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Gamestop Inc Will Die, They Say, But Publisher Actions Speak Louder Than Words

By Perry Rod, Published: October 29th, 2009 12:54 PM CDT

Gamestop’s closest U.S. comparable is Best Buy (BBY).  Analysts for Best Buy Inc. are predicting an 8% year over year EPS growth rate.  Based on current trading prices, BBY trades at a P/E ratio of around 13.

Meanwhile, analysts project a 14% year over year EPS increase at Gamestop Inc (NYSE:GME).  With higher analyst growth expectations, one would expect GME to have a higher P/E ratio than BBY, right?  Wrong.  Gamestop, with also less debt relative to its market cap than Best Buy, trades at a P/E of less than 10, reflecting a belief from analysts (and even some industry executives) that Gamestop growth is doomed.

There are two main reasons for this belief – but they are not actually reasons, they are theories.  Theory #1 is that competitors will start biting into GME’s used game business.  Theory #2 is the more popular idea, that digital distribution will start cutting significantly into the retail business.  None of this has actually happened.  They are theories.  Yet, Gamestop trades as if they are facts.

The used game competition theory has already proven to be questionable with retailers like Best Buy and Wal-Mart (WMT) making passive deals with third parties to make room for used game trade machines that are supposed to market themselves to game traders.  Amazon and others have jumped in with me-too concepts and Gamestop has seen little impact, because Gamestop’s approach to used games is in no way passive.  The fact of the matter is no other retailer besides Blockbuster is really equipped to compete in a meaningful way due to store size, and meanwhile Blockbuster is closing down stores.

But Gamestop is the next Blockbuster, they say, due to digital downloads.

One would think skeptics of Gamestop’s business model would have the burden of proof when it comes to the idea of GME's model breaking down.  Where is their example of a $20+ product selling like crazy as a digital download?  Where is there a single example of a $40+ product selling digitally in huge numbers?  The technology is available and ready.

Games will be like CDs turning into an iTunes-like model, they say.  But by that logic, we would also see video game sales drop by over 90% overall as it did with CDs.  The reason this won't happen is unlike when free programs suddenly made music easy to share illegally, the video game industry more carefully regulates itself against piracy.  Moreover, one could argue losing music albums where most people bought the album for 1 or 2 songs, makes much more sense than losing big budget games that require large retail sales.

In related news, the PSP Go, a digital download console, launched at the beginning of this month and is already looking like a massive failure.  Likewise, Take Two Interactive (TTWO) tried to release high quality $20 “episodes” of top brand name Grand Theft Auto.  It was such a major flop given the reviews and brand name that Take Two’s next episode is being promoted as a packaged retail release, despite originally slated as a digital release.

Nobody doubts that digital sales will grow.  But the idea that there will be a dramatic shift of the way games are bought and sold seems very naïve and idealistic.  $60 games which everybody knows will eventually be $20 games require marketing and salesmanship.  The box, the CD, the retailer are all part of the process.

Here’s the best analogy: everyone commenting on the movie industry thought that pay-per-view and on demand type services would kill movie theaters.  Everything about the pay-per-view model makes more financial sense for the consumer than wasting on expensive tickets for a movie.  And today with huge HDTVs and sound systems, why are movies still thriving?  Because cutting out distribution cuts out the hype of the movie, meaning fewer sales.  Studios figured that out a long time ago.  Kill the movie theaters and you kill big productions and you will thus kill the business.

The idea that video game retailer legs will get chopped off just because downloads are offered is almost the same thing.  Forward thinking publishers and hardware manufacturers know, or will soon enough realize, that trying to pass up retailers will kill their business.  That's part of why they are not offering new games online at discounts on day one.  They rely on retailers much more than many people understand.

And again, from the consumer standpoint, paying $60 for a full game digital download or paying $60 for a nice looking box they can unwrap with a shiny CD and manual - all with resale value - is a no brainer choice for most people.  Going to a place with a thousand video games is also not a chore to most people interested in video games.  Video games are in the entertainment category for people, like toys (for all ages).  But new big budget games are not cheap.  Nice looking game packaging is a part of the distraction process in getting people to shell out the cash.  There will always be some people who don't care about all that but it’s a small minority of consumers.

Bottom line: the theory about digital downloads hurting retail does not properly take entertainment consumer psychology into account and would mean that video game's best marketers will fall, and video games as a whole will fall to things like sports and sunshine.  Games do not sell themselves.  Many people might think they do but publishers’ sales and marketing teams know better and depend a lot more on retailers than anybody likes to give them credit for.  In fact, publishers fight for space at retail, leaving smaller publishers struggling for attention.

Some smaller publishers such as Take Two Interactive still do not seem to get it.  The GTA downloadable content effort created a longer delay of the next console GTA and has largely failed.  But that's not Take Two’s biggest failure.  Their biggest failure – similar to some of the Japanese publishers who are losing ground – is being squeezed out of retail space by Electronic Arts (ERTS) and Activision Inc (ATVI) – whose sales and marketing teams better understand the industry as a packaged goods industry foremost, and so they flood retail space with their games.  They fight for retail space at Wal-Mart, Gamestop and others while Take Two and other quixotic companies think the games with high ratings will sell themselves.

Investors should not be Take Two executives, persisting with the idea that it's just all about high quality digital content.  That's only half of the equation of what makes the sale.  The winning formula includes retailers as 100% part of the process.  Here’s what Matthew Tattle, Group Manager of The NPD Group says:

“Game packaging is the most influential form of advertising for game manufacturers and retailers.  Particularly among impulse shoppers, game packaging is considered a much stronger motivator than TV commercials, online ads or trailers. The graphics and images on game packages should be chosen strategically to ensure buyers are attracted to the game.”

Let’s face it.  With Blockbuster falling apart, Gamestop has further monopolized the business of small video game retailers in the United States.  Publishers and hardware manufacturers would love to see more competition, but know there is no hope for that at this point.  They are as dependent on Gamestop as software makers are dependent on Microsoft.  Naturally, executives and industry insiders, like rebellious children, will make statements that try to undercut Gamestop’s value to them.  But behind closed doors they fight for every available space and plan for packaged goods offerings that support the high price points they need to stay growing and profitable.

Disclosure: author owns stock in GME, WMT and TTWO


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