This Game is Complex and Risky

Mihir is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The last few days have been super exciting for gamers across the globe with the announcement of the much awaited Microsoft's (NASDAQ: MSFT) Xbox One, as well as the announcement for the launch of the PlayStation 4. Even though Xbox One has been caught in a privacy issue, its functionality and other aspects have been lauded by gaming experts across the board. This could well be the break the gaming industry had been looking for and a window of new opportunities for GameStop (NYSE: GME), the world’s largest multi-channel video games retailer.

First quarter: the good and the bad

The results for the first quarter had both high and low points, with the biggest area of concern being a drop of approximately 25% in GameStop's net earnings on a year-over-year basis. Total global sales took a hit of 6.8% amidst tough business challenges. Lately, the gaming industry has slowed down because of a lack of newer attractions that could keep customers engaged. 

Some good news for investors is a massive growth of 290% in mobile sales. We know mobile is going to be the future, and it is encouraging to see GameStop already in the league in a big way. The advent of smartphones has led to customers switching from gaming consoles to cheaper and exciting mobile games, and as such have led to hard times for the video games retailer. Hence, a growth of 290% in mobile sales is welcome news for the company.

Another laudable thing was GameStop’s cost cutting initiatives, which enabled the company to achieve higher margins this quarter compared to last year. GameStop also increased its market share this quarter, and expanded its gross margin by 100 basis points. 

The beginning of new challenges

It’s definitely soothing to see some good things happening, but sadly the challenges are far from over for the company. One of the biggest challenges GameStop faces is around the used games business, which accounts for almost a third of the company's revenues. The buying and selling of used games is a big component of GameStop’s business, whereas console manufacturers like Microsoft are inclined towards the sale of new games more than used games. As per reports, Microsoft is expected to charge a fee for used games with the launch of Xbox One, and this will put GameStop in a tight spot as to the pricing of used games, as well its distribution.

However, I am not really confident about Microsoft's pricing strategy for Xbox One at $399, as the high price can easily discourage gamers from buying a new console. Microsoft has packed in a host of new features, including watching TV, into the new console, but since its main audience is gamers, such a high price might not be sustainable.

Best Buy Vs. GameStop

Being the world’s largest video gaming retailer, GameStop does not face huge competition in the industry--it mainly competes with Best Buy (NYSE: BBY). Lately, GameStop has been eating into Best Buy’s market share as the latter has failed to provide a diverse collection of new and used games at competitive prices. Best Buy has been struggling for quite some time to meet investor expectations as a result of fierce competition, high costs, and a limited selection of products.

Even though it reported better than expected results in the first quarter with non-GAAP EPS of $0.32, Best Buy is far from having a positive trajectory. CEO Hubert Joly has done a good job on managing spending and discontinuing unfavorable operations as a move to sustain profitability. Like GameStop, Best Buy is also expecting to ramp up its gaming sales with the launch of new gaming consoles. If Best Buy can capitalize well on these newfound opportunities in the gaming industry, it would provide a fresh breeze during a rough patch.

The final words

Coming back to the point of used games and new gaming consoles, let me first brief you about the entire scenario and then talk about how it affects GameStop. After the launch of Xbox One, Microsoft announced that if a gamer wants to play a used game, he will have to pay a charge for installing it on his console. This means that a particular game can be attached to only one Xbox Live account. There is not enough clarity around this now, but if this is confirmed then it poses a serious concern to GameStop. It will then have to take decisions regarding the pricing of such used games because gamers might want to actually get the new game instead of paying a fee plus the cost of the used game. This is going to be a big challenge for GameStop, which has established a strong foothold in the market for used games.

Another big question for GameStop to handle is the fast-paced transition to digital games. Most gamers prefer to download game files directly to their consoles instead of buying game discs. I can see GameStop trying to enter the territory of digital games, but as of now it does not have a large share in this market. This quarter digital receipts grew by an impressive 47.3%, but the key is to maintain this growth over time as more and more gamers are moving towards a digital format.

I would not suggest taking a new position in the stock until we get more clarity around used games from Microsoft and Sony (anticipated to follow the same course as Microsoft). Besides this, we should also wait to see the response to the Xbox One. 

The brick-and-mortar versus e-commerce battle wages on, with Best Buy caught in the middle. After what might have been its most tumultuous year in history, there are now even more unanswered questions about the future for the big-box electronics retailer. How will new leadership perform? Will a smaller store format work out for both the company and its brave investors? Should you be one such brave investor? To help answer all these questions, The Motley Fool has released a premium research report detailing the opportunities -- and the risks -- in store for Best Buy. Simply click here now to claim your comprehensive report today.

Mihir Mehta has no position in any stocks mentioned. The Motley Fool owns shares of GameStop and Microsoft. Try any of our Foolish newsletter services free for 30 days. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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