What a Paradigm Shift in Gaming Means for This Retailer

Successfully pivoting away from you core business model is never easy. Can this electronics retailer be one of the few successes?

Jun 6, 2014 at 11:00AM

Mobile gaming is on the rise, and soon enough you will be able to play major video games, such as FIFA and Madden, with just your TV. That could mean bad news for one of the nation's largest consumer-electronics retailers, GameStop (NYSE:GME). Shares are now down 25% year to date and are 35% off of their 52-week high back in November.

The short interest in the stock remains high at 28%, which makes it one of the most shorted stocks in the market. This means that a large part of the market is still betting that GameStop has more downside to come.

Feeling pressure from all angles
It is tough to be bullish on GameStop's business model, especially when retail giant Wal-Mart is getting active in the used-game space. Wal-Mart started allowing customers the ability to trade in their video games earlier. Shoppers can then put that money toward the purchase of anything at Wal-Mart.

GameStop and Wal-Mart actually have a similar number of stores in the U.S., slightly more than 4,200. Yet the key for Wal-Mart is that shoppers can visit its stores to buy or trade in games while also picking up nearly every other necessity.

The decline of shoppers actually visiting stores to buy consumer electronics is another headwind for GameStop. Sears Holdings noted on its recent earnings call that its biggest drag on sales last quarter was the consumer-electronics business.

Expanding beyond its core gaming business
It took seven years for Microsoft and Sony to launch new consoles. Could this be the last iteration of consoles? With the rise of mobile gaming and smarter TVs, it is quite possible. As a result, GameStop has turned to focusing on wireless stores.

It invested $77 million in wireless stores in 2013, including buying up Simply Mac, Spring Mobile, and an AT&T authorized retailer. In 2014, GameStop plans to double the number of opened Simply Mac stores, which sell and repair Apple products.  

On the wireless side, it will be opening upward of 250 locations for its AT&T exclusive Spring Mobile subsidiaries and as many as 150 Cricket Wireless storefronts. On the other hand, GameStop has its own AT&T postpaid wireless stores called Aio Wireless. The problem is that third-party wireless stores are not as profitable as its game-focused stores.

Weakness in other areas
On average, GameStop's stores average 1,400 square feet. Compare that to Best Buy (NYSE:BBY); its stores average 45,000 square feet. GameStop plans to focus on stores that are between 900 and 2,600 square feet for its wireless locations. If stores come in on the upper end of that range, that larger square footage will require additional capital spending.

As well, toward the end of 2013, Best Buy got more aggressive on its game trade-in discounts. It already offered 10% discounts on pre-owned games, and 10% credits for trade-ins for its loyalty program for gamers. But its most recent initiative has the company offering 20% for new video game purchases. 

My Best Buy Gamers Club Unlocked membership. The consumer electronics superstore's loyalty program for die-hard gamers, which offered double the points on purchases that could be used for reward certificates, 10% discounts on pre-owned games, and a 10% credit on trade-ins, introduced a new savory perk: Best Buy would offer members 20% off new video game purchases.

The wireless industry could be seeing some weakness as well. Best Buy saw sales come in below expectations last quarter, driven by soft demand for mobile phones. The company expects that to continue for the next few months.

How shares stack up
GameStop has been a workhorse for investors when it comes to returning capital. Its current dividend yield is 3.5%. It has reduced its shares outstanding by 30% over the last five years. What is more is that Its dividend yield is the highest it has been in almost four years.

GameStop trades at a P/E ratio of 10 based on next year's earnings estimates. Best Buy trades at a forward P/E of 11. GameStop's return on invested capital is still a solid 16%, which is higher than Best Buy's 13%.

Bottom line
GameStop is still struggling to find its own identity. The rise of downloadable games and new gaming outlets could put a further damper on GameStop's sales. For investors looking for exposure to the consumer-electronics industry, they would be better off looking elsewhere.

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Marshall Hargrave 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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