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A Victim of Digital Downloads, GameStop Is Exploring a Buyout

Digital downloads of video games erode GameStop's lucrative used game business, and it's going to get worse

By Brad Moon, InvestorPlace Contributor

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Source: GameStop

After a three and a half year slide that saw its stock fall from $47 to under $13, GameStop Corp. (NYSE:GME) has been on an upswing for the past week. And yesterday, GME stock had a pop of over 3.6% on rumors were circulating that the company was exploring a sale. Yesterday evening, GameStop issued a press release confirming that it is in “exploratory discussion with third parties.”

GME Stock Pops on Rumor of Buyout Talks

On Monday, rumors began circulating that GameStop was exploring the possibility of a buyout, resulting in GME stock rising as much as 11%. On Tuesday morning, Reuters published a report that claimed GameStop was “holding talks with private equity firms about a potential transaction after receiving buyout interest.” CNBC followed up with a report that Sycamore Partners was an interested party.

That was enough to send GME stock up further, eventually closing with a 3.62% gain on the day.

GameStop has now confirmed the rumors were more than speculation. Yesterday evening, the company issued a short press release with the following statement:

“GameStop Corp.(NYSE:GME), today confirmed it is in exploratory discussions with third parties regarding a potential transaction. There can be no assurance any agreement will result from these discussions. GameStop does not intend to make any additional comments regarding these discussions unless and until it is appropriate to do so.”

GameStop’s Challenge

Consumers have always had a wide range of retail locations to buy video games and consoles. GameStop became a top choice among gamers because its locations stocked consoles, accessories, a large selection of games — not just the top 10 bestsellers — and because it sold used video games.

Those used games in particular were key. They let players trade in a title they had finished with, and use the money they received to buy a new game. Then GME could sell the used game at a discount (keeping all the money of the re-sale with none going to the publisher), luring in buyers who were otherwise reluctant to pay big money for a new release. And that used game could be traded in again, with GameStop pocketing the profit every time it was sold. This business model is why GME stock once traded over $60.

Digital downloads have been hitting GameStop, but it’s expected to get worse. All the game console manufacturers — Microsoft (NASDAQ:MSFT), Sony (NYSE:SNE) and Nintendo (OTCMKTS:NTDOY) — have been pushing digital downloads.

The appeal to consumers is that they can get a game instantly (or nearly so depending on their internet speed) without having to drive to a store. That deprives GameStop of the initial sale. And those digital downloads can’t be traded in, depriving GameStop of its used game goldmine. Console makers and game publishers are also expanding into monthly game streaming and library services such as Microsoft’s Xbox Game Pass. And Microsoft just created a new cloud gaming division

The fear is that the next generation of consoles could go entirely digital, eliminating physical media altogether.

GameStop has been adjusting it business model in an attempt to reflect the changing reality of the market. It sells point cards for gamers to use for those digital downloads, has expanded into collectibles and owns Spring Mobile — an AT&T (NYSE:T) reseller.

However, Gamestop’s business remains challenged and signs point to the situation only getting worse with the prospect of digital downloads ultimately replacing physical media. GameStop ended up shutting down 150 stores in 2017 while its stock slid 32% on the year. In addition, the company has been experiencing rapid turnover in its leadership team.

Being sold to a private equity group won’t change the realities of a rapidly changing business model for GameStop. But it could provide a cash infusion, let the company regroup and do so without having to publish quarterly earnings reports or push to keep those quarterly earnings up for shareholders.

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

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Article printed from InvestorPlace Media, https://investorplace.com/2018/06/victim-digital-downloads-gamestop-corp-buyout/.

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