Don't let it get away!
Keep track of the stocks that matter to you.
Help yourself with the Fool's FREE and easy new watchlist service today.
On the surface, it appeared that the video-game industry got a double dose of good news last week. Retailer GameStop (NYSE: GME ) posted better-than-expected third-quarter results on Thursday. A day earlier, Activision Blizzard (Nasdaq: ATVI ) announced that sales of Call of Duty: Modern Warfare 2 totaled $550 million during its first five days, a new record in the industry. Take-Two Interactive's (Nasdaq: TTWO ) Grand Theft Auto IV was the previous record holder.
The reports offered a welcome break from the industry's recent funk. Video-game hardware and software sales have fallen during seven of the previous eight months.
Not so fast, though. Dig deeper into both of last week's events, and the end result isn't all that inspiring.
Let's start with Activision Blizzard. The latest Call of Duty installment is clearly a winner, but what about the rest of the company? Analysts see revenue falling by 4% when stacked up against last year's holiday quarter. Earnings should improve substantially during the quarter, but it's hard to get excited about improving margins when the world's biggest video-game company breaks a sales record yet is still expected to fall short on the top line.
At GameStop, sales rose 8%, to $1.83 billion. Earnings before debt-retirement costs checked in at $0.32 a share -- better than last year's profit before merger-related costs, but just ahead of analyst expectations of $0.30 a share. The 8% top-line boost was the product of a 2% dip in hardware sales, a 9% improvement in new software sales, and a healthy 19% spike in used-software sales.
However, your average store didn't see any of these gains. GameStop's aggressive expansion over the past year propped up all of those figures. On a comps basis, GameStop's sales fell by 7.8%.
That's in the past, of course. Lower console prices and hot titles should make this a turnaround holiday season for GameStop, right? Well, it turns out the small-box retailer is projecting negative comps (between -1% and -7%) for the current quarter.
Optimists will point out that GameStop is doing just fine. Sluggish hardware sales are a blessing in disguise, since hardware is a low-margin affair for GameStop anyway. Used games, on the other hand, are big business. They account for nearly half of the company's gross profit. Even Toys "R" Us and Amazon.com (Nasdaq: AMZN ) are testing the buyback model this year to potentially get in on the action.
However, isn't hardware the leading indicator here? If folks aren't spending money on new systems, how will software sales grow down the line? Well, maybe those gamers are just buying more software titles for the hardware they already own.
Maybe. But the trend I really worry about when it comes to GameStop is that Microsoft's (Nasdaq: MSFT ) Xbox 360, Sony's (NYSE: SNE ) PS3, and the Wii all have options for digital purchases that leave out GameStop entirely. Even though the retailer is gaining market share now, it's doing so as the result of breakneck expansion.
I'm just not that impressed by growing a concept when comps are slipping, since doing so only creates a bigger mess to clean up down the road.
I would love to eat my words, but until GameStop's comps bounce back, it's hard to argue against a sector that may have peaked in its present form.
Rick knows that plenty of diehard gamers disagree with his bearish interpretation. If you do, let him have it in the comment box below.