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GameStop's Losing Big to Digital

By Lawrence Rothman, CFA - Jan 23, 2020 at 2:25PM

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GameStop is confronting increasing pressure from digital gaming companies.

GameStop (GME -4.79%) stock has not been fun for shareholders to own, losing approximately 90% of its value over the past five years. What's behind this precipitous fall? While management talks about the lack of new gaming systems hitting the market, the bigger picture is more troubling.

GameStop increasingly faces competition from digital games, including those backed by large and deep-pocketed companies. This is only going to intensify. The company's same-store sales, a key retail metric, have suffered, with a negative figure in 2018. Allso, its annual profitability has declined since 2015, going from operating income of $608.7 million in 2015 to an operating loss of $702 million in 2018.

For the first nine months of 2019, its operating loss widened from the same time frame in the year-ago period..

The fourth quarter does not look good, either. For the nine-week holiday period that ended Jan. 4, comps cratered 24.7%, and management lowered its fiscal 2019 comps guidance to -19% to -21% (prior expectation was a decline in the low teens) and now expects to report a loss for the year, although it did not provide a more specific figure. For the first nine months of 2019, GameStop lost $489.3 million compared to $526.3 million in the comparable year-ago period.

In a press release, CEO George Sherman said:

We expected a challenging sales environment for the holiday season as our customers continue to delay purchases ahead of anticipated console launches in late 2020. However, the accelerated decline in new hardware and software sales coming out of black Friday and throughout the month of December was well below our expectations, reflective of overall industry trends. While we expect the challenges that we faced in the fourth quarter to continue into fiscal 2020, we believe we have the right long-term action plans in place to optimize profitability and increase new revenue streams in advance of new console introductions for holiday 2020. 

While management is optimistic about the long term, I think there are major hurdles to the company growing sales and becoming profitable again.

A man sitting in front of a large computer monitor. He has his right hand covering his eyes. He is making a fist with his left hand.

Image source: Getty Images.

Digital erodes GameStop's sales

Microsoft has a version of its Xbox gaming system, Xbox One S All-Digital Edition, that does not use disks. Rather, you download games and stream media content. Although GameStop sells the system, it loses out on selling games, hurting higher-margin and more profitable new and used video game software sales.

Other behemoth companies such as Alphabet and Sony are also in the business of supplying digital gamers. Ubisoft Entertainment, a maker of well-known franchises like Assassin's Creed, is another major online game provider that continues to threaten GameStop's sales.

GameStop management continually cites the dearth of new consoles and remains hopeful that launches in late 2020, when Microsoft's Xbox Project X and Sony's Playstation 5 are due to come out, will turn around sales. On the third-quarter earnings call in early December, Sherman said:

Simply put, our top-line results remain softer than our original expectations and we believe they are a direct reflection of the overall industry. ... The near-term headwinds confronting the industry as we enter the final stages of the current Microsoft and Sony console cycles are having an outsized impact in our business, given we are the lone specialty retailer in the space. ... This is a console issue and consoles are the trigger point for our industry, with Generation 9 consoles on the horizon set to bring excitement and significant innovation to the video game space, those anticipated releases in late 2020 are putting pressure on the current generation of consoles and related games...

It is true that new video game hardware sales for the first nine months of GameStop's fiscal 2019 were roughly 41% below the year-ago mark. However, most of its other product categories, including new video game software and pre-owned video games, also experienced sales softness.

GameStop recognizes that video games are increasingly sold digitally, which is taking share away from physical video games. Its "GameStop Reboot" strategy, which was launched last May, includes building digital initiatives and pushing an omnichannel approach. Thus far, GameStop's digital sales comprise less than 3% of sales, and they experienced a sales decline in the first nine months of the fiscal year.

This game's no fun

Adding insult to injury, the company repurchased shares this year at higher prices than where it currently trades. Hence, it has not been a good use of capital thus far.

GameStop eliminated its dividend last June, never a good sign. While its efforts to conserve cash make sense, they do seem to indicate the issues facing the company are not transient.

All in all, GameStop is in a tough spot. While new gaming systems may help 2021 results, this could prove too little, too late given ongoing challenges.

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