Is GameStop the Next Netflix?

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GameStop's (NYSE: GME  ) earnings report and conference call remind me of why I bought Netflix (Nasdaq: NFLX  ) in the midsummer of 2007. Back then, analysts hated Netflix for two seemingly valid reasons: First, it was fighting a bruising price war with Blockbuster, and its margins were suffering. Blockbuster was bigger and had the advantage of bricks-and-mortar stores for immediate store pickup and drop-off. (Advantage bricks? Can you believe that?) Second, Netflix was in the antiquated business of moving DVDs by snail mail. Analysts scoffed at the Netflix model because they knew the future belonged to digital downloads.

GameStop is similarly despised in the investing community today.  Analysts still know that the future belongs to digital downloads, and they see margin erosion from competition in the used-game market from retailers such as Wal-Mart (NYSE: WMT  ) . 

But I liked Netflix in 2007 because the management team was financially prudent, aware of the threats, and patiently evolving the company's strategic response. Netflix's financials showed healthy cash-flow metrics that were usually better than reported net income. Moreover, management was looking to the future and experimenting with instant viewing. Do you remember how clunky those first viewers were, with stuttering video and frequent crashes? But each iteration got better, and customer usage was steadily climbing.

GameStop's management today is demonstrating a similarly prudent execution plan. The company's financials are excellent -- free cash flow exceeded net income by 21% in 2009 and is on the same track for 2010. Management is incrementally improving digital downloads, which grew by 9.9% in the most recent quarter.

"We continue to be the fastest-growing website in the gaming space as we became the No. 2 largest online game retailer behind Amazon (Nasdaq: AMZN  ) ," said GameStop President Tony Bartel this week.

In addition, the company is leveraging its physical locations with its PickUp@Store program to provide immediate gratification for customers who like to browse before buying.

Moreover, GameStop has several immediate catalysts that make me bullish about the stock. Demand for Microsoft's (Nasdaq: MSFT  ) Kinect and Sony's Move platforms are driving a new demographic to the stores and keeping supplies tight. Meanwhile, more traditional gamers are buying Activision Blizzard's (Nasdaq: ATVI  ) Call of Duty: Black Ops at record levels. Those sales and the upcoming World of Warcraft: Cataclysm release, also from Activision, should boost earnings nicely. No wonder management raised guidance for the year!

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Fool contributor Tomasz Johannsen owns shares of GameStop, Activision, Microsoft, and Wal-Mart. Microsoft and Wal-Mart are Motley Fool Inside Value picks., Activision Blizzard, and Netflix are Motley Fool Stock Advisor choices. Wal-Mart is a Motley Fool Global Gains selection. Motley Fool Options has recommended a synthetic long position on Activision Blizzard. Motley Fool Options has recommended writing covered calls on GameStop. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Activision Blizzard, Microsoft, and Wal-Mart. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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  • Report this Comment On November 26, 2010, at 4:29 AM, BioBat wrote:

    Yes, Gamestops website is the #2 site for gaming purchases but that's not the same as being the #1 or #2 site for digital purchases, which they are not.

    Steam, with 25m users, is the market leader and already entrenched as the gamers place to go for digital downloads. It has approx. 70% of the digital download space for PC gamers (a market that Gamestop has moved away from in recent years). Last year it brought in downloads for Macs and just recently branched out into downloads for the PS3. I'm certain it won't be long before the Xbox is on their as well.

    Gamestop may have lots of cash but they're so far behind in a real digital strategy it isn't funny.

    Sorry, Gamestop isn't the new Netflix. Steam is.

  • Report this Comment On November 26, 2010, at 5:05 AM, ecburton wrote:

    Biobat, I couldn't agree more. Very well said.

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