GameStop (GME -0.26%) expects to do pretty well for itself now that the gaming console upgrade cycle has officially kicked off. Although its stock cratered after the release of its third quarter earnings report, the video game retailer says now is when the rubber hits the pavement.
Now that Microsoft (MSFT 0.13%) has released its new Xbox series X and Sony (SONY 0.84%) debuted the new Playstation 5, GameStop anticipates the new consoles are "now segueing into what we see as a period of sustained growth." And with an activist investor pushing GameStop to slim down and lean into the digital gaming revolution, the retail outlet might not be at death's door any longer, no matter the market's reaction to the earnings news.
Addressing the elephant in the room
GameStop reported sales plunged 30% year over year to $1 billion, which was below the $1.1 billion Wall Street expected, but the $0.29 per share loss it recorded was much better than the analysts consensus of $0.85 per share.
Comparable store sales plummeted nearly 25% in the period, worse than the 20% expected, but the retailer said November's comps -- reflecting when the game consoles went on sale -- jumped 16.5%, marking the first month in nearly two years GameStop saw an increase.
CEO George Sherman basically said the quarter was as bad as everyone thought it would be, but now it's going to get better from here. Let's see if the optimism is warranted.
It took some time to bring GameStop to heel, but it certainly appears this old dog is learning some new tricks.
The retailer signed a partnership deal with Microsoft that not only allows it to use the software giant's cloud-based back-office business solutions platform, but importantly also gives GameStop a cut of any revenue generated from the Xbox ecosystem on sales it makes along the line.
How much that's actually worth to GameStop is unknown, but it is an alternative revenue stream tied to the digital age of gaming and indicates Microsoft at least still views the retailer as important to the future of video games.
GameStop also began selling TV sets from Vizio that are manufactured for gamers. The new sets are exclusive to the retailer and the 4K P-Series Quantum TV was rated by industry site IGN as the best 4K gaming TVs of 2020. While most people won't think of GameStop as their first stop for a new gaming-oriented TV model, it seems a natural extension of its product offerings.
Like the Microsoft deal, the exclusive partnership with Vizio shows GameStop has begun thinking differently about the future. It needs to transform its business, and these baby steps are a welcome change.
A whole new mindset is needed
Yet GameStop needs to go much further. Activist investor RC Ventures thinks the retailer isn't doing nearly enough to change course and more drastic action is needed.
The hedge fund is worried the fleeting success GameStop is enjoying will convince management it is on the right track and will keep it from implementing strategies that strike at the core of the old way of doing business. It sent a letter to management excoriating its leadership that has damaged the company, and said the stock gains merely mask the deficiencies still present.
Much has been made of the massive increase in digital sales generated during the pandemic, but it's clear that is mostly a one-off event. Suddenly confronted with few options for entertainment when forced to stay home, gamers turned to GameStop's online store to get what they needed, but the growth rate of such sales is declining.
E-commerce sales jump 519% in the first quarter, and were up over 1,000% during the six week period its stores were closed at the onset of the pandemic. They then rose 800% in the second quarter, and GameStop just said they rose 254% in the third.
While that's hopeful because it suggests gamers still view GameStop as the go-to place for video game hardware and software, it also means after the pandemic passes, the digital channel may just normalize. Also, there's a lot of online competition coming, not least from Amazon.com, Apple, and Alphabet's Google, which have launched new streaming services that don't require physical consoles.
The hedge fund views that correctly as a real threat to GameStop's stores, which is why it says the retailer must focus only on its most profitable locations and get rid of all the others. GameStop has also yet to prove it can sustain an omnichannel business model that leans heavily on the e-commerce portion.
What comes next
Because the upgrade cycle will soon pass, GameStop can't wait. It needs to take whatever profits it generates from the early stages of sales and invest them in whatever course it will take to confront tomorrow's challenges.
I like that management seems to show a willingness to think differently, but there also need to be signs that bigger changes are coming. For example, GameStop announced it intended to sell $100 million in shares of new stock, essentially the opposite of the stock buybacks investors have urged the company to do.
Where buybacks boost earnings per share, stock sales dilute investor holdings, though it would give GameStop some financial flexibility to meet any liquidity challenges.
Even with the big drop in its share price as a result of the earnings news, the stock still has come very far on hope for change. Investors should probably continue sitting on the sidelines until the video game retailer shows it is ready to take the next step.