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GameStop, I'm Not Impressed

By Rick Munarriz – Jan 14, 2014 at 12:15PM

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GameStop sells a ton of hardware, but not a lot of software.

GameStop (GME -1.98%) investors are getting a glimpse of the future of the leading video game retailer, and it's not pretty. 

GameStop shares opened 15% lower today after it announced disappointing results for the critical holiday shopping season. The top line isn't scary. Global sales climbed 9.3% to $3.15 billion for the nine weeks through Jan. 4, fueled by a 7.1% increase in domestic comps and an impressive 17.4% spike in comps for its international locations. 

However, as you can probably imagine, the growth here was entirely the handiwork of Microsoft (MSFT -0.04%) and Sony (SONY 0.84%) putting out new consoles in November. New hardware sales nearly doubled as folks snapped up $500 Xbox One and $400 PlayStation 4 systems. 

That's pretty much where the good news ends. New software sales plunged by 22.5%. This was worse than GameStop projected, but any gamer could've seen this coming. Microsoft's Xbox One and Sony's PS4 are not compatible with game discs from earlier generations. Owners of Xbox One and PS3 consoles aren't going to be making big investments in software if they plan to upgrade later.

There's also the very nature of the Xbox One and PS4. Yes, they play games on discs, but they are also high-end TV-viewing set-top boxes. They feed into each company's digital marketplace where GameStop's once-potent niche of selling software is less relevant, given the vibrant ecosystems that Microsoft and Sony have established. 

This is the worst possible scenario for GameStop investors, because hardware is a low-margin category. GameStop has its biggest markups on software and pre-owned games and gear. If folks are walking into GameStop just to buy a next-generation console, they won't be buying too many physical games -- much less trading them in for store credit -- in the future. 

GameStop did experience a 7% increase in pre-owned sales, but that was mostly the older consoles that are now that much cheaper since they were traded in by early adopters saving up for the new Microsoft and Sony platforms. It wouldn't be a surprise to see pre-owned sales start to slip after this, just as it wouldn't be a surprise if new software sales don't bounce back as the digital migration takes over.

The end result of better-than-expected hardware sales and weaker-than-expected software sales is that the bottom line is going to take a hit. GameStop now sees a profit of $1.85 to $1.95 a share for the quarter, well short of the $1.97-to-$2.14-a-share range that it was forecasting less than two months ago.

GameStop shares nearly doubled in 2013 as investors warmed up to the potential of the Xbox One and PS4. Well, they're here, and now we're seeing holiday profits falling well below the $2.16 a share it rang up a year earlier.

The game isn't over for GameStop. It's still very profitable, and it's in fine financial condition. However, expect the naysayers who wrongly argued that the chain had peaked two years ago to begin getting vocal again. This time, they may be right.

Longtime Fool contributor Rick Munarriz has no position in any stocks mentioned. The Motley Fool owns shares of GameStop and Microsoft. 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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