Bet on GameStop, But Hold Off on Game Publishers

Both the Xbox One and PS4 have begun to ship, marking the beginning of the "next-generation" console cycle. The refresh of the console cycle could be seen as the start of a renewed growth phase for the gaming industry. The Xbox 360 and PlayStation 3 will continue to become "obsolete" and outdated in the coming months.

Unique position
GameStop (NYSE: GME  ) has a unique advantage because it is not tied to any single component of the next-generation console cycle. GameStop is exposed to the successes of new consoles, software titles, and the increased trade-in activity that will result from the transition.

GameStop's buy-sell-trade model makes the firm a "low cost" provider. GameStop's customers have nearly $2 billion of "credits" built up from selling used software and hardware products, according to research conducted by Needham. These credits are bound to be used to buy new products, and (obviously) have to be used at GameStop stores.

More than that, the database of customers' personal inventories (such as what games were recently bought, new or used) allows the company to tailor its promotions more effectively. The company offered customers several promotions, offering more credits for used games during the lead-up to the console launch in order to capture a greater share of launch hardware sales.

Strategicaly, pre-owned games are the most important category for the company and represent the largest portion of gross profit dollars. They represent 45% of the company's gross profit mix while accounting for 28% of the sales mix, according to Gamasutra.

Power of the industry
The power of the gaming industry is underscored by the over $1 billion in sales for Grand Theft Auto V in its first week on the market. Consumers flocked to purchase the game on the PS3 and Xbox 360 consoles, which have become "outdated" just a few weeks later.

According to a study conducted by PWC, the global market for console-related video game sales declined at a 4% compound annual growth rate, or CAGR, from 2008 to 2012 to end up at $24.9 billion. However, the market is expected to grow at a 4.6% CAGR through 2017. The U.S. market is expected to remain the largest region for console sales and it is expected to grow at a 5.5% CAGR through 2017. GameStop's market leading position with 4,425 stores across the U.S. gives investors direct exposure to industry growth.

Projecting the success of individual companies next year might not be as easy. Gamers are likely to switch their game franchise allegiances at console transition, and potentially their hardware allegiances as well.  

Due to the raw amount of new games set to come out over 2014 and 2015, making a call today on who will emerge as "the" winner is too difficult.  It is also entirely possible that there will be no clear winner as the market is big enough for many companies to survive.

On the flip side, shorting the group going into 2014 could be an exceptionally poor move due to huge catalysts coming into play in the first half of 2014.

It is impossible to overstate how important Destiny from Activision  (NASDAQ: ATVI  )  and Titanfall from Electronic Arts  (NASDAQ: EA  )   are for driving demand at their respective companies.

New billion dollar franchise for Activision
Activision has teamed up with Halo developer Bungie to create a new franchise game called Destiny, a first-person shooter is set for release in September 2014.  The company's CEO Eric Hirshberg hopes it will be a new multi-billion dollar franchise and become as important as the Call of Duty and Skylanders franchises.

During the company's recent conference call, the company's CEO updated investors on Destiny's hype.

Reception for Destiny at Gamescom was incredible. All told, Destiny has received about 75 awards, including Best of Show, at Gamescom and is on track to achieve the most preorders of any new IP in history.

Electronic Arts' exclusive game 
Electronic Arts is potentially set to release its Titanfall franchise in March 2014.  The game will be "exclusive only for the lifetime of the title on Xbox One, Xbox 360, and Windows PC."

The new franchise is led by former creators of the Call of Duty franchise who can leverage their success and create a new billion dollar franchise.  

Titanfall players fight in online multiplayer-only matches that has some experts labeling the game as the "next great evolution of the twitch-action first-person shooter."

Foolish take
GameStop appears to be the best way for investors to benefit from the strong demand in consoles and games.  Investors don't need to worry about the Battlefield versus Call of Duty debates as the store will happily sell any game on any console to its customers.

On the other hand, the data suggests growth in video games through 2017, so investors could take a cautious approach today by diversifying and investing in both Activision and Electronic Arts and holding for the longer term.  Investors can "hedge" their position in case one company grows at a much faster rate than the other, which is a possibility.  This seems like a prudent approach given that the new consoles are still fresh to the market with major blockbuster title releases still months away, and predicting a clear winner in any time frame is nearly impossible.

What's the Fool watching next year?
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  • Report this Comment On December 23, 2013, at 11:05 AM, Becker2011 wrote:

    As a resident CPA / old gamer - I don't play many games anymore but will be pre-ordering Destiny due to how high expectations are for this game. If the game is making me dust off the controller and buy xbox live again, I would say the excitement is indeed very real.

    I would like to see a reference to a $2 billion in credits thought by Needham.... almost 25% of their revenue is in credits? Pretty exciting but hard to believe.

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