Technology Is Spelling the End for GameStop Corp. (GME)

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GameStop Corp. (NYSE:GME) has been a watering-hole for gamers for many years now. It’s a place where people can buy games, consoles, or just socialize with their friends at different game releases or events. Ironically, advances in technology are going to harm the entertainment retailer given that it’s current business model relies on the stock-and-sell method of selling video games.

Zombie mode

GameStop Corp. (NYSE:GME) has barely held on to its stagnant revenue for the past few years.  No major consoles have been released since 2006, when the PS3 and XBOX 360 brought in tons of sales for the brick-and-mortar retailer. Things probably haven’t gotten any better in the first quarter of this year. GameStop is expected to report around an 8% loss of revenue compared to the first quarter of 2012, due in part to a trend away from physical game sales to direct publisher sales of downloadable content.

GameStop Corp. (NYSE:GME)Instruction manuals and that new-game smell are about the only benefits to buying physical copies of games nowadays. Companies like Activision Blizzard, Inc. (NASDAQ:ATVI) are migrating towards online sales of game expansions. Expansions for the company’s popular game World of Warcraft can be readily downloaded online. The publisher’s Call of Duty downloadable map packs are sold exclusively online and are a huge source of revenue as well.

DLC is here to stay

Other game publishers are taking the same approach. Electronic Arts Inc. (NASDAQ:EA) has reported that downloaded game content (DLC) sales are up 35% year-over-year, and the company expects those numbers to increase another 25% in 2013 alone. Electronic Arts also reports that the cost of revenue for digital games is 30%, versus 51% for physical games. Those savings translate into big differences for the company’s profits- Electronic Arts is bring in a net profit for the first time in years.

But besides losing profits, physical game sales require GameStop Corp. (NYSE:GME) to take on more risk by investing in physical copies that have to be sold at full price, half price, or any price to get them off the shelves.

Stock-and-sell is not effective anymore

The company’s price-to-sales ratio is currently .49, but this may be more of an ominous sign than a reflection of good sales and future opportunity.

To illustrate, Activision Blizzard, Inc. (NASDAQ:ATVI) recently released an expansion to its popular online game World of Warcraft, called Mists of Pandaria. The expansion’s retail price was $39.99, and still sells for that much on Blizzard’s website as a digital download.

However, GameStop Corp. (NYSE:GME) overshot its inventory when stocking the product and is now selling the expansion at a 50% discount ($19.99) in order to dump unwanted inventory. This style of stock-and-sell can’t compete with the margins of digital sales and may be the culprit behind why GameStop has a -3% profit margin.

New consoles don’t spell success

GameStop Corp. (NYSE:GME) estimates earnings of $2.75-$3.15 in 2013, due in part to a surge in demand from new major consoles being released. The earlier editions of these consoles drove a big part of game sales in previous years, and the retailer hope to continue that pattern. But  while these consoles may help store sales in the short-run, Sony Corporation (ADR) (NYSE:SNE)‘s Playstation 4 and Microsoft Corporation (NASDAQ:MSFT)‘s Xbox One consoles could actually be the proverbial nails in the coffin for GameStop.

The Playstation 4 is highly focused on cloud gaming and downloadable or streamable game content. The Xbox One will be heavily intertwined with digital content as well. The console will allow consumers to resell used games (despite reports otherwise), but may charge a fee for doing so. Activision Blizzard, Inc. (NASDAQ:ATVI)’s highly anticipated Call of Duty Ghosts is going to launch as a downloadable game for the Xbox One, setting a digital precedent for all console titles to come.

Hard mode

GameStop Corp. (NYSE:GME) is currently trading at a high that it hasn’t seen since 2008. But the recent hype over the “benefits” of new console sales deserves a second look. When looking closely, the new consoles are actually making GameStop more obsolete than the old point-and-shoot cameras lurking in our attics and junk-drawers.

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