Sony Corporation (ADR) (SNE), Microsoft Corporation (MSFT), GameStop Corp. (GME): This Is Still a Value Trap

Microsoft has pushed aggressively into cloud computing, and some investors, like the hedge fund ValueAct, believe Microsoft’s real value lies in its public cloud product, Azure.

Games that rely on the power of the cloud to function are inherently digital. If part of the gaming is being rendered on Microsoft’s servers, the files kept on the physical disc do not truly represent the actual game.

It won’t happen overnight, but by the end of their life cycles, both the Xbox One and the PlayStation 4 could be primarily digital consoles.

What about refurbished electronics and its digital game sales?

GameStop’s management understands the challenges to the company’s business long-term. To offset the eventual decline of used games, GameStop has diversified into two areas: refurbished electronics and digital games.

The former is an interesting notion, but seems unlikely to offset the decline of GameStop’s game business. GameStop buys used smartphones, mp3 players and tablets, refurbishes them, and resells them. GameStop has done this for years with used video game consoles.

But GameStop is one of the only companies refurbishing consoles; when it comes to tablets and smartphones, there is plenty of competition: the online service Gazelle, for example, as well as Apple itself. Outerwall is even testing a vending machine concept that would automate the process of buying refurbished electronics.

Then there’s GameStop’s own digital games service — the retailer sells digital games on its website.

Here again, though, the competition is immense. There are innumerable websites (Steam, GOG, Amazon, etc) offering downloaded PC games. And while GameStop also sells digital versions of console games, consumers have no real reason to buy a digital game from GameStop’s website — consoles already have built-in digital marketplaces (Microsoft’s Xbox Arcade, Sony’s Playstation Network).

Investing in GameStop

GameStop has been one of the best stocks to own over the last year. Excitement over the next round of consoles, combined with alleviated fears about used game restrictions, has prompted a powerful rally.

But GameStop’s business model is becoming obsolete. It may take three years, five years or longer, but games — likes music, movies and books — are going digital. And a retailer that depends on the sale of physical games — whether they be used or new — is in trouble.

The article GameStop Is Still a Value Trap originally appeared on and is written by Sam Mattera.

Sam Mattera is long GameStop Puts dated January 2015. The Motley Fool owns shares of GME and Microsoft.

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

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