Shares of GameStop Corp. (NYSE:GME) have doubled since hitting a 52-week low near $15 last summer. However, GameStop stock dropped precipitously last week, from more than $39 on Monday to $32.35 by early Friday afternoon.
Which of these is the “real” GameStop Corp. (NYSE:GME)? Is this a long-undervalued stock finally getting its due, or a falling knife? I think the latter is more likely to be the case. The GameStop business model is being disrupted from multiple angles, such as: (1) the growth of mobile gaming, (2) new innovations that will enable “cloud”-based gaming, and (3) changes in the video game distribution landscape.
As a result, while management is confident that the company will return to earnings growth next year, I think the company could be entering a permanent decline. The launch of new game consoles from Sony Corporation (ADR) (NYSE:SNE) and Microsoft Corporation (NASDAQ:MSFT) could provide a brief boost, but no more. As a result, GameStop Corp. (NYSE:GME) stock — which still trades for more than 10 times earnings — could decline much further.
Mobile gaming arrives
Mobile games are obviously not as good as console video games or PC games. However, for many casual gamers, mobile games will be “good enough.” The widespread penetration of smartphones and tablets means that most people now have a mobile gaming device. Moreover, NVIDIA Corporation (NASDAQ:NVDA) is betting that the shift to mobile gaming will go beyond casual gamers. The company recently launched “Project Shield”: an Android-powered mobile gaming device that includes a console-quality controller.
While GameStop may make some money from hardware sales of the $349 Shield, software sales will all go through the Google Inc (NASDAQ:GOOG) Play online store. This is critical, because GameStop Corp. (NYSE:GME)’s gross margin on hardware last year was just 7.6%. The company really sells new gaming hardware in order to drive more profitable software sales. If the software revenue stream starts to dry up, GameStop stock is likely to hit further turbulence.
Moving to the cloud
Another risk for GameStop Corp. (NYSE:GME) stock is the potential for wholesale disruption of the game console market. NVIDIA Corporation (NASDAQ:NVDA) is a threat here, as well. The company is building GPUs for server environments, which could allow the streaming of video games. The graphics will be rendered by cloud-based GPUs and the video output sent to the user’s TV, tablet, or other screen, while controller input will be sent back to the server. NVIDIA Corporation (NASDAQ:NVDA) has stated that this new platform (called GRID) will have latency similar to a traditional console.
By centralizing the hardware, it will allow game creators to create software-as-a-service offerings. This new business model would eliminate the up-front hardware and software costs associated with today’s game consoles, which would be popular with many gamers. As a result, cloud-based gaming could significantly disrupt the console market over the next few years. GameStop Corp. (NYSE:GME) would be a clear loser from this development.