We've been long-time bulls and multi-year holders of GameStop (NYSE:GME) but some recent developments in the retailing and gaming world have us taking a hard look at our investment. In fact, we are actively considering selling the remainder of our shares (we reduced our position in GameStop by half for most clients when the stock traded around $50 per share).
In previous articles we've explained why we liked GameStop, why we thought digital wasn't as big a threat as it was made out to be, and why GameStop wasn't like Blockbuster. But to understand the recent threats we need to understand what is really GameStop's core business model.
At its very simplest GameStop's business model is selling $60 video games for $40. It's business model is not simply retailing physical versions of new and used video game software like many believe. Why GameStop has managed to stay in business despite the threat of digital has been its extremely successful buy/sell/trade model that allows gamers to pay only $40 (either through trade in credits or by waiting for a used copy) for a video game that would otherwise retail for $60. Many people in the investment world that I've talked to about GameStop have well above average incomes. For them the difference between $40 and $60 is not material and I have found they really did not grasp GameStop's appeal to gamers when discussing the company. When I talked to my friends who are avid gamers and browse several gaming forums I've found that many of them have below average incomes and to them trading in their old games is key to making the new titles affordable to them.
Previously GameStop did not face any significant threats to its underlying business model but that looks to be changing.Threats Beginning to Appear on the Horizon
The biggest threat I see for GameStop is Amazon's (NASDAQ:AMZN) decision to begin offering 20% discounts on video games to Amazon Prime subscribers. As you can see below that means new video games (we checked the price of MLB The Show 16 for PS4) are being retailed by Amazon for $48.
This move is threatening the low end of GameStop's buy-sell-trade model. If you're a hardcore gamer who loves to buy the newest game, play it through, and then trade it in to get the latest release Amazon doesn't offer a compelling value.
The table below taken from GameStop's retail website shows the top trade in values.
If you just got done playing Tom Clancy's The Division you could trade it for MLB The Show 16 and pay a net price of $30.29 (assuming you're a PRO member). This is well below Amazon's price.
Next we looked up the trade in value for Need for Speed which was released in 2015. If you're not quite that dedicated to gaming and are trading in a popular old game from last year you'll get around $20 in a trade in.
This still gives you a net price of $40.19 for a new video game. Again, well below Amazon. However, things change if you just play games occasionally and don't always want or buy the latest and greatest. If you have an old game from say 2013 sitting around and trade it in you only get around $10. Below is the price quote we got for Need for Speed: Rivals (from 2013).
This would put your net price for a new game right in the same neighborhood as Amazon.com. Odds are that as a casual gamer you'll find Amazon's two day delivery just as convenient as making a special trip into a GameStop store.
This is what Amazon's threat looks like today. The big question is what will it look like in the future? Remember Amazon is a company that seemingly despises profits. What might Amazon be willing to do to take more of the market from GameStop? Also, remember Amazon is experimenting with drone-based 30 minutes or less delivery for packages. Would you rather make a 30 minute round trip to a local GameStop or spending 30 minutes playing your old video game while you wait for a drone to deliver your new one? We're likely years away from a scenario like that being widespread but the stock market is forward looking.
According to a recent customer survey posted on reddit Microsoft (NASDAQ:MSFT) is exploring the possibility of digital trade-ins for the Xbox One. If Microsoft eventually went through with the plan it looks like the model would allow users to trade in a game for 10% of the purchase price in online store credit. While $6 back on a $60 video game isn't great it is something. Much like Amazon's Prime discount program Microsoft's potential model is aimed at the customers that make up a minority of GameStop's customer base. Very casual gamers and more well off gamers where an extra $5-$20 isn't worth a 30 or 45 minute trip to a GameStop store.
Of course Microsoft denied via Twitter that digital trade-ins are being considered. But there is a big difference between not being considered now and being ruled out for eternity. Additionally, company executives (across all industries) are not know for their truthfulness when it comes to disclosing product plans. Given the size of the used game market (~$2B) I find it hard to believe companies like Sony and Microsoft aren't actively trying to find a way to muscle in.Summary
What we believe we are seeing with Amazon's move and Microsoft floating the idea of digital used game trade-ins is the beginning of the erosion of GameStop's business model that the short sellers have been clamoring about for years. Remember GameStop's business is selling $60 games for $40. The closer competitors get to that price point the greater the threat to GameStop. Right now it appears that competitors are just nibbling at the edges of GameStop's customer base but we believe that as time goes on the industry will start taking a bigger bite. We are currently evaluating investment alternatives to GameStop and would encourage other holders to reevaluate their investment thesis in light of the shifting competitive landscape.
Disclosure: I am/we are long GME, MSFT.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: As stated in the article we are considering selling our shares in GameStop (GME).