Finding Opportunity In Rumors About Game Consoles: Gamestop In Play

by: Daniel Radakovich

The rumor mill begins

Recently there have been leaks of rumors that suggest both Microsoft (NASDAQ:MSFT) (1st rumor) and Sony (NYSE:SNE) (2nd rumor) will release new consoles to combat used games and possibly piracy. The thesis is game publishers will gain momentum in selling new games at the same price point and increase revenues and profits. In order to do so, game publishers are cutting out the middle man in digital distributions. They hope it will help the gaming industry, including, but not limited to, EA (NASDAQ:EA) and Activision (NASDAQ:ATVI). Finally, the theory holds that casual gaming is cutting profits from these publishers, making it difficult to compete in the market, as they rely on console manufacturers to sell their products.

Life without the middleman

There are several issues with these main theories. First, these assumptions are the basis to create an argument to short or bet against the survival of the industry as a whole and the viability of Gamestop (NYSE:GME) in particular. The majority of core gamers in today's world who play on the PS3, Xbox 360, or Wii have also grown up playing consoles and handheld video games. The casual gamer is not a frequent and avid gamer when compared to someone who owns all three Playstation systems or both Xboxs. The "gamer" or "core gamer" of the industry thrives in a niche market where there is a unique industry with different variables and intangibles. They enjoy their entertainment, talking about games through online forums and review sites, going to retail stores including Gamestop, and playing video games with their friends. Gamestop's business strategy allows consumers interested in video games to purchase games at a lower price point by one of two ways (2012 10-K). One is they can buy the new game at a $60 price point and trade it in later for $20 credit towards another purchase. The other is a customer purchases a used game for $40 after it has been released and is able to avoid buying on an impulse decision. This unique aspect of the Buy-Sell-Trade business model and the overall gaming industry has increased the popularity of all gaming consoles, accessories, and software titles enjoyed by gamers at all prices.

Rise of Indie games and unique gaming experiences

Another major factor is that the gaming industry hasn't focused on what is truly occurring in digital distribution of games through the Playstation Network or Xbox live. The Indie genre is making inroads into the software sales through unique gaming experiences that can be offered under $15. A prime example is on the Playstation Network. Sony released a game made by That Game Company, titled Journey. Journey is a unique, immersive, and beautiful game that offers a completely different perspective of console gaming compared to your frequent shooter and sport titles. It creates a passion of excitement and allows the gamer to enjoy the game's unique playing opportunities. One can look at casual games on the smart-phone and understand how unique and different types of games are hits at the right price point. The first console manufacture to exploit this market of casual gamers includes Nintendo (OTCPK:NTDOY). The Wii console has motion sensing technology that created new entertainment for friends and families across the globe. The continued success of the Wii will allow Nintendo to develop another updated version utilizing the same factors that made the original so successful (WiiU). If Sony and Microsoft rely on selling retail games at $60 over and over like Madden and Call of Duty franchises, then the industry will struggle without the ability to trade and purchase used games. The reason is simple: evolution of valued added entertainment plus the purchasing power of the consumer will be greatly inhibited. In the end, the traditional casual and core gamer will find cheaper entertainment elsewhere.

Taking advantage of the changing video game industry

I believe that the industry is not going to go down this road; however, it has offered some unique opportunities to invest in certain companies. Nintendo has a unique and quite interesting console coming out in 2012. This console will compete with the PS3, Xbox 360, and the next generation consoles. It uses a tablet based controller and immerses the gamer into the game unlike anything before. Gamestop comes to mind with their excellent retail financing and cash management. A loss of their used game business would not just harm their business, but it would also harm the whole video game industry.

Rumors like these create small opportunities to take advantage and learn about the market and focus on the companies surely to benefit when the new console refresh occurs. Simply put, I would recommend one to look over Gamestop's financial position and recent market value and see if they believe it is a good long term position. As for Nintendo, I cannot offer a recommendation for the lack of better competence in their financial situation. As an avid gamer and intelligent investor, I do not believe these rumors are true, but I do see an opportunity to be greedy when others are fearful.

Disclosure: I am long GME.

Additional disclosure: I am long Gamestop. I do not have any other positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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