When Electronic Arts Inc. (NASDAQ:EA) released its quarterly results last month, the market reacted positively — EA is now at five-year highs. But the good news for the video game publisher had the opposite effect for retailer GameStop Corp. (NYSE:GME).
GME stock immediately began to slide, losing nearly 8% over the next few days before eventually gaining about half of that back. What’s good for video game publishers isn’t always good for GameStop, especially when it comes to digital content.
That EA earnings report noted that for the first time, EA’s digital revenue for 2014 surpassed physical sales. And that’s bad news for a retailer like GME, which depends on selling (and reselling) games.
GameStop and GME investors are spooked by the prospect of a video game industry that’s increasingly going digital.
GME Stock: Vulnerable to Digital Sales
Video game publishers love the idea of going digital. Having customers download their games instead of buying physical discs saves the publisher on many fronts. (Say good-bye to printing, packaging and transportation costs.) If a game doesn’t do as well as expected, there’s no warehouse full of unsold inventory.
It’s also not lost on publishers that they don’t have to lose a big cut of the sale price to a retailer like GameStop.
EA makes console game titles available as digital downloads, sells expansion packs for those games digitally, operates its own digital storefront for PC video games (currently with 468 titles to choose from) and over the holiday quarter counted 160 million active monthly users for its mobile games — those smartphone and tablet titles also bypass GameStop’s cash registers.
Video game retailers, such as GME, fear the digital future because it makes most of its money selling physical copies of video games. New, used, disc or cartridge, the stores are dedicated to games — unlike Wal-Mart Stores, Inc. (NYSE:WMT) that typically stocks the current releases, a small collection of best-sellers and a discount bin.
When games go to digital downloads, not only do the discs disappear from GameStop shelves, but the secondary market of selling used games goes with it.
In its most recent earnings report, GME booked $1.7 billion in new and used game sales. That’s roughly 58% of total earnings.
GME also sells hardware (the video game consoles themselves plus accessories), and at $1 billion for the quarter, that’s far from chump change. However, video game consoles and accessories is not a big growth segment — Microsoft Corporation (NASDAQ:MSFT) and Sony Corp (ADR) (NYSE:SNE) would consider the Xbox One and PlayStation 4 successes if they end up matching the overall sales numbers the previous generation consoles racked up.
GME Stock: Investors React
GameStop investors recognize the threat the move to digital gaming poses to the retailer’s business. You can see this in action when looking at the movement of GameStop stock.
Remember in January 2012 when rumors started flying that the Xbox One wouldn’t support playing used games? That was followed by speculation the Xbox One may not even have an optical drive (meaning all digital downloads). That period of uncertainty kicked of a GME slide that shaved 31% off GameStop stock over the next six months.
In a more recent example, Electronic Arts’ announcement last July that it was launching the EA Access digital games subscription service on Xbox One quickly knocked 7% off GME stock.
The current GameStop stock drop is just the latest in a series of fluctuations tied to digital gaming developments.
GameStop is making money from digital video games — but it’s not by actually selling the games (at least not directly) and it’s definitely nowhere near enough to replace the revenue it stands to lose from selling discs.
GameStop says it collected $53.2 million in revenue from digital sales over the holiday quarter. However, most of those “digital” sales were actually plastic cards — Xbox Live points, Xbox memberships and PlayStation Store cards. The same cards you can pick up in virtually any corner store, grocery store or department store (and frequently at a discount).
Fortunately for GameStop, Electronic Arts is slightly ahead of the pack when it comes to digital video game sales.
EA may have seen digital revenue surpass physical sales in 2014, but Re-Code points out that other video game publishers are still playing catch-up. Activision Blizzard, Inc. (NASDAQ:ATVI) reported 46% of last year’s sales were digital, while Take-Two Interactive Software, Inc (NASDAQ:TTWO) said digital accounted for just 22% of its 2014 sales.
The Bottom Line
The disc-equipped PlayStation 4, Xbox One and Nintendo Co. Wii U should be good for another five or six years before their replacements arrive. But that next generation of video game consoles is more likely than ever to go all-in on digital. If so, that means GME has a half decade at best to figure out how to survive in a digital gaming world.
During that time, it could be a wild ride — expect GameStop stock to reflect every milestone, rumor and announcement about the industry moving away from discs.
As of this writing, Brad Moon did not hold a position in any of the aforementioned securities.
