- The challenges GME will face with their new IOS trade-in program
- The existential threat of GME's main business going the way of the dodo if content providers make their content readily available for direct download
While neither of these points has been invalidated by the recent earnings call, I think it is important to discuss the current trends of the business and why I think the business is decelerating faster than people realize.
The first red flag I took away from this quarter's earnings call was the top-line miss vs. the company's guidance. On January 9, 2012, the company issued a press release (Holiday Sales Press Release) announcing its 2011 holiday sales and reiterated its guidance for the rest of the quarter (i.e. the month of January). Wall Street analysts (the "smart money") divined that the press release meant the company would produce roughly ~$680 million in revenue for the month (it had already announced November and December). When the company announced last week, it came in at $560 million for the month (Full 4Q $3.58bln - First 2mos $3.02bln = $0.56 billion). That means that the company missed the one-month guidance to the Street by ~20% in a little over 20 days. In light of that performance how much faith can anyone have in management's 2012 guidance? To me, this type of miss signals that the team closest to the business doesn't have a firm grasp on the controls.
The second big takeaway I had from the earnings call was management's insistence that its trade-in program offers too much value to the video game ecosystem to be cut out in a transition to direct download. I couldn't disagree more. The basic premise of the current system is this:
- Electronic Arts (NASDAQ:EA) [or a peer] creates a game
- They sell that content to Gamestop and Gamestop marks it up ~20% (new video game software gross margin in FY2012 and this is probably conservative) and sells it the consumer
- Gamestop then buys that video game back from a consumer for a discount and resells it at a mark-up to another consumer
Gamestop's argument is that the ability to resell at that discount creates a lot of "liquidity" in the system to then buy a new game. What I think it is failing to admit is that there is a lot of value to consumers if GME's ~20% mark-up goes away and they can go straight to the content provider for their game. Factor in the opportunity cost (time and fuel) of having to go to the store and Gamestop's "value proposition" starts to look less and less attractive to the consumer. Content providers should be more than happy to allow the consumer to access some of those savings rather than pay it to GME.
In many ways, I applaud Gamestop's management team. It is fighting an uphill battle and trying to transform a challenged business model on the fly. Unfortunately, that doesn't change the facts that a) the business is deteriorating at a much faster clip than even management realizes as evidenced by the disastrous January it just reported and b) their "value proposition" is a lot less attractive at second look.
Disclosure: I am short GME.