No Digital Disaster Yet for GameStop

 | May 28, 2013 | 10:00 AM EDT  | Comments
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msft

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sne

Since bottoming out in July of last year, video game retailer GameStop (GME) has been on a tear as investors anticipate a slew of new gaming consoles this holiday season. The shares are up almost 100%.

On Friday, the stock got whacked once investors realized that Microsoft's (MSFT) recently-announced Xbox One could hurt the used game market. Any changes to the used game market would have a significant effect on GameStop's business model.

Microsoft held a press event last Tuesday to announce the new Xbox One. While the announcement was long on hype and short on details, investors came to the conclusion that Xbox One could change the way used games are bought and sold. Presumably, Xbox One would allow consumers to trade used video games digitally after paying a fee to Microsoft. Customers would login and pay for access codes, to activate old discs.

 While Microsoft has not confirmed the rumors, the gamer blogs lit up the Internet all weekend with angry rants about the possibility of having to pay a fee to trade a video game that you've already bought. After all, if you lend your car to a friend, the automaker doesn't get a commission on the transaction -- why should Microsoft?

With the possibility of the used disc fee equal to the brand new disc, there would be little incentive to trade physical discs. The entire business would move to the Internet. Both Microsoft and Sony (SNE) have danced around the issue by avoiding any explicit statements about the used market or how the new business model would work. (Although both say the used market will still exist.)

One thing is clear. With gaming inevitably going digital, GameStop faces a very serious challenge to its business model. GameStop officials have said since the new gaming consoles are not backwards compatible, GameStop's business should stay healthy since buying and selling used games can continue for quite some time. After all, there are millions of old games out there. Many gamers like to browse through the used bins and pick up games they haven't played for 50% off. Used games account for 48% of GameStop's revenue.

GameStop reported earnings on Friday and raised guidance towards the high-end as management believes it will benefit from a strong holiday season. During the first quarter, same store sales fell 6.7% as revenue fell 6.8% to $1.87 billion. With a lack of new hardware products, hardware sales fell 30.6%. Software sales fell 3.8% and used games were weak -- falling 7.5%. Guidance for the second quarter was weak, but not unexpected. Investors are looking towards the more important third and fourth quarters. The company expects to report full year fiscal 2014 earnings per share of $2.75 to $3.15, which equates to $8.18 billion to $8.89 billion in revenue.

While changes in the used game market are important to the company over the long run, I think investors will continue to focus on the all important holiday season. It's been a while since a new platform came out and this year both Sony and Microsoft will have new hardware on the market. With a lot of folks short this stock, a better-than-expected Xbox launch will drive GME shares much higher.

Microsoft has a knack for gaming. When the Kinect for Xbox came out it was a major hit. In the first year since its release, Kinect sold over 18 million units. Xbox 360 has sold almost 78 million units and Microsoft said last week it would release a refreshed version of the 360 when it officially announces the Xbox One at the E3 conference on June 11th.

GameStop maybe facing a digital disaster in the future, but it's not here yet.

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