Why GameStop's stock is getting zapped
Despite double-digit profit growth and an army of rabid customers, videogame chain GameStop can't get any respect from investors.
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| Customers at a GameStop in Manhattan. With over 4,300 stores in the U.S. alone, it is the world's largest video-game retailer. |
(Fortune Magazine) -- Even when consumers curb their spending, they have a hard time letting go of their favorite vices. Sales of guilty pleasures such as chocolate, cigarettes, and alcohol usually stay strong during downturns. Now it might be time to add videogames to the recession-proof roster: Last year the industry's overall U.S. sales jumped 19% to $21 billion, according to NPD Group.
One barometer of that growth is the success of videogame chain GameStop (GME, Fortune 500), No. 27 on Fortune's Fastest-Growing Companies list in 2008. The Grapevine, Texas, company has been able to post double-digit revenue and earnings growth at a time when other mall mainstays are suffering. "It's one of the few publicly traded U.S. retailers to have year-over-year earnings growth in 2008, and I think that's also going to be the case for 2009," says Anthony Chukumba, an analyst at FTN Equity Capital Markets.
In large part that's because more people are playing videogames than ever, brought into the fold by family-friendly offerings like Guitar Hero and the broad appeal of the Nintendo Wii. The relatively low-priced and user-friendly console has won over new demographic groups, including women and baby boomers, moving the category beyond young male gamers.
Plus, videogames appeal to penny-pinchers. After shelling out for a system like the Wii or Microsoft X-box 360, consumers' biggest expense is $60 games (less for used titles) that provide hours of entertainment. That might sound like a lot, but it's not a bad value proposition compared with a $12 one-time movie pass, or pricier tickets to a sporting event.
As Fortune reported last year ("GameStop Racks Up the Points"), the retailer was well positioned to benefit from the boom because of its scale and its specialized approach to the market. With $8.8 billion in sales in 2008 and more than 4,300 stores in the U.S. alone, it's the world's largest videogame retailer. Unlike big-box giants Wal-Mart (WMT, Fortune 500) and Best Buy (BBY, Fortune 500), GameStop is almost exclusively devoted to selling video and PC games, and its outlets are typically staffed by avid gamers.
But the chain's biggest edge over the competition may well be its decade-old used-games business, which lets customers sell back their old titles for cash or credit toward a new purchase. Not only does the policy bring consumers back to the stores, but close to 80% of trade-ins lead to a sale, according to GameStop COO Paul Raines. Reselling games also happens to be the most profitable part of GameStop's business, with margins hovering at 45% to 50%.
Despite the company's robust financial performance, its once-highflying stock has plummeted over the past year, falling 50% compared with the S&P 500's 40% drop. Investors are worried that its rapid growth - boosted by foreign acquisitions and a blitz of store openings - will slow. It also faces new competition. In early March, for instance, Amazon (AMZN, Fortune 500) began testing its own trade-in business, though industry observers don't expect a huge impact. GameStop tried a similar mail-in model and found that customers wanted the instant gratification of walking into a store and leaving with a new game. And GameStop also wins on price, now offering a better value than Amazon, according to a survey of 79 titles by gaming research firm Electronic Entertainment Design & Research.
The bigger threat on the horizon is online distribution. There are still barriers to selling content-rich videogames over the Internet, including limited bandwidth and storage capacity on current-generation systems. But it's hard to predict how GameStop will fare if the model changes.
"If you think about distribution moving online, any edge they've had in the brick-and-mortar world doesn't carry over," says Morningstar analyst Sunit Gogia. For now, GameStop is tracking broadband penetration against its store footprint. "In the short term we just don't see it becoming a meaningful part of the business, but we plan to participate," says GameStop's Raines. In the long run that may be where the game is won or lost. 
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