GameStop Corp. Is Running Out of Lives in Digital Revolution

GME stock’s earnings beat wasn’t quite what bulls would have you believe

By Laura Hoy, InvestorPlace Contributor

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This year video game retailer GameStop Corp. (NYSE:GME) has been struggling to fight back against the digital revolution. Worries that the firm’s core business — selling video games — will be eroded down to nothing by the growing popularity of buying and downloading video games online have pushed GME stock to multiyear lows. However, brighter-than-expected third-quarter results have given some investors hope. And they’ve allowed GameStop stock to rise 6.6% over the past month.

GME Stock Beats the Bears

GME bulls were pleased to see that the company’s sales increased in the third quarter and same-store sales maintained a modest 1.9% growth pace. Management’s forward guidance for the upcoming holiday shopping season wasn’t bad either. The company is expecting to see strong smartphone sales. There’s also a lot of excitement about new consoles and big game releases. With that in mind, management raised its 2017 outlook. The news helped boost GME stock higher and prompted a wave of positive press surrounding the stock.

Don’t get me wrong. I commend GME for producing such strong results while fighting against so many strong headwinds. However, I don’t think it will last. Investors who buy GME thinking a comeback is building momentum may find themselves sorely disappointed in just a few months.

Yes, sales increased for GameStop. But operating profit bombed. This is because the sales rise came largely from low-margin hardware, new software and collectibles. GME makes a lot of its money from pre-owned sales. This part of the business saw a decline in the third quarter. Digital sales were also lackluster, suggesting that the firm is struggling to keep up with the digital revolution.

Digital Trouble for GME Stock

It’s impossible to ignore the elephant in the room for GME stock: online game downloads. The company isn’t doing enough to fight against, or at least somehow join in on this trend. As InvestorPlace contributor James Bromley pointed out earlier this week, most expect video game sales to switch to digital almost completely within years.

Electronic Arts Inc. (NASDAQ:EA) said it believes 40% of games played on devices like Xbox and Playstation will be downloaded rather than purchased in a physical store location. Analysts at Piper Jaffray believe that around 80% of the gaming industry’s revenue will come from downloads in just a few years.

Downloads eliminate the need for middle-man retailers, so it’s hard to see exactly where a brick-and-mortar store like GameStop will fit into that equation.

InvestorPlace contributor Dana Blankenhorn believes GME will sputter along by catering to younger gamers who are just starting to get into the world of gaming. And Luke Lango pointed to the firm’s consoles and accessories business as a way for the company to move forward.

However, as I mentioned in an earlier article, building out all of GameStop’s other bets like mobile sales, plush toys and collectibles takes time and money — two things the retailer is short on. Sales of hardware may be up but that’s GME’s least profitable segment. Not only that, but foot traffic in GameStop stores appears to be on the decline. It remains to be seen exactly how the store plans to revamp its offerings and create new revenue streams.

Bottom Line on GME Stock

I likened GME’s efforts to coax customers back to buying their videos the old-fashioned way to that of failed video rental business Blockbuster. Bromley compared GameStop’s struggles to those of Eastman Kodak Company (NYSE:KODK) when digital cameras first came on the scene. Both firms watched new technology transform their industry, but continued to push forward with a product that was on the way out.

There is a chance that GameStop will be able to change its business and find a way to thrive as gaming goes digital. But with the way the company looks right now, that chance appears slim.

At the moment, it looks like GME is backed into a corner. Although the firm is coming out swinging, I don’t see much hope for the firm’s future. At very least, I’d wait to see what the fourth quarter holds before cheering third-quarter results as evidence of a turnaround.

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

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