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GameStop: Tough Days Ahead

In this article, I will discuss:

1. Why is digital gaming such a threat to GameStop Model?

2. Who are the major players in the digital gaming era and what they are doing?

3. How GameStop's latest acquisition and financials are cause for concern

Should GameStop fear digital gaming?

Personally, I can attest to this potential gaming revolution. I am a big fan of video games, particularly those in the Call of Duty and Madden series. Going to a store like GameStop is a hassle for both me and my parents. However, with the rise in digital downloads or streaming for such video games, that hassle will cease to exist in the near term.

All kids and their parents need now is a credit card. From the comfort of their home, they can log on, select a title, pay, and download or stream a game. Digital gaming is changing the way kids and parents purchase these titles. One can now directly download (or stream, which I will discuss next) new games on one’s Xbox or PlayStation through their respective digital platforms. The rapid advancement of these platforms will soon replace physical discs.

What about physical discs and GameStop?

The increasing adoption of digital platforms should be worrying to companies heavily dependent on in-store sales, like GameStop. Selling physical discs is GameStop's core business and it will still be 50% of the company's projected revenues in 2019, as per company CEO.

The reliance on in-store physical disc sales contributing significant revenue should be worrying as the market shift to digital gaming has the possibility of eating into half of GameStop’s revenue – at a conservative estimate. The rate of digital growth could indicate the decline in the percentage of GameStop’s revenues. If market trends are any indication, it is time for GameStop to up their game in the digital domain.

Who are the "big boys" of the digital gaming era and what are they doing?

To me, there are 2 big players in digital gaming: Microsoft and Sony. Xbox (Microsoft’s game console) digital platform allows for both streaming and downloads. Xbox Live Arcade (XBLA) allows for Xbox live users with an Xbox 360 to choose over hundreds of games and download one in the cost range of 10-20 USD. Additionally, those with an Xbox One can stream Xbox One games to any Microsoft tablet or PC equipped with Windows 10. This works both ways as Microsoft unveiled their master plans to bring all Microsoft devices together under one system. Put simply, this plan implies someone with a Microsoft phone can purchase an app on said phone and stream it across any other Microsoft device, including most versions of the Xbox.

Next, there is Sony's PlayStation. Playstation's digital revenues (on the PS4 and PS3) were double that of both Xbox One and Xbox 360 in 2015. PlayStation is better known in digital gaming for their PS3 streaming service, called PlayStation Now (PS Now). This service is what some believe to be the "Netflix of games". Why? Because you pay a flat fee for a certain period of time (1 month for $19.99 and 3 months for $44.99) and gain access to a selection of over hundreds of games. PS Now is so versatile that the service can be streamed across any Sony device. Put simply, what Netflix is for movies and TV shows, PS Now intends to be for digital gaming. PS Now also has a rental service where you could gain access to even more PS games, only these games are discs and are slightly more expensive than their streaming service.

Even though this rental service may not live up to Sony's expectations, PS Now looks like will strive to be the template for the future of gaming. Although currently pricey in terms of membership fees, Sony will likely lower the costs by entering into multiple agreements with most game publishers within the next 5 years to give the consumer a fairer price, just as how Netflix did with their movie and television show providers. I believe that PS Now, with a few upgrades, could be the "Netflix of Games", given PlayStation’s young, global player base.

In the current market, it looks like Sony is angling for the biggest presence in digital gaming, followed by Microsoft. These two heavy presences in the gaming market should be reason enough for GameStop to begin to shift its primary business model.

What did GameStop recently do that signals they're in trouble?

On August 2, GameStop acquired 507 of AT&T's mobile stores. GameStop now owns over 1,421 AT&T stores in its Technology Brands division. In that division, it also includes GameStop-owned Simply Mac, which sells Apple products. GameStop and others who are bullish on the stock say that this division is great "diversification" and will "drive" revenue in the long-term. In reality, this is a quick fix and a low growth part of GameStop's whole company. Why? All these stores do is sell phones and other technology devices. That gives zero edge for GameStop because anyone can sell technology devices. Additionally, employees in the Simply Mac stores are likely not as informed about the products as the employees in actual Apple stores. That would make it harder for these employees to convince consumers to buy from them instead of the official Apple store. Also, online retail giants like Amazon and eBay are gaining steam in the technology device market, making for even more competition for GameStop's custom stores.

GameStop management’s slow shift to digital gaming is clearly puzzling. However, the company does have a digital gaming division. Their digital gaming division contributed 7% of the company's total revenue in 2016. In 2015, GameStop's digital division had comprised roughly 10% of their total revenue. This YOY decline indicates that not only is GameStop approaching this division wrong, but they are also not prioritizing it. This is concerning for those currently invested or planning on investing in the company because it shows GameStop's lack of concern for what could be the biggest threat to their current business model: digital gaming.

I have yet to go over recent market moves by GameStop and analyze their impact, like:

Will they be allowing access to digital gaming directly on their native console only or could it be streamed across multiple devices, too? Why would anyone need a third party (like GameStop) to digitally download games from, when one can download games directly onto his or her console or stream the same games across any device like Netflix?

The point is, how much leeway will GameStop have when publishers of original titles can use Microsoft and Sony platforms (partnerships or alliances) to distribute. In fact, GameStop coming up short with its own streaming service should point to a business model in trouble.

In sum, I think rapid growth in digital gaming will lead to GameStop being one of the most heavily shorted stocks on the market. As digital gaming takes off within the next 5-10 years, GameStop's core business will be driven hard to look for an alternative path for growth. GameStop needs to consider, urgently, how it would like to play its part in the digital gaming environment or face a stand-off against heavily favored competitors.

Please read my Disclaimer before taking any financial action.

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