Death of a Retailer: GameStop’s Q2 Earnings Pave Way to Digital Future

But poor quarter for game companies resonated at GME

Despite many troubles, GameStop (NYSE:GME) might yet survive the death of physical media. The video game retailer reported its second-quarter earnings Thursday, and not all the news was good. Total sales came to $1.74 billion, a fall of more than 3% for the period. Profits dropped down to just below $31 million from $40 million during the same period last year.

As always, it was used video game products that accounted for the lion’s share of GameStop’s gross profits. Used video games and gaming machines sales totaled more than $292, generating 46% of the company’s profits. Chief executive Paul Reins said, “GameStop’s resilient retail model enabled us to achieve our earnings plan despite a challenging period for the industry.”

Challenging period indeed. The second quarter was rough for most players in the traditional video game field. Nintendo‘s (PINK:NTDOY) Nintendo 3DS crashed after a successful March release, Sony (NYSE:SNE) saw PlayStation 3 sales sink, and game publishers like Take-Two (NASDAQ:TTWO) saw earnings fall even with successful releases like L.A. Noire, a title GameStop singled out as one of its bestsellers for the period. These companies are GameStop’s business, and their poor sales mean trouble for GameStop’s future.

There is a major silver lining in the company’s earnings report, however — GameStop is growing its digital games business. One reason those game device makers and game publishers are hurting is the growing prominence of low-cost mobile and social games accessible on smartphones and web browsers. GameStop has been pushing hard to evolve its business beyond its brick and mortar stores to accommodate the new digital market.

GameStop has opened new stores that push digital content alongside retail products and has made a number of high-profile acquisitions to give itself a foothold in the space, including the independent games website Kongregate. The effort is paying off. Digital sales grew 69% over the second quarter. The company’s “other” reporting category, which includes digital products, racked up sales of $98 million and accounted for nearly 42% of the company’s profits.

Will digital content see GameStop return to the massive profits and huge share prices it enjoyed back in 2008? Probably not, but the company has at least proven that it won’t die alongside the disk-based video game.

The chain isn’t slowing down, either. A Friday report at Games said GameStop currently is testing a new cloud-based gaming service that will stream PC, PlayStation 3 and Microsoft (NASDAQ:MSFT) Xbox 360 games to audiences without them having to purchase the games themselves. Think of it as Netflix (NASDAQ:NFLX) but for video games.

This is similar to existing services like OnLive that have proven viable if not yet profitable. Spawn Labs, a streaming technology company GameStop acquired in April, is developing the service. Although it hasn’t detailed pricing yet, GameStop expects to open the service for business during the first half of 2012.

This is how GameStop will survive the death of physical media — by transforming from a retailer into a service company. Will it survive as a major publicly traded company? Check back in 2015.

As of this writing, Anthony John Agnello did not own a position in any of the stocks named here. Follow him on Twitter at @ajohnagnello and become a fan of InvestorPlace on Facebook.

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