Gamer Survey Shows Why GameStop Might Not Be Doomed After All

The bear thesis for video game retailer GameStop (GME 2.56%) is well known -- sales of cloud-based digital games will eventually overtake sales of new boxed games, which account for over half of its top line. Netflix (NFLX 1.74%) and Apple (AAPL 0.52%) iTunes' respective victories over Blockbuster and Sam Goody/Musicland also seemingly support the notion that GameStop could soon be irrelevant.

Yet new data from GameSpot GameTrax, which surveys 3,500 gamers across its CBSi Games Network monthly, revealed that the vast majority of Sony PS4 and Microsoft Xbox One gamers still preferred buying boxed versions of the games.

Even though 48% of Xbox One owners and 42% of PS4 owners had purchased at least one full-price digital title, these games only accounted for a small percentage of total games sold. Over 75% of the PS4 and Xbox One titles purchased by the CBSi audience were boxed retail copies.

When asked about their overall preference in game purchases, the gamers overwhelming supported boxed retail versions over their digital counterparts:

Source: GameSpot GameTrax, March 2014.

Here are the five leading reasons that the surveyed gamers disliked digital downloads:

• Lack of resale and trade-in value

• Preference of a physical copy for a collection

• Lack of sufficient hard drive space on the console

• Slow downloads or throttled speeds/download caps from their ISP

• Lack of digital ownership rights

The first two reasons strongly indicate that GameStop's core businesses of selling and trading video game software and hardware could still have a bright future despite its low-tech approach.

GameStop's quarterly sales remain robust
During the third quarter, GameStop posted year-over-year comparable-store sales growth of 20.5%, fueled by strong sales of triple A titles such as Take-Two's (TTWO 0.42%) Grand Theft Auto V.

Sales of new video game hardware and software soared by the double digits, despite the fact that GameStop's third quarter ended on Nov. 2, prior to the North American launches of the PS4 on Nov. 15 and Xbox One on Nov. 22.

Source: GameStop 3Q report.

GameStop's fledgling mobile and digital sales segments respectively reported sales and receipts growth of 14.4% to $49.9 million and 8.6% to $137.9 million.

Despite that robust top line growth, bearish arguments portraying GameStop as the next Blockbuster or Sam Goody have caused the stock to tumble more than 20% over the past six months. An NPD report that software sales fell 17% year-over-year in the crucial holiday quarter of 2013, reinforced by GameSpot's own sales decline over the holidays, also spooked investors.

Yet investors had already expected weak video game sales throughout fiscal 2013, since gamers were expected to hold off on purchases until GTA V hit the market in September and new consoles arrived in November. While it's clear that sales of GTA V boosted GameStop's new video game software sales, its double-digit growth in new video game hardware during the tough third quarter is admirable.

Bears oversimplify the mind of the gamer
Leading publishers like Activision Blizzard (NASDAQ: ATVI) and Electronic Arts (NASDAQ: EA) are eager to embrace the model of digital distribution for an obvious reason -- it's a high-margin business that eliminates the costs of boxes, manuals, and physical discs.

Gamers, however, aren't the same as Netflix or iTunes customers.

Video games are frequently classified with toys, and not movies or music, for a key reason -- they are products that are meant to be played with. Video games are digital toys and sandboxes, and not simply films or CD tracks that are purchased, downloaded, and played.

Activision's Skylander interactive toys. (Source: Giantbomb.com)

That's the reason Activision reached out of the digital world and into the physical one with its Skylanders interactive toy figures, and why publishers still sell massive collector's edition packages filled with physical items. The film and music industries have tried similar tacticst, but rarely in packages as large as collector's edition video games.

GameStop bears also miss the fact that gamers love to buy their consoles at retail stores for two simple reasons -- instant gratification and the lack of shipping fees. Moreover, when gamers purchase a console at the store, they will likely pick up a few boxed titles as well to reinforce a sense of physical ownership. Gamers also love to trade in their software and hardware every console cycle, and as long as they do so, there will be a market for brick-and-mortar retailers like GameStop.

Hardware and bandwidth limitations
Both the PS4 and Xbox One are equipped with 500GB hard drives. That might seem like plenty of space, but consider the installation sizes of some upcoming titles:

Sources: Rock Paper Shotgun, Push Square, Geek.

Although those requirements don't look too overwhelming, gamers should remember that each game will require big updates (often over 1GB in size), and DLCs (downloadable content) will gobble up several more gigs of space per title. These games will only get bigger as the PS4 and Xbox One mature graphically.

Considering the fact that Net Neutrality was recently nixed in the United States, the average download speed per customer could be throttled, especially for gamers regularly downloading 50GB games onto their hard drives. Therefore, we could reach a breaking point when it would simply be faster to drive to GameStop and buy a physical copy of the game instead, as long as the majority of the game data is on the disk.

Netflix, which streams HD video at a rate of roughly 1 to 3 GB per hour, has already cut a deal with Comcast (NASDAQ: CMCSA) for faster speeds. Apple, which also sells full-length TV shows and films via iTunes, could be next. That punches a huge hole in the idea that cloud-based gaming will destroy physical games and render GameStop obsolete.

If anything, the end of Net Neutrality and the start of metered Internet connections will directly boost sales of physical games.

Game over for GameStop? Hardly.
A lot of people are buying into the broad and uninformed argument that cloud-based games will leave GameStop in the dust. Short interest in the stock has more than doubled since the end of September.

However, these bears are neglecting the hardware and bandwidth limitations for distributing eighth generation games, as well as the market preference for boxed games -- which could help GameStop avoid Blockbuster's fate.