Why GameStop is destined to become another Blockbuster video

Wednesday, January 27, 2021

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GameStop’s stock is on fire, but that has nothing to do with reality

GameStop (GME). Who would have thought the most talked about stock on Wall Street in early 2021 would be a past-its-prime mall retailer? And yet here we are. The company’s stock has gained an incredible 8,949% in the last 12 months at market close Wednesday, with much of that coming in just the last two weeks.

By now the reasons behind GameStop’s massive gains are well documented. The stock has been a major target for short sellers due to the continued shift to digital game sales. But earlier this month, the stock shot up after activist investor and Chewy founder Ryan Cohen joined the video game retailer’s board along with two allies who had previously worked with him.

Traders on Reddit’s WallStreetBets board, seeing so many short positions in GameStop, then dove headlong into a massive short squeeze, forcing the stock’s price even higher and crushing short sellers as they moved to buy up stock to cover their losses. Traders from the board have also been squeezing short positions in stocks like AMC (AMC), Bed Bath & Beyond (BBBY), and BlackBerry (BB). But GameStop has been the most high-profile target.

One of my best friends put about $24,000 into the stock after reading WallStreetBets and was up as much as $113,000 as of Wednesday afternoon — though he wasn’t going to convince me to get in on the action.

The stock’s performance is so far divorced from the reality of its retail operations it’s practically operating in a parallel universe. In its most recent quarter, GameStop’s total sales were down more than 30% compared to the same time last year. Gamers, meanwhile, continue to transition away from buying physical copies of games in favor of digital downloads. And the launch of cloud gaming services spells disaster for traditional game retailers.

“GameStop’s problem is not that they don’t do a good job selling video games online — I guess they could do a slightly better job, everyone can — it’s the fact that more and more gamers, they are not buying physical games, they are just downloading them,” Loop Capital Markets’ Anthony Chukumba told Yahoo Finance Live.

“GameStop can have a better website than Amazon, and that’s not going to change that,” he added.

To be sure, some on Wall Street paint a rosier picture for GameStop, noting it has a turn-around plan that focuses on interactive experiences and e-commerce. If that plan doesn’t work, though, the retailer will likely end up as just another Blockbuster — a shell of its former self, with one surviving store in the entire world, if it’s lucky.

GameStop’s pivot

GameStop has struggled for years, but recently pared its losses by focusing on its transition plan that seeks to create a more robust online retail presence. And it’s working to a degree. While the company saw net losses of $470.9 million in fiscal 2019, that was down from $673 million in 2018. And its Q3 2020 earnings saw net losses of $18.8 million compared to the $83.4 million in net losses it saw in Q3 2019.

So things weren’t exactly great, but they were looking up. In fact, the company said in its Q3 earnings report that it would return to profitability in Q4 thanks to the launches of Microsoft’s (MSFT) Xbox Series S and Series X and Sony’s (SNE) PlayStation 5.

But this month, GameStop reported that its holiday sales were down 3.1% year-over-year, as coronavirus forced it to shutter stores temporarily or for good. The retailer was also hit by severe shortages of Microsoft and Sony’s new consoles, which are nearly impossible to find. Believe me, I’ve tried.

Bulls are banking on Cohen and his RC Ventures, which bought up GameStop stock and got three new seats on the company’s board on Jan. 11. GameStop has also made plans to improve its standing as an omni-channel destination for everything from games, action figures, and boardgames to TVs, gaming PC, and peripherals.

One optimistic analyst, Joseph Feldman at Telsey Advisory Group, says the company will likely benefit from the release of Microsoft’s and Sony’s consoles when they’re more readily available, as well as its healthy balance sheet and those new product offerings.

“The shift to digital is real, it’s happening, but I’m not sure that it’s going to completely take over the industry,” Feldman told Yahoo Finance.

“People still want to buy consoles which are physical, people still want to own the discs, which are physical. A lot of people do stream it now, much more than they used to, but I don’t know that that means it’s going to entirely go that way. And if it does, it’s going to continue to be a larger transition to that,” he said.

But there’s plenty stacked against GameStop.

The future of gaming is digital and the cloud

Let’s first focus on those new console sales. Microsoft and Sony will eventually increase their inventory of the latest and greatest systems, but GameStop is far from the only retailer to offer them. Amazon (AMZN), Walmart (WMT), Target (TGT), Best Buy (BBY), and others are all selling Xbox Series S and Series X and the PS5.

So while GameStop will likely benefit from those sales, it’s not going to save the retailer in the long-term, especially as the market becomes saturated and fewer people need to buy them.

In the long-term, GameStop also faces a major threat from the shift to digital sales. Since its fiscal Q3 2019, Sony has sold more digital games than physical games, with the company selling 59% digital titles in its fiscal Q2 2020. EA games, meanwhile, said that 56% of titles sold were digital rather than physical in the 12 months preceding its Q2 2021 quarter.

What’s more, Sony, Microsoft, and Nintendo allow you to download titles to their consoles, offering frequent sales, and making it incredibly easy to buy a game without having to visit a separate website or get up off your couch.

It’s not just the PlayStation, Xbox, or Nintendo Switch’s dedicated marketplaces taking share from GameStop. PC gamers have Valve’s Steam, EA has its Origins platform, Activision Blizzard (ATVI) has its Battle.net service, and Ubisoft has its Ubisoft Store.

Digital games can pose unique problems, of course. Feldman points out that they require high-speed internet connections that some video players just don’t have access to.

“The pressure point is the infrastructure for it,” he explained. “These games are pretty high volume in terms of the size of the game. And so it requires a pretty wide pipe to get into your house effectively to be played well. I know those sound like the old issues that used to be there, but that’s all still true.”

Still, the rise of 5G connections could bring high-speed internet to more people.

What’s more, digital games aren’t the only alternatives to physical ones. Cloud gaming allows players to access and stream games on devices ranging from game consoles to smart TVs, tablets, and smartphones — heck, you can even play on a 10-year-old laptop that’s been sitting in a closet collecting dust.

Some of these cloud services will require you to purchase digital versions of games, while others will simply let you play via a subscription. Reminds you a bit of how streaming video services like Netflix (NFLX) demolished Blockbuster, right?

That company was once the go-to video and video game rental retailer. But then Netflix came out with its online streaming service, which kicked off a slew of new competitors. And while Blockbuster offered its own streaming service, it simply couldn’t keep up, and filed for bankruptcy in 2010. (Though as a penny stock, it’s skyrocketing thanks to the Reddit trade, too.)

Just like with Blockbuster, it’s probably too late for GameStop to redefine itself many years after you begged your parents to drive you there to buy the latest games. That won’t change no matter how high the retailer’s stock skyrockets.

By Daniel Howley, tech editor. Follow him at @DanielHowley

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