We Are Witnessing the Death of GameStop
Soroush is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In the investing world, the term “value trap” is used to describe a stock that appears cheap when using traditional valuation metrics, but is trading at a lower than fair value due to a firm-specific factor, such as a fundamental industry shift, the loss of a competitive advantage, or leadership changes. In many cases, the bulls will run wild with any stock that appears undervalued, but it is important to determine if the ground is shifting beneath a company’s proverbial feet, because if it is, quantitative indicators may be unreliable. Here’s a good example of a similar situation that occurred last month.
GameStop (NYSE: GME), the $2.2 billion used video game retailer, has the characteristics of fitting this bill. Since the start of 2012, shares of GME have lost more than 30% of their market value, and currently trade at price-to-earnings (6.7X) and price-to-cash flow (3.7X) ratios far below historical averages. In fact, over the past half-decade, GameStop’s earnings have traditionally traded at a 9% premium to those of the S&P 500. This year, they appear much cheaper, trading at a 55% discount. While the stock’s undervaluation is more pronounced than console makers Microsoft (NASDAQ: MSFT) and Sony (NYSE: SNE), or game developers like Electronic Arts (NASDAQ: EA) and Activision Blizzard (NASDAQ: ATVI), it does not mean that the stock is a clear-cut buy. As mentioned above, there may be qualitative reasons for this sell-off.
Caught between a rock and a hard place, GameStop has been wounded by the mobile boom, which has hurt both the PC and console markets; this year alone, industry-wide sales are expected to hit only $12 billion, down from the $21 billion reported in 2008. As if this wasn’t enough, a growing transition toward downloadable content is very worrisome for brick-and-mortar retailers like GameStop. By 2017, it is estimated that digital delivery will account for $35 billion of the industry’s total revenues, up from $19 billion today. Over this same time, physical game sales are expected to remain stagnant. While it is predicted that GameStop’s digital revenues will increase from $675 million to $1.8 billion by 2017, this is but a drop in the bucket, which brings us to our next point.
Last year, GameStop acquired Impulse, a digital distributor of PC games, though this is hardly the business-saving move that many pundits claimed it would be. For starters, Impulse only garners between 5% and 15% of the digital PC gaming market share; privately owned Valve’s “Steam” service holds a whopping 70%. Secondly, this move only gives the company a foothold in the computing space; it is completely unprepared for the next generation of gaming consoles.
It is speculated that Sony and Microsoft’s next platforms – the unofficially titled “PlayStation Orbis” and the “Xbox 720” – will be out by Christmas of 2013. Moreover, both consoles are expected to rely heavily on digital game downloads, maybe even opting to go digital-only. These will be sold directly from game developers like Electronic Arts and Activision Blizzard, which obviously cut GameStop out of the picture entirely. Now, the retailer’s CEO has claimed that DLC add-on packages will be a key source of revenue going forward, but it will have to compete with game developers themselves, console-specific virtual stores, and larger peers like Valve.
While these two points can be debated, it is clear that GameStop will not return to the 2006-07 heyday when its network of 6,600 stores was the place to go to find used games. The digital gaming revolution makes the entire concept of a used game obsolete, and rumors of a fabled “used game trading platform” are just that – not to mention that publishers’ end-user license agreements expressly forbid them. By the time the next Microsoft and Sony consoles are in gamers’ living rooms, there will be plenty of places to digitally download video games from the likes of EA, Activision Blizzard, and other developers, or competitors like Valve; GameStop will have to keep up with the Joneses just to stay afloat. Compared to the high-flying stock investors once knew, we are undoubtedly witnessing the death of GameStop.
WealthLift’s Sentiment Index rates GME as a sell, with the majority of the community’s users placing an “underperform” rating on the stock. For more trading ideas in today’s uncertain market environment, WealthLift INSIDER has you covered.
WealthLift has no positions in the stocks mentioned above. The Motley Fool owns shares of Activision Blizzard, 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 Activision Blizzard. 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.