The Gamers Aren't All Right

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.

Amazon.com, Activision Blizzard, and GameStop are Motley Fool Stock Advisor selections. Take-Two Interactive Software is a Rule Breakers recommendation. Microsoft is an Inside Value pick. Motley Fool Options has recommended a diagonal call on Microsoft. Try any of our Foolish newsletter services free for 30 days.

Longtime Fool contributor Rick Munarriz admits to still playing video games, when he can find the time. He owns no shares in any of the companies in this story and is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.


Read/Post Comments (15) | Recommend This Article (12)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 23, 2009, at 2:43 PM, TheNine wrote:

    The stupidity littered across this article and your last have proven 2 things.

    A) You're clueless

    B) You have an agenda

    I'm not the most bullish person on GME, but it is a short term winner, and your concerns are very, very far off, to the point where they shouldn't even be considered in forward looking statements.

    As for the rest of your comments on the publishers themselves, such as ATVI.. i just can't grasp your logic.

    Good luck with your short positions.

  • Report this Comment On November 23, 2009, at 2:45 PM, TheNine wrote:

    Good luck with your short positions.

    The agenda is now clear as day.

  • Report this Comment On November 23, 2009, at 3:36 PM, BioBat wrote:

    The 'digital options' for gamers using the Wii, 360 or PS3 are not anywhere near the same as full on developed hardcore games that sell $500 million worth in a week.

    They're small, low power and labor cost developed games with a good profit margin but weak overall support. Yes, the margins are good but the people buying the games are doing so often on a whim, not because of soundly developed games that they need to have. Picking a winner in that field is akin to throwing darts. It's near impossible.

    Conversely, Modern Warfare and games of the like have strong user bases who want the game immediately when it comes out and until games like that have fast digital downloads - the brick and mortar sales outlets are here to stay as are the big game companies.

  • Report this Comment On November 23, 2009, at 4:07 PM, esxokm wrote:

    Rick,

    I share your concerns about GameStop. Especially the same-store sales aspect. What you say is true.

    And on ATVI: I probably will sell out of my long-term, profitable position in January to lock in profits (assuming the position remains profitable). Yes, I am selling then for the stupidest reason on Earth: taxes! But I agree that ATVI may have problems, since I read that DJ Hero could be a flop and that the Guitar Hero series probably already peaked.

    However, I did pick up a little GameStop today for a trade. I figure with the excitement of the holidays, the potential for used-game sales in this economy, the catalyst of Call of Duty and New Super Mario, a recent upgrade (I forget from what group), and the hope that management is low-balling the comps guidance, I'm counting on at least a $1 move from where I bought today. I know that's very short-term for the Fool, but this would be in my Roth.

    Thanks for the piece...

  • Report this Comment On November 23, 2009, at 4:44 PM, Fool wrote:

    Next year the new expansion to World of Warcraft will release to a mass following as usual. So explain how you don't see this gaining momentum for the company? Also, Starcraft II and Diablo III are on the near herizon.

    So yes many hardcore gamers disagree with you as 3 sequels to the best selling franchises on computer will be releasing in the next 18 months. That is why they will have a loss, it is called R/D and it pays back good companies.

  • Report this Comment On November 24, 2009, at 2:32 AM, hilorob wrote:

    Rick

    You wrote: "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."

    I don't see this point. "Top line" refers to revenue, is that right? Revenue was $1.63 Billion during the 4th quarter of 2008, and is estimated at 2.25 Billion for the 4th quarter of 2009 (sources: MSN money and Yahoo Finance, respectively). I note that analysts project earnings for the Dec 09 quarter at $0.44 a share. The same quarter for the previous year was $0.31 per share (source: Yahoo Finance). So given the game release lineup, the spectacular success of MW2 and the increase in year-over-year earnings, I think the price of this stock will increase considerably in the near term. Average target price is $15 per share and many sources (including a recent Barron's article) indicate that this stock is undervalued.

  • Report this Comment On November 24, 2009, at 7:47 AM, MBULL80405 wrote:

    TOO MUCH INCREASE IN TRADING/ACCUMULATION VOLUME OVER THE YEARS ( WITH A RISE IN THE / SHARE PRICE SUGGEST THAT HIGHER STOCK PRICES ARE MORE LIKELY DESPITE( BEING SARCASTIC HERE)RECORD ENTERTAINMENT SALES AND A TON OF CASH

    AND UPGRADES ( ONE TODAY EVEN )AND THE ATTENTION TO THE RECORD SALES SURE MAKES THIS A STOCK I SURE WOULD BE LOSING SLEEP OVER WITH ANY SHORT POSITIONS IN IT.... ITS ALREADY BOTTOMED FOLKS !

  • Report this Comment On November 24, 2009, at 9:12 AM, galtline wrote:

    There aren't that many big players in the video gaming industry...and ATVI tops the list. They are the only one managing their company well and sitting on boatloads of cash (mark my words, they'll be gobbling up other companies and titles). This is still a long term hold for me.

    Gamestop - I think they'll continue to do well in the short term. Long term, I believe they'll be rendered obsolete as online game purchases mature (that may anger some, but it is the direction I see it inevitably heading).

  • Report this Comment On November 24, 2009, at 2:54 PM, EquityBull wrote:

    Downloads are a non-starter for major games

    1) You cannot use them on multiple consoles in your own house

    2) You cannot bring to your friends house to play them on

    3) You cannot trade them in when you are done with the game (i.e. beat it or bored of it or just want something better). No download trade in's period

    4) HD storage on consoles is not large enough. Loading an entire library of games will require far more storage then the paltry allocation shipping on todays consoles. Doing that will require more expensive drives. While this is the smallest hurdle it does exist and will for awhile

    As far as same store comps almost every retail store has negative comps. This will change if/when the usa comes out of recession and economy improves. Majority of retailers and restaurants are all showing negative same store comps. This is nothing to worry about in this macro envioronment.

    By the time same store sales start showing increase of 3% to 10% the stock will already be north of 35 and investors will be too late to make the easy money on GME. You have to skate to where the puck will be...not where it is now.

  • Report this Comment On November 24, 2009, at 2:55 PM, EquityBull wrote:

    Downloads are a non-starter for major games

    1) You cannot use them on multiple consoles in your own house

    2) You cannot bring to your friends house to play them on

    3) You cannot trade them in when you are done with the game (i.e. beat it or bored of it or just want something better). No download trade in's period

    4) HD storage on consoles is not large enough. Loading an entire library of games will require far more storage then the paltry allocation shipping on todays consoles. Doing that will require more expensive drives. While this is the smallest hurdle it does exist and will for awhile

    As far as same store comps almost every retail store has negative comps. This will change if/when the usa comes out of recession and economy improves. Majority of retailers and restaurants are all showing negative same store comps. This is nothing to worry about in this macro envioronment.

    By the time same store sales start showing increase of 3% to 10% the stock will already be north of 35 and investors will be too late to make the easy money on GME. You have to skate to where the puck will be...not where it is now.

  • Report this Comment On November 24, 2009, at 3:07 PM, galtline wrote:

    EquityBull,

    Let me address the concerns that you put forth regarding online games:

    -----1) You cannot use them on multiple consoles in your own house

    What if it were tied to your gamer ID?

    ----2) You cannot bring to your friends house to play them on

    Same as #1.

    ----3) You cannot trade them in when you are done with the game (i.e. beat it or bored of it or just want something better). No download trade in's period

    You know how Microsoft tracks your arcade games through your XBOX Live ID? Why can't it track what games you own? Once it does that, what is stopping them from allowing you to TRADE the games that you own (electronically)?

    ---4) HD storage on consoles is not large enough. Loading an entire library of games will require far more storage then the paltry allocation shipping on todays consoles. Doing that will require more expensive drives. While this is the smallest hurdle it does exist and will for awhile

    Funny...because out of all the items that you listed, I considered this the biggest hurdle. In my mind though, why does the game have to be run solely from the game console?

  • Report this Comment On November 24, 2009, at 4:40 PM, Varchild2008 wrote:

    <--- Wonders if Today's economy was still at 4.5% unemployment...

    Would the author still be talking about bad same store sales at Gamestop and lack of growth for ATVI?

    Just wondering.... Cause expecting insane growth at 10.2% unemployment as if somehow...someway...unemployment figures....joblessness....does not and should not be factored into your article???? huh???

    The reality is that an awful lot of RETAIL company's that do not sell video games (HOTT) <--example.....are not creating increases in COMP...

    There are tons and tons of retailers that are struggling... One such retailer shut down several stores and layed off 4,000 in New York just recently...

    I know last month in Michigan... INK SPOT (I think that's the name) shut down all of their stores due to bankruptcy...

    Retailers..... Consumer Sensitive stocks.... are all doing horribly this year and last year.... It's called JOB-LESS-NESS.....

    How does JOB-LESS-NESS get ignored in favor of labeling these earnings reports as evidence of a PEAK? a PEAK????? Has Human Population Growth Peaked?

  • Report this Comment On November 26, 2009, at 8:05 AM, TMFBreakerRick wrote:

    Hilorob, analysts use non-GAAP figures in their ATVI projections. During last year's Q4, non-GAAP revenue was $2.343 billion:

    http://investor.activision.com/releasedetail.cfm?ReleaseID=3...

    You're right about the $2.25 non-GAAP billion for the current quarter (hence the 4% projected year-over-year decline).

  • Report this Comment On November 27, 2009, at 4:00 AM, hilorob wrote:

    Thanks, Rick, for that explanation. I've read that for companies that make a good portion of their revenues via selling subscriptions, non-GAAP revenue can be a better indicator of momentum (because GAAP revenue calculations require proration of the subscription income). Might this apply to a company like ATVI (which gets part of it's revenue from World of Warcraft subscriptions)? Or is there a reason to think that GAAP income provides a clearer picture of the company's health?

  • Report this Comment On November 28, 2009, at 11:37 AM, trpugh wrote:

    I think everyone is missing the main point on GME. Th big picture trend in gaming is gaming as entertainment vs as software; i.e., more like movies.

    Yes, the game developers could develop a direct-sales model eventually - broadband speeds will get faster, and hard drives will get bigger, but they need a way to market their games. This should be GME's future, generating interest, holding launch parties, etc.

    While game developers can launch an independant nationwide campaign for something major, like Call of Duty or GTA, they need a way to generate interest in smaller games. They don't have the infrastructure that a hollywood studio has to get the word out, so partnering with Gamestop is a natural.

    This should be the future of GME, and this is why game developers should partner with them. In this model, it's the Best Buy's and Walmarts that get squeezed out of the sales chain, not Gamestop.

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