GameStop (GME):  A Secular Decline Story
Price Target $17.50

Link to SI News Release
June 6, 2017

Once upon a time GameStop (NYSE:GME) was a sexy growth story.  During its heyday, the company’s stock price shot up from a low of $3.86 in February of 2003 to a high of $63.30 in December of 2007.  Those were the glory days.  Thereafter, the stock traded in the $50s, then in the $40s, then in the $30s, now in the low $20s.  We expect this trend to continue, and we see the stock trading in the $17s within a year.  With a lack of catalysts and the significant investment risks facing GameStop, were it not for the dividend, we would have forecasted an even gloomier stock price.  For sure, this company represents a dying breed of retailer. 

GameStop’s crisis is at once secular and macro in nature; quite outside of its control.  Secular declines were key bankruptcy drivers for companies such as Circuit City, Blockbuster Video, and Sam Goody.  History shows that these three bankrupt companies were less able to adapt their business models to a changing and dynamic marketplace.  Such is the case with GameStop.

Circuit City, which filed for bankruptcy protection in 2008, had many of its retail locations in close proximity to competitor Best Buy (NYSE:BBY) but was unable to effectively compete with its more relevant rival.  In fact, just a couple weeks ago, Best Buy’s most recent earnings report showed a beat on its top and bottom lines as well as a 1.6% increase in comparable sales, quite a feat in the age of Amazon (NASDAQ:AMZN).

GameStop is facing a crisis with its business model, very similar to Blockbuster Video, which filed for bankruptcy protection in 2010.  Blockbuster, the former provider of home movie and video game rental services, reached its heyday in 2004 when the company consisted of approximately 9,000 retail locations and 60,000 employees.  Shortly thereafter, a secular shift occurred in the home video space, one that Blockbuster was never able to take advantage of.  Netflix (NASDAQ:NFLX) dethroned Blockbuster with a better and more adaptable business model, first with movies direct via mail, then with video on demand, now with original content.

GameStop bears a striking resemblance to Sam Goody in many respects.  Sam Goody was a music and entertainment retailer which filed for bankruptcy in 2006.  The company’s sales consisted primarily of music and video game sales.  It began as a small retailer of vinyl long-playing records, eventually moving to the era of CDs.  At its peak, Sam Goody consisted of over 800 retail locations.  Due to the challenges posed by stiff competition, neither of its successive parents (Best Buy then Musicland then Trans World Entertainment) were able to revive the Sam Goody brand.

This quarter, the Nintendo Switch provided a much needed boost to GameStop’s most recent earnings report.  Earnings per share topped expectations by $0.12 and revenues similarly topped expectations slightly, resulting from an increase in hardware sales of 24.6% and gains in accessories of 8.2%.  However, the company’s website shows no more of the consoles in stock, while it can currently be purchased at the websites of Amazon, Ebay (NASDAQ:EBAY), Wal-Mart (NYSE:WMT), albeit at higher prices.  Going forward, the delay of “Red Dead 2” by Take Two Interactive (NASDAQ:TTWO) into 2018 could cost the company 1.5% in total sales.  Guidance is somewhat unclear because while it implies improvements in the second half of this fiscal year from Apple’s (NASDAQ:AAPL) expected iPhone 8 launch, annual revenues are expected to decline by as much as 5%.

GameStop is facing an existential crisis at this point in time.  The company has no competitive advantage or uniqueness.  Most of its products can be purchase elsewhere online.  And while the overwhelming majority of gamers believe that playing video games increases mental acuity (which will further serve to grow the video game industry), mobile gaming is the new wave.  Gamers are increasing downloading games digitally, rather than picking up games in stores.  According to Newzoo, “Mobile gaming generated 37% of total global video videogame revenue in 2016, rising 21.3% year over year and surpassing PC revenue for the first time ever.”  Virtual reality is a bright spot in the gaming sector as 40% of the most frequent gamers say they intend to purchase VR within a year.  eSports is another area of growth.  Its sales are expected to top $589 million worldwide by 2020. 

Who benefits most from these changing trends in gaming?  Certainly not GameStop.  Activision Blizzard (NASDAQ:ATVI), maker of Call of Duty and WarCraft, stands poised to benefit.  Electronic Arts (NASDAQ:EA), owner of Madden and FIFA, also stands to benefit from these changing trends in gaming.  These two makers of videogames are reaping the rewards from the growing trend toward digital distribution, a process that bypasses GameStop altogether.

Ontario-based online giant Shopify (NYSE:SHOP) is tightening the screws even further into GameStop’s coffin.  The company has recently released a new software development kit called Unity Buy.  Unity Buy will allow gamemakers to sell physical goods such as T-shirts or hats within the game, just like ordering from a store.  Gamemakers will now have a direct ingame option to sell branded merchandise relating to their games to gamers using their credit cards, another growing trend that bypasses GameStop altogether.  Electronic Arts’ Madden NFL and TakeTwo Interactive’ NBA 2K could benefit greatly with increased sales of licensed NFL and NBA merchandise.

Going forward, GameStop is placing its fortunes in collectibles, board games, new game consoles, and the Apple’s iPhone 8.  The first 3 are a dying breed, proving our point that the company is clearly unable to adapt its business model to a changing and dynamic marketplace.  While GameStop expects sales of collectibles to total $650 - $700 million in fiscal 2017, collectibles will not turn its fortunes around.  Neither will board games.  Neither will game consoles, which may be obsolete by 2020.  This strategy is akin to Sisyphus pushing that rock up the hill.  Albert Camus hit the nail on the head.  The gods were wise in perceiving that an eternity of futile labor is a hideous punishment.  Hideous punishment indeed!

Disclosure:  We are short GameStop.  We do not have a financial relationship with the company.