Does GameStop's CEO Know What He's Talking About?

GameStop's CEO can't defend his company's increasingly irrelevant business model.

Apr 23, 2014 at 6:15PM

GameStop (NYSE:GME) CEO Paul Raines appeared on CNBC Tuesday evening pitching his company to Mad Money host Jim Cramer. To his credit, Cramer was critical of GameStop, asking Raines to respond to many of the arguments I've been raising about the retailer in recent months: the parallels to now-defunct Tower Records and Blockbuster, the rise of streaming video games, and the growing accessibility of digital downloads.

Raines did not offer up much in the way of a rebuttal. To the contrary, he made a number of statements that are downright puzzling. If the interview was any indication, GameStop's management team may not be fully aware of the trends that are threatening to make its core business obsolete.

Raines on the parallels to other failed media companies
"I used to shop at record stores," Cramer said. "Then I got iTunes."

With virtually all modern video games available to be digitally downloaded, the parallels between GameStop and the once-dominant corporate record behemoths of years past are obvious and overwhelming. Consumers, preferring to purchase mp3s rather than CDs, simply stopped showing up. The same could soon happen to GameStop. Raines responded:

We've heard that before ... We had $730 million of digital sales last year ... We are the leading seller of digital content for consoles ... When the consumer is ready ... we're the leader in selling digital content in store.

It's true: Investors have been proclaiming the imminent decline of GameStop's business model for years. Noted short-seller Jim Chanos, for example, first compared GameStop to Blockbuster in 2011. So far, those calls have been premature, but we're nearing the tipping point.

The PlayStation 4 and the Xbox One, released last fall, are far more digital in nature than their predecessors, the PlayStation 3 and Xbox 360. Those consoles allowed owners to purchase digital copies of some games, but not all of them -- and often, the games were released days, weeks, or even months after the retail version appeared on GameStop's shelves. The PlayStation 4 and Xbox One, however, have all their games available for download on the same day as (or even, in the form of pre-loads, ahead of) GameStop.

And it's true that GameStop does sell digital video games. If you head to your local GameStop, you can purchase a PlayStation Network or Xbox Live Arcade gift card. But you can also purchase one of these cards from your local grocery store or even many gas stations.

I'll have to take Raines' word on GameStop being the largest seller of digital console games -- but there's no reason to expect that to continue. Owners of the PlayStation 4 and Xbox One can use their credit card to purchase games directly through their consoles -- removing GameStop from the equation. The Xbox team has even gone so far as to undercut GameStop's prices

Unfortunately, revenue data for the PlayStation Network and Xbox Live is hard to come by, not directly broken out in earnings releases. It's an old number, but in 2010, Reuters reported that the PlayStation Network was generating annual revenues of $800 million, up almost 100% from 2009. It would be reasonable to assume that it's higher today, and should continue to increase given the runaway success of the PlayStation 4. The Xbox Live Arcade, meanwhile, generated almost $300 million in revenue in 2012, according to research firm FADE (via VG 24/7).

It's not clear why GameStop's business is necessary in a world in which digital game downloads are the norm. Tower Records wasn't able to persist selling iTunes cards, nor did Borders Books survive by selling Kindles.

A one-way street
Raines on the nature of video game downloads: "They're interactive games. That's why it's called interactive entertainment. It's not a one-way download."

This one flat out just doesn't make any sense. I have to assume that Raines misspoke -- if not, this points to some confusion about the nature of video game downloads. When you purchase a digital game from the PlayStation Network or Xbox Live Arcade, it is downloaded directly to your console -- no different from purchasing a digital song for your iPod, or purchasing a digital book for your Kindle.

It is very much a "one-way download" -- there is simply nothing interactive in the purchase of a digital video game. Playing a video game is clearly much more interactive than listening to a song or reading a book, but the actual purchasing process doesn't differ in the slightest.

The digital future is inevitable
For investors in GameStop, the question is simple: Can the retailer survive long enough to justify an investment? GameStop is using its free cash flow to buy back shares and paying a steady dividend (currently yielding over 3%), but its core business, the sale of video game software, is under assualt.

Eventually, this business will become untenable. Not today, maybe not tomorrow, but it appears inevitable. Even GameStop's management doesn't dispute that digital downloads are a growing part of the video game landscape: "Our point is not that there won't be downloads," Raines said.

GameStop is working on some new initiatives, but even management doesn't anticipate that they'll comprise more than 10% of its business by 2016. GameStop has tried to branch out into other areas -- toy stores, streaming gaming -- but these initiatives have all failed. Perhaps this time will be different.

But I wouldn't bet on it.

GameStop isn't the only company dependent on the living room
Most of the games sold at GameStop are played on a big living room TV -- but video games aren't the only thing TVs are used for. You know cable's going away. But do you know how to profit? There's $2.2 trillion out there to be had. Currently, cable grabs a big piece of it. That won't last. And when cable falters, three companies are poised to benefit. Click here for their names. 

Sam Mattera is short shares of GameStop. The Motley Fool owns shares of GameStop. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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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