. In our opinion, industry-wide packaged goods game sales peaked during 2008 and GameStop’s ability to continue to take domestic share has become more difficult – company is already over-stored.”
Gamestop has been making efforts to diversify. The Grapevine, Texas company acquired web-based gaming outlet Kongregate in an effort to broaden its digital initiatives. While Gamestop’s stewardship of Kongregate only began on August 1, though PiperJaffray’s analyst doesn’t see much hope in the new strategy. “The recent acquisition of a social gaming company makes little sense to us and actually clouds our view of forward strategy. Although GME valuation and cash flow characteristics look attractive, we find it difficult to recommend a business in which we see little long-term earnings growth …The company’s digital initiatives are sketchy, but we expect the company will try multiple efforts to take share.”
Gamestop may still have a stellar 2010. With Microsoft (NASDAQ: MSFT) launching their new motion control device, Kinect, this fall, it’s possible that this holiday season will be marked by a phenomenon comparable to the Nintendo (PINK: NTDOY) Wii. Even then, though, the success of new hardware this year will only act as a band-aid on a mortal wound for a business that needs physical media to survive.
As of this writing, Anthony Agnello did not own a position in any of the stocks named here.
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