GameStop Post Earnings: No Threat From Electronic Arts

Electronic Arts and other video game publishers and manufacturers continue to shift towards digital content. Knowing this, GameStop continues to diversify in to new categories to

May 27, 2014 at 2:00PM

April's NPD data revealed a disturbing trend that total physical retail game sales fell 10% year over year to $227.9 million. The findings were consistent with earnings report from Electronic Arts (NASDAQ:EA), which reported strong gains in digital download sales.

Electronic Arts shifting toward digital
When Electronic Arts reported its fourth-quarter results in early May, the company said that its digital sales came in better than expected. It saw $550 million in digital net revenue, exceeding the company's guidance by $93 million.

Electronic Arts' Chief Financial Officer Blake Jorgensen said during its fourth-quarter conference call:

The new generation consoles are showing impressive growth in full game downloads. In North America we have seen two to three times greater downloads on the new consoles versus the prior generation. We expect this will continue to fuel growth of this part of our digital business.

Electronic Arts is making digital a main component of its business, and for good reason. The company noted that its fourth quarter non-GAAP gross margin improved to 77.4% from 74.3% a year ago due to a pickup in digital revenue.

Electronic Arts is forecasting its digital revenue to generate nearly $2.1 billion in fiscal 2015, a 17% improvement from fiscal 2014.

Why wouldn't Electronic Arts push its digital sales if it helps boost margins? It makes sense to cut out a middleman like GameStop (NYSE:GME) and sell directly to the consumer.

So does mark the begging of the end for GameStop, possibly making the company become "the next RadioShack"?

Far from it.

Don't expect GameStop to just die
As GameStop proved in its quarterly report on May 22, the company's core game business is in fine shape with comparable-store sales rising 5.8%.

Specifically, GameStop is well positioned to continue its dominance in its used game business which provides gamers added value that is impossible for a game publisher or manufacturer like Electronic Arts to match. During the quarter, GameStop's pre-owned/value software sales rose 5.3% in a quarter with fewer AAA titles launched.

GameStop continues to leverage its market-leading position by expanding into new consumer electronic categories as well.

GameStop is investing in business that will help insulate the company from the cyclicality in the game business, which is without any doubt shifting toward digital. By doing so, GameStop can at least partially offset inevitable cash flow declines as digital game downloads continue to gain momentum.

GameStop plans to heavily spend on store expansion and potential acquisitions to grow its exposure in prepaid and postpaid mobile. The company is already seeing results from this, with an impressive 36.2% gross margin rate in the quarter.

The company's CEO J. Paul Raines further explained the concept during the company's conference call on May 22:

Many investors have also asked, why the mobile category is a good opportunity for GameStop. In our recent Investor Day, we pointed out that our five competencies of real estate, human capital, buy-sell-trade, PowerUp Rewards and financial strength are transferable to other concepts.

Additionally, GameStop continues to expand its "Simply Mac" concept. The company believes each store can target between 50,000 to 100,000 customers.

As a whole, mobile and consumer electronic revenues grew over 100% year over year to $102.2 million. The rapid revenue growth could be seen as a preview of what is to come as GameStop plans to build or acquire 300 to 400 of these stores during the rest of 2014.

Foolish take
GameStop has brilliantly created a whole universe of "buy-sell-trade" that spans phone stores, Apple stores, and video games. J. Paul Raines said that GameStop's vision has created a "tailwind for the category" which should excite investors.

In terms of GameStop's core business, it is reasonable to assume that the company will remain the market leader. Physical discs will likely be around for the foreseeable future given that the next-generation consoles contain disc drives and there are no talks on the table from the console manufacturers of blocking used games.

Electronic Arts has a solid lineup of titles in its pipeline including new "Battlefield" and "Need for Speed" games (the latter of which was delayed for a year), which positions the company attractively for growth over the near term. Additionally, digital revenues should continue to grow which should result in a higher margins.

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Jayson Derrick has no position in any stocks mentioned. 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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