Video Game Sales Continue to Plummet, GameStop Down Big
RJ is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
According to market research firm NPD, sales of physical video sales fell 28% in May 2012 compared to May 2011. As a result, video game store GameStop (NYSE: GME) has seen its shares drop precipitously. Sales in its most recent quarter were down 12% compared to the same time last year, and net income fell 10%. Though the company is facing stiff competition from online retail and direct downloading via Xbox Live (MSFT) and the Playstation Network (SNE), we think the sector faces many challenges going forward. As a result, we are putting the firm’s valuation under review.
Since the video game hardware makers tend to cluster releases within the same time period as each other, the console market right now is fairly mature. Xbox 360 was released in late 2005, while Playstation 3 and Wii (NTDOY) were released in late 2006. As consoles mature, the price of the hardware falls. Therefore, an Xbox that retailed for $399 is now available for $299.
Instead of focusing on building new platforms and next generation consoles, Microsoft (NASDAQ: MSFT) and Sony (NYSE: SNE) have focused primarily on building additional console accessories. Microsoft has updated Xbox with new software, improved the user experience into a full-service entertainment device, and added Kinect. Nintendo (NASDAQOTH: NTDOY.PK) has announced its successor to the Wii, but neither Sony or Microsoft have followed suit.
Though the lack of new hardware is certainly hurting GameStop, we think the lack of releases is having a greater impact. According to NPD, releases are down 27% year-to-date. During the days of Super Nintendo and Sega Genesis, there were literally thousands of titles available. The technology wasn’t nearly as advanced, so the cost of games was significantly cheaper than it is today. Consider for a second that there was a video game for the show ”Home Improvement” on Super Nintendo, which would never happen today. With the massive amount of research and development that goes into making games, and the relatively concentrated number of games that people play (a result of online multiplayer modes), video games have to be blockbusters to be worthwhile for the game makers, as was evident from the recent results at Electronic Arts (EA) and at Activision Blizzard (ATVI).
In addition to fewer games being developed, the gaming sector is being challenged by the evolution of mobile gaming. Gameboys were popular; however, it is the iPhone (AAPL) and Android (GOOG) that are stealing share from the consoles. Games like Zynga’s (ZNGA) “Scramble with Friends” are capitalizing on smartphone growth and taking advantage of the social aspect of gaming. Though “Call of Duty” and “Angry Birds” aren’t perfect substitutes by any means, we believe casual gamers are more likely to download free or $0.99 games than shell out $60 for the latest console titles.
This trend is hurting everyone from the consoles like Xbox and Playstation, to the software makers like EA, all the way down to Best Buy (BBY) and GameStop. Further, we think the generation that grew up with console gaming is gradually aging, leaving them with less time to play video games, resulting in fewer purchases.
Since all of these trends point to a secular decline, we think competitors at every level of the supply chain will battle to capture profits. Though Sony announced its next-generation console will have a physical disk drive, we think a lot of game buying will move to digital downloads. Much like TV, digital downloads provide users with the path of least resistance. Why run out to GameStop, which will add financial and time costs, when a user can simply download the game in five minutes? There are some obvious constraints, such as storage space, but we expect storage prices will continue to fall over the long term. The game makers will also have to spend less on physical distribution and will not have products resold, so we think software companies would certainly support the transition. We think there’s a very real chance that video game stores go the way of video and music stores.
GameStop can buy back stock and pay a dividend, but the long-term prospects of the company are not very favorable, in our view. The firm’s large store footprint will likely require some closures, but the company still has a chance to survive. The used game selection at GameStop locations is generally very robust, and consoles have a collection of hardcore gamers that will always enjoy playing — often going into the store. We are reassessing our valuation of the firm’s shares and plan to publish an updated report soon.
Valuentum has no positions in the stocks mentioned above. The Motley Fool owns shares of GameStop and Microsoft and is short Sony (ADR) and has the following options: long JAN 2013 $22.00 calls on Sony (ADR). Motley Fool newsletter services recommend 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. If you have questions about this post or the Fool’s blog network, click here for information.