GameStop Investors Need to Look Beyond the Console Upgrades

With its stores closed for long stretches as part of the pandemic shutdown, GameStop (GME -0.68%) was always going to see its second-quarter earnings skewed. But its financial results should be a secondary consideration. 

The start of the upgrade cycle for video game consoles is of more immediate importance, and really, investors should be looking out much further than that as well. The shelf life of game consoles is growing longer, and though GameStop will profit from gamers upgrading their systems now, the industry is transitioning away from the retailer's wheelhouse.

GameStop needs to fundamentally transform its business to accommodate this new model if it wants to survive, let alone remain relevant to consumers, which waiting for the next console iteration won't do.

The new Xbox Series X and S gaming consoles. Image source: Microsoft.

The new consoles are coming

Microsoft just announced the new Xbox Series X will go on sale in November at a price of $499 (with the Series S costing $299), with Sony right behind with its PlayStation 5.

The preorder process saw the consoles virtually sellout in short order, but GameStop, can't count on the rush to keep it going.

The gaming retailer came into this upgrade cycle grasping for a lifeline, and these potent new machines promise to revive its flagging fortunes. PC-level power, 4K graphics capabilities, 8K TV support, ray tracing, and solid-state drive storage are just some of the features that have gamers salivating at the potential.

Yet the transition to online gaming means the next cycle could be even more damaging to GameStop's business if it's even still around. 

The long goodbye

The life cycle of video game consoles is being extended with virtually every new version, and their average life span is about 77 months, or a little over six years and rising.

GameStop won't be around in 77 months if it keeps doing business the same way. Net sales fell 27% last quarter, which was somewhat better than the 34% plunge in the first, but adjusted losses nearly tripled to $91 million compared to the year-ago period.

The 800% jump in e-commerce sales this quarter is also hopeful, even if it represents a meaningful slowdown from the first quarter. GameStop, though, says online sales should become a $1 billion business this year.

The question is whether it can maintain that momentum going forward. A lot of the online sales were driven out of necessity, and we've already seen the e-commerce sales growth moderate, slowing from 1,000% gains in the six-week period its stores were forced to close in the first quarter.

But it's just a short-term fix because the benefits of the console upgrades may take time to materialize. For example, there might not be as many games available beyond the few marquee titles like Halo Infinite for the Xbox and The Last of Us Part II and Ghost of Tsushima for the PlayStation, and consoles are a low-margin business for GameStop. It makes most of its profits on reselling.

And the dearth of quality titles is one major reason not everyone rushes out on day one to buy a console, along with the bugs that are inherent in a new system. It's why GameStop can count on robust console sales for several years: The second wave of buyers is usually much larger.

Yet it's what happens when those sales begin to fade that investors need to be thinking about.

A new future

GameStop can't simply continue being the retail middleman and needs to make its vast network of 5,000 stores a destination location for gamers. To an extent, it's begun doing that with its store renovations that allow gamers to try out new titles. But it needs to really lean into the social aspect of gaming and the community that grows up around it.

How it participates in the digital arena, however, will be key to GameStop's long-term viability. It has a new chief digital officer to focus on the issue, and the retailer is launching a redesigned mobile app later this month that it says will make the gamer's experience in-store and outside more meaningful. Execution will determine its success.

And most recently an activist investor revealed a 10% stake in GameStop with an idea to transform it into an e-commerce play by expanding its selection of goods and offering super quick shipping that would rival Amazon.com.

As farfetched as that sounds, the console upgrade cycle could at least allow GameStop to take the profits it should generate from these sales and plow them back into these initiatives and more.

Should I stay or go?

There will always be people who resist the digital transformation, while demands on broadband delivery brought on by the pandemic will constrain the ability of others to fully pursue digital gaming as much as they want. There will still be a need for physical media, but GameStop can't be the buggy whip manufacturer in the age of the automobile.

Few companies are as enmeshed in the fabric of their industry as GameStop is in video games, yet it can come to an end. Investors need to look beyond the current earnings season and even the upgrade cycle, and determine whether GameStop is growing with the industry or remaining stuck in the past.