Retail gaming giant GameStop (NYSE: GME ) announced a share buyback late last week, and investors rewarded the company with a large pop in the share price of the struggling company. The repurchase could total as much as $500 million, with $300 million allocated toward share buybacks and $200 million to repurchase senior notes. This share buyback is in addition to a $300 million buyback announced in January.
GameStop is one of the most heavily shorted stocks in the market, and the announcement was good enough for a fairly significant short squeeze, but can the share price continue to appreciate with the headwinds facing the gaming industry, and more specifically a brick-and-mortar retailer?
The next Blockbuster?
Many investors and analysts like to compare GameStop to Blockbuster, predicting doom for the game retailer. Just as Netflix (Nasdaq: NFLX ) made the Blockbuster business model irrelevant, some believe that online gaming and delivery will do the same to GameStop.
However, there are some important differences between the two companies. Most importantly, Blockbuster rarely produced profitable years. The company was poorly run, and even during its glory years from 1996-2000 when the economy was booming, the company still lost more than $700 million. Obviously, things only got worse for the company from that point on.
GameStop has a creative management team that has targeted a niche that the big-box retailers like Best Buy (NYSE: BBY ) and Wal-Mart (NYSE: WMT ) have not been able to replicate successfully. GameStop is the leader in reselling used games. While Best Buy has recently launched a foray into this sphere, it is not the company's first attempt. The margins on used game sales are significantly higher, and the games are less expensive for buyers, which has helped the company weather the economic slowdown.
Picking up the scraps
Speaking of Blockbuster comparisons, the video chain's store closings have opened up many desirable real estate locations where GameStop can look to expand. On the most recent quarterly conference call, Chairman Dan Dematteo stated:
"I would think that as they continue to close stores, again, it gives us opportunities, especially into highly dense urban areas. If you take like the LA area, for example, which is a very difficult real estate market, it gives us opportunities to get into centers that we've not gotten into. And oftentimes what's happening is that we're actually taking a piece of the Blockbuster store as the landlords break up those stores into two or three smaller stores. It's a positive for us to get in to grow market share in markets that we heretofore couldn't get into."
The digital world
While GameStop has created a profitable niche as the leader in used games, that won't matter if gamers continue to shun buying physical games and consoles, and completely move to online delivery.
GameStop's management understands the threat and in July purchased online game distributor Kongregate. While management believes the company will be able to grow revenue from this acquisition, the site is a "free" gaming spot. So they certainly aren't looking to increase revenue from the actual selling of games.
Additionally, top video games made by heavyweights such as Electronic Arts (Nasdaq: ERTS ) and Take-Two Interactive (Nasdaq: TTWO ) are not selling as they once did, thus requiring discounting soon after release. EA recently released its top-selling sports franchise Madden NFL 11. As usual, it was lauded with release parties and celebrations, but this time around with discounts as well. Less than a week after the game's release, Amazon (Nasdaq: AMZN ) knocked $10 off the game, and GameStop had to soon follow suit.
The Foolish bottom line
While GameStop faces significant headwinds in updating its business model to be able to compete in the online gaming space, it is way too early count this company out. The savvy management team has had to be creative before in warding off the big-box retailers. By successfully creating a used game program, the company has successfully developed a niche that these large retailers have not been able to match. While the task at hand looms large, I think management deserves the benefit of the doubt in proving they are up to the challenge.
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