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After months of gloom, the console video game market finally has some wins to celebrate. Microsoft's (Nasdaq: MSFT ) Halo 4 game met with huge demand when it came out last week. And then Activision Blizzard's (Nasdaq: ATVI ) new Call of Duty game did its part, selling more than 1 million copies at launch. Both rollouts set records for their respective franchises.
And they also gave a much-needed boost to GameStop (NYSE: GME ) , whose latest sales forecast included a plus sign, for a change. The company saw sales tank by 8.3% in the third quarter. And it projected that comparable sales could fall again, by as much as 7%, in the fourth. But those sales could also eke out a gain of 1%, according to the forecast. Is that a ray of light at the end of the tunnel for GameStop, or just an oncoming train?
How did GameStop get to this low point -- that of celebrating a potential 1% quarterly gain in an overall down year? Part of the answer can be found in Microsoft's financial reporting, of all places.
In its 2008 annual report, Mr. Softy had this to say about the console market that it dominates along with Sony and Nintendo: "The lifecycle for video game consoles averages five to seven years." But Microsoft tweaked that language in its next report, and going forward, saying: "The lifecycle for gaming and entertainment consoles averages five to 10 years."
Microsoft moved the goalposts on console innovation. And Sony and Nintendo played along. So the industry finds itself in a six-year drought, the longest between console refreshes since Princess Peach was first kidnapped from Mushroom Kingdom.
But aging consoles aren't the only problem. Mobile devices exploded onto the scene over those years, too. And that trend has put millions of tiny gaming devices running Apple's (Nasdaq: AAPL ) iOS and Google's (Nasdaq: GOOG ) Android into people's pockets. There are more than 1 million Android devices being activated each day. And over 100 million iPad tablets have flooded the market since that product was launched. That's a lot of competition for gamers' hands.
What's more, rising numbers of digital downloads are giving people less of a reason to trek out to the store for game purchases, hurting traffic even more. And fewer physical disks floating around has also taken a bite out of the resale market, one of GameStop's most lucrative divisions.
Despite that triple whammy on the company's business, GameStop had some bright spots in its third-quarter report this week. Yes, sales of new video game hardware continued to tank, falling by almost $100 million when compared to the year-ago quarter. And a rise in digital receipts from the company's download program wasn't nearly enough to stem those losses.
But there was good news too. The company saw its profit margin tick up to 31.4%. And it bought back almost 4 million more of its own shares, at an average price that's well below where the stock is sitting now. GameStop also continued its $0.25 quarterly dividend, which amounts to a near 4% annual yield.
Foolish bottom line
At a P/E valuation that's stuck in the single digits, it's not hard to see why the company sees value in its own stock. But should investors follow that lead?
I'm cautiously optimistic. With the Nintendo Wii U launching this Sunday, GameStop finally has new hardware to offer console gamers. And initial sales of the two megahits from Microsoft and Activision suggest that there might be solid pent-up demand for fresh games this holiday season.
The new Wii console probably won't be the blockbuster that its predecessor was. But that doesn't mean it can't be a success anyway. Even if it doesn't ignite sales and bring gamers rushing back into the market, as a recent New York Times review of the system concluded, it can still make "a pretty nice present."
We won't have answers until after all the holiday presents are opened. That's when we learn if GameStop managed a sales gain in the crucial fourth quarter. If it does, then at least we'll know that console gaming still has some lives left, and so does GameStop.
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