Endgame for GameStop?

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Shares of GameStop (NYSE: GME  ) took it on the chin last week, after Best Buy (NYSE: BBY  ) announced that it will allow diehard gamers to trade in used games for gift cards this summer.

Buying used games and gear at rock-bottom prices and reselling that inventory has been a high-margin endeavor at GameStop over the years. (Nasdaq: AMZN  ) , Toys "R" Us, and Best Buy kicked around buyback models last year, but now Best Buy will make it an official practice throughout its domestic superstore chain.

GameStop's stock fell by 11% last week, thanks in part to the news. That's even more than shares of Best Buy squandered after posting uninspiring financials that fell considerably short of market expectations.

Value investors may find their tails wagging about now. GameStop is trading for just 7.3 times this year's projected profitability. Comps have been challenging given the gaming industry's dreary sales figures over the past year, but GameStop's attractive unit-level economics keep the bottom line pointing in the right direction.

Unfortunately, it's still hard to cast GameStop in the digitally delivered gaming landscape of tomorrow. OnLive -- the cloud-computing-based online game service -- officially launched last week; Microsoft (Nasdaq: MSFT  ) and rival console makers continue to promote their download marketplaces. 

GameStop is trying. The small-box retailer teamed up with Activision Blizzard (Nasdaq: ATVI  ) to promote Legends of Zork -- a free-to-play Web browser-based game -- earlier this year. It has enough clout to negotiate store-level exclusives.

However, there's no reason to believe that GameStop's fate in moving physical software titles won't be all that different from what ultimately tripped up record stores, DVD shops, and booksellers.

GameStop's shares got whacked because Best Buy may start to nibble away at its highest-margin business, but there are evolutionary factors weighing on the chain's prospects elsewhere.

The stock is cheap, but it's cheap for a reason. The attractive store-level model can crumble quickly once the supply of used gear thins out, folks are buying digital downloads from their consoles, and hardware becomes less of a factor in a cloud-computing scenario. It may hold up OK in the near term, but this still appears to be a model on the way out.

How can GameStop prosper in the digital revolution? Share your thoughts in the comments box below.

Best Buy and Microsoft are Motley Fool Inside Value recommendations. Amazon, Activision Blizzard, and Best Buy are Stock Advisor picks. Motley Fool Options has recommended a bull call spread on Best Buy, a diagonal call position on Microsoft, writing covered calls on GameStop, and a synthetic long position on Activision.The Fool owns shares of Activision Blizzard and Best Buy. Try any of our Foolish newsletter services free for 30 days.

Longtime Fool contributor Rick Munarriz 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 (4) | Recommend This Article (7)

Comments from our Foolish Readers

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  • Report this Comment On June 22, 2010, at 10:15 AM, MagicDiligence wrote:

    Been seeing your arguments on GME for several months. Funny that the Fool is down on GME under $20, but was gung-ho at $40 a few years ago.

    Digital is not going to take over the gaming industry. Not with HD titles coming in at over 4GB. It just takes too long to download (it's faster to drive to GameStop). There will be some segmentation, but the AAA big-TV titles will be on physical media for a long time.

    Gamers have not exactly embraced digital. The two GTA4 downloadable episodes did not sell well at all.

    Remember also that a lot of kids that play these games don't have credit cards, and getting a gift card under the Christmas tree is less than exciting.

    Best Buy's used game program may hurt some, but not that much. Trade-ins go through the customer service desk, behind the guy returning his Blu-Ray player and the woman applying for a credit card. Ugh. Plus used inventory will be well below what GME has.

    Good value at current price.

  • Report this Comment On June 22, 2010, at 11:40 AM, mojoworkun wrote:

    Once again Mr Munariz, your view seems simplistic and naive. Just because some new technology is out, or around the corner, does not necessarilly spell utter doom for leading industry players. Did masive changes in computing dethrone IBM from being a major player? Hardly. Your mistaken affinity for satellite radio shows your proclivity to erringly side with new technologies whether they be game changers or not.

    Some past technological changes, you mentioned, hardly have any bearing on whether new formats for game delivery will affect GME greatly or not. Citing the music industry is a fallacious comparison. The music industry/record stores were set up to be massively changed in good part due to now illegal downloading that was rampant during earlier days of the internet. If Hollywood movie studios had stepped in earlier to assert the nation's laws to uphold copyrights better; the music industry would likely not have been altered nearly as much. It is almost always nearly impossible to compete with free, that is what greatly affected the music business; and helps explain why satellite radio has only been a niche player. The game industry has nothing in its future similar to the onslaught of free/illegal downloading the music business had to endure.

    And perhaps you should,consider a bit more GME's indutry clout when new methods of content delivery are discussed. GME will not be standing still.

  • Report this Comment On June 22, 2010, at 12:05 PM, wyrdmage wrote:

    I gave up on GME and cut my losses at a good time before it plummetted even further. It is a risky possibility that GME may gain an investor a ton of money from the current low price, but in the same light of a failing company then perhaps shares of BP will make a killing comeback...if BP doesn't stay in a pit and fall too far behind its competitors. How solidly GME is able to pull itself out of its pit is no longer a sound enough risk for me to be enticed by a worthy company that failed to stay on top and then fell too far behind its competitors.

  • Report this Comment On June 22, 2010, at 9:49 PM, EquityBull wrote:

    At today's price the margin for error is soundly built in. GME should be about a 30 to 40 stock today. At 18 bankruptcy in the near future is all built into the stock. By the time that happens they will have earned back their entire market cap and then some for a great return. GME will see 35 before it sees zero

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