Why GameStop Corp. Is at a Tipping Point (And Not in a Good Way)

Kudos to GameStop Corp. (NYSE:GME). Against a brutal headwind that’s driven GME stock from $56 per share in late-2013 to its current price near $19, the video game retailer has found a way to at least maintain the top and bottom lines, even if not grow them.

It’s almost enough to make one think GME stock is a buy here at a multi-year low. Don’t be fooled though. GameStop has thrown everything but the kitchen sink at its primary, growing problem, but is still very much on the defensive.

That problem is, of course, the increasing preference from gamers to download video games rather than purchase them on a disk (or in the old days, a cartridge). This challenge, which bypasses game-retailing middlemen, has grown in 2017 and may well be at a tipping point that finally forces GameStop into retreat.

At the Tipping Point

During its third quarter earnings call hosted in early October, the top brass at Electronic Arts Inc. (NASDAQ:EA) voiced an outlook most observers who know how the video gaming industry has changed in recent years more or less had to agree with.

The outlook? That by the time 2017 comes to a close, 40% of games designed to be played on consoles like the Xbox and Playstation from Microsoft Corporation (NASDAQ:MSFT) and Sony Corp (ADR) (NYSE:SNE), respectively, will be downloaded via the internet rather than purchased in physical form at a brick and mortar store.

It’s a shocking prognostication to be sure, though not one that’s tough to believe.

To be clear, this wasn’t a look at game downloads plus all the other add-on, in-game purchases a player can make to enhance game play. From that perspective, downloaded digital content sales already surpassed sales of physical disks in 2013, and have widened that difference every year since.

Digital-market tracking NPD estimates that last year the industry sold $18.1 billion worth of digital content including in-game tools like maps, weapons and the like, but only $6.4 billion worth of games in a physical format. Nevertheless, the trend is alarming to say the least.

As Piper Jaffray analyst Michael Olson cautioned late last month, downloads will make up between 70% and 80% of the industry’s revenue within “a few years,” up from the 40% he also estimates are downloaded rather than bought in a store right now.

That’s just too much resistance for GameStop to overcome.

Fans and followers of GameStop, and presumably owners of GME stock, will argue that if the trend hasn’t taken a painful toll on the company yet, that may be because it’s not going to happen. And in a superficial sense, that’s not a bad argument.

Take a look at what GameStop has done to offset the paradigm shift that favors downloads over disks though. Regular visitors to its stores will notice there’s a lot more non-game retail going on, with the company making a more serious push of toys, game-related merchandise, and even cell phone plans from Net10.

These initiatives have only created a revenue-neutral benefit, however, and game downloads themselves are not even at the halfway point. Soon, the game retailer is going to run out of new non-game merchandise to sell without confusing its customer base. That is the long-term problem for GME stock.

Bottom Line for GME Stock

Perhaps the most dangerous aspect of this shift towards more downloads and waning purchases of physical disks is that it’s happening so slowly, at times it may seem like the company is holding up against the onslaught.

Don’t be fooled though. This is an uphill battle that will never not be uphill again as long as the GameStop we know and recognize today persists.

It’s a scenario akin to the one Eastman Kodak Company (NYSE:KODK) experienced in the mid-90’s, when digital cameras became commonplace. The company, which could have gotten into the digital camera space itself, chose not to and instead remained focused on making film for traditional cameras.

Kodak finally came around to the new reality and launched a digital camera of its own, but it was too late; it missed the market and ignored the undeniable reality that technology had changed the market.

That’s not to say GameStop has to suffer the exact same fate as Eastman Kodak, which filed for bankruptcy in 2012. It is a warning to current and would-be owners of GME stock, though, that it’s rare for consumers to revert back to a less convenient technology.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter, at @jbrumley.

« Stocks Are Still Holding All the Lines How Macy’s Inc Stock May Survive on Nostalgia Alone »