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Is Now the Time to Trade in GameStop?

By Daniel Jones – Mar 23, 2014 at 4:00AM

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Now that Wal-Mart announced plans to begin accepting and selling pre-owned games, is GameStop toast? Or can the company somehow survive against the world's largest retailer?

Source: Wikimedia Commons

Wal-Mart Stores (WMT 1.22%)recently announced that beginning March 26 it would offer customers the opportunity to trade in used games for in-store credit. The retail giant's latest move caused investors to push shares of GameStop (GME 2.31%) lower by more than 3% on the day the development became public. Now that such a major market player is on the move, does this mean shareholders should trade in their shares of GameStop? Or does the specialty retailer still stand a chance?

The implications of Wal-Mart's move could be enormous
In its press release, Wal-Mart announced that its decision to repurchase and sell pre-owned video games opened the door to a $2 billion market. Incidentally, this is almost equal to the $2.4 billion in sales GameStop generated from pre-owned video game sales in 2013.

Making things worse for the specialty retailer, Wal-Mart said that it would begin its pre-owned game initiative at 3,100 of its 4,005 Wal-Mart stores in the U.S. It will also give gamers the ability to use store credit for the purchase of items in any Wal-Mart, Sam's Club, or online. This stands in stark contrast to the opportunity to only trade in games at GameStop for in-store credit that can be used for game-centric purchases. It also represents, numerically, a significant threat to the 4,425 GameStop stores located in the country.

Source: Wikimedia Commons

Wal-Mart's move isn't out of spite
If you think that Wal-Mart is moving into the pre-owned video game market solely for the purpose of stealing a few pennies on the dollar, think again. GameStop's 2013 gross margin on pre-owned games was 48%, which was converted to a gross profit of $1.2 billion and accounted for 44% of the company's gross profit for the year.

This is far greater than the 22% gross margin the retailer generated from new video game software and better still than the nearly 8% margin booked from its new video game hardware sales. Another way to view the situation is to compare it to Wal-Mart's gross profit margin. For the year, the mega retailer saw its consolidated gross margin come in at 25%.

Foolish takeaway
Based on the data provided, it looks as though Wal-Mart is making a very intelligent, strategic move. Aside from jumping into an area that can provide some nice, fast revenue growth, it will also experience higher margins than consolidated sales offer now.

More likely than not, Wal-Mart's entry into this market will result in depressed margins for GameStop. The smaller franchise lacks the same economies of scale its larger rival has created over time. This will likely serve to harm the specialty retailer, which has already seen its net income fall over the past three years from $408 million to -$269.7 million...but may not kill it off. Either way, the picture for GameStop doesn't look too nice going forward, while the future for Wal-Mart looks brighter than ever.

Daniel Jones has no position in any stocks mentioned. The Motley Fool owns shares of GameStop. 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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