Yes, GameStop Corp. (GME) Should Worry About Game Pass

A couple of weeks ago, Microsoft Corporation (NASDAQ:MSFT) dropped a bomb on video game retailer GameStop Corp. (NYSE:GME), announcing a subscription-based service that allows Xbox owners access to more than 100 games at a time, all for $9.99 per month. No need to make the trip to GameStop — just download and play it.

Yes, GameStop Corp. (GME) Should Worry About Game Pass

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GameStop stock slid a total of 8% in response to the introduction of the so-called Game Pass. Already under pressure from the advent of downloadable games, an organized, robust service that offers a huge library of games for a nominal price could post serious trouble for the retailer.

Microsoft eventually put a band-aid on the wound, making a point of saying a day later that it intends to work with GameStop rather than work around it. The gauntlet’s been thrown down, though, and this is a battle GameStop going to lose sooner or later.

Introducing Game Pass

It’s been described as the Netflix, Inc. (NASDAQ:NFLX) of video games, meaning for one monthly fee a gamer can play any of several titles available at the time. Microsoft said the service will include some of its hottest titles, too, including Halo 5 and NBA 2K16. Presumably, those available games will rotate, the same way Netflix’s content changes every month or so. Once a game is rotated out of the library, it’s no longer playable, unless …

The detail that should have GME stock holders worried: If an Xbox One owner likes a game well enough to buy it permanently, subscribers will be given a 20% discount on that game’s regular retail price. It’s a lease-to-own deal that could leave many consumers wondering what purpose a video game shop serves.

GameStop will be selling access to Game Pass … a measure of goodwill from Microsoft to GameStop that’s as pointless as it sounds.

All Big Change Starts Small

Microsoft tried to downplay the adverse impact the new initiative may have on GameStop’s business, but there’s no way of denying this is the shape of things to come. And it’s only going to get worse.

Not everyone sees it that way. Mizuho Securities analyst San Phan is one of those observers that’s not terribly concerned, recently commenting:

“Most of the used games we saw from Game Pass can be purchased used from GameStop for $5-$25 which we think generally remains a better value for players. Subscribers do not own the games they download from the subscription service and could theoretically lose access to a game they are playing if it was rotated out of the catalog unless they buy it outright.”

Phan went on to point out how when Sony Corp (ADR) (NYSE:SNE) developed a similar game-rental service in 2015, it didn’t do much damage to GameStop’s business. A comparable product from Electronic Arts Inc. (NASDAQ:EA) doesn’t seem to have been a problem for GME stock either.

Baird analyst Colin Sebastian sees it differently, responding to the news by noting:

“While the Xbox Game Pass program has been in development for some time, and is a logical extension of the platform’s Games with Gold service (which offers a selection of free downloads each month for Xbox Live Gold members), we believe that it further raises the risk profile for GameStop.”

Both analysts — and several others — make good points in support of both sides of the argument. Sebastian and the other “con” crowd, though, seem to have an appreciation for the trajectory of Game Pass, and the other game-makers like Nintendo Co., Ltd (ADR) (OTCMKTS:NTDOY) that will certainly follow suit, if Microsoft proves the premise. The threat isn’t where Game Pass is today. The threat lies in the potential of where digital rentals and easy (and discounted) digital purchases will be five years from now.

Example: The cord-cutting phenomenon Netflix started? It took years to get going, and it’s still got years to go before on-demand and online TV is the norm. Give Game Pass some time. The longer it stews, the more comfortable gamers will become with the whole idea.

Bottom Line for GME Stock

Don’t jump to the worst-case-scenario conclusion. GameStop can survive, even if its core business shifts from new games to used games, and to more non-game merchandise. The retailer’s been rather impressive with this shift already. It’s also worth mentioning the retailer’s margins on used goods is much better than it is on new merchandise.

On the flipside, the more traction downloadable games get, the less used merchandise GameStop will have to resell in the future.

Either way, with one less reason to step foot in its stores, GameStop needs to address this industry-wide paradigm shift, and fast. It may not be a measurable problem in 2017, but the VCR wasn’t a problem for BetaMax players when VHS machines were first unveiled in 1977 either.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

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