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Tom Shaughnessy is owner of SecretCaps.com, an independent investor and analyst. He has been investing in the stock market since the age of twelve. His style is comprehensive and includes multi-layered research on a concentrated set of stocks. Tom enjoys constructive dialogue regarding various... More
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  • The Xbox One Effect: Gamestop 0 comments
    Jun 3, 2013 12:51 PM | about stocks: GME, MSFT, VHC, NFLX, VZ, ATVI, WMT, EA, GOOG, AAPL

    Recently, Microsoft (NASDAQ:MSFT) unveiled its newly redesigned, widely popular, Xbox gaming system. Packing a Kinect motion sensor that can understand your joints and even read your heartbeat, Xbox One can do it all. Here's the specs, a 500GB hard drive, 8GB of Ram, 1080p HD camera for video chatting through Skype and even Wifi direct. With all these enhancements, the question is, how will Xbox One affect GameStop (NYSE:GME).

    Gamers love driving, don't they?

    If you have ever seen the commercials for that new game that is soon to debut on your gaming platform, that super hyped reason for you and your friends to cancel your plans, then you most definitely do not want to waste even 30 minutes going to the store to buy the game. Let alone having to go once to Gamestop to pre order the upcoming game and then again to wait in a line to actually pick up the game. Xbox One is flaunting a newly redesigned app store and internet experience that like the current Xbox 360 can download games directly to the hard drive. These games will have to be authenticated by the user, paid for and then will be downloaded to the users hard drive. Moreover, with increased bandwith through internet providors that is now available such as Verizon's (NYSE:VZ) Quantum internet, downloading games will be faster than driving to your local gamestop.

    In Gamestop's last annual report they list their forward looking statements. These are meant to educate investors of events that can harm the business or profitability of the company. The third forward looking statement in their annual report is as follows:

    The launch of next-generation consoles, the timing and features of such consoles and the impact on demand for existing products following the announcement of the launch of next-generation consoles;

    This information discloses to the public that the company is aware that next generation consoles can impact the profitability of their brick and mortar stores. With the onslaught of new technology and consoles it is my opinion that Gamestop's profitability of selling new and used games will decline.

    Earnings and stores

    Gamestop has much higher margins for used games then they do for new games; 46.8% margins for used games vs 21.3% for new games. With more and more users downloading games directly to their devices such as with Xbox One, it will affect sales as a whole irrespective of margins.

    The investment community is not blind to the idea that Gamestop may be a declining company. Gross profit has declined from 2011 to their 2012 fiscal year. Moreover, expenses are higher than they were in the 2010 fiscal year and depreciation and amortization has increased over the past two years. Although more striking is that operating earnings, net income, and diluted net income per common share are all negative in the 2012 fiscal year, despite being positive in the 2010 and 2011 fiscal years. These are the metrics of a company that investors should stay away from. With 6,602 stores globally and a price per share closer to the 52 week high than the low, I would not want to be invested in Gamestop. In fiscal 2012 the company opened 146 new stores and closed 227 stores for a net closure of 81 stores. The closure of stores is respective of a declining market share. Moreover, the company flaunts that it is the only company that offers games as a specialty in it's brick and mortar stores, yet competitors like Walmart can more than make up anyone who wants to buy physical games. My point is that the company is not the only physical presence in selling physical games. Competitors like Walmart (NYSE:WMT) infringe on Gamestop if in the future Gamestop's only hold to profitability is that they are a physical presence selling games when it's competitors can serve that portion of the market. Why pay a price per share of a company near the 52 week high when the company is on the rocks?

    Sales breakdown

    So what has this article been hitting on mainly? The majority of Gamestop's income medium that will be taking the biggest hit. When adding up new game software and used game software as a percentage of net sales the number is 67.7% for Gamestop. With Xbox One allowing games to be easily downloaded on the system to the hard drive, new game sales from Gamestop will decline. Also, since these games will not be able to be physically sold back to a retailer such as Gamestop, the used game market will also decline for the company. Microsoft has not stated whether games can be sold or traded system to system, although it would be a good idea to allow users to trade licenses for games. See the net sales percentage breakdown for Gamestop below.

    Is Gamestop competing with the online world?

    It makes sense for manufactures like Activision (NASDAQ:ATVI) and EA Games (NASDAQ:EA) to get games to their users faster. This allows their content to be absorbed more quickly into the market and allows for in app purchases to happen faster. Moreover it cuts down on Gamestop as not only a middleman taking profits but as an unnecessary time block, making it longer for users to get developer's software. Software developers will not be damaged by any change in Gamestop's sales since their games can be delivered to users digitally.Gamestop states in their last annual report that they are expecting the future of a more digitally downloaded world.

    We expect that future growth in the electronic game industry will be driven by the sale of video games delivered in digital form and the expansion of other forms of gaming

    It can not be disregarded that Gamestop is attempting to compete with the online world. They have a very successful online gaming website called Kongregate.com, a PC distribution system called Impulse and Spawn Labs that is the company's technology streaming company. Although the company is attempting to grow its online presence it is my opinion that it will not be successful in competing with the ease of use Microsoft offers. Xbox makes it so simple through the platform to just go on their app store and download the game you want to play. With all factors considered, Gamestop does not fit into this relationship of gamer and game developer. If the company plans to grow its online presence Kongregate through new "Bloons Defense" games that are now successful that will help the bottom line through advertising and in app purchases, but the content of these games can not compete with the likes of games that users can download and play on their Xbox gaming system.

    Other companies will profit from Xbox One

    Microsoft has announced that they will fully include their Skype technology in Xbox One. Directly from the website they state the features that Skype will contribute for users.

    Skype has been specially designed for Xbox One.
    Chat with friends on your TV in stunning HD. Use
    Skype in Snap mode to chat while you watch TV.
    Or do three-way Skype calls with people around the
    world, all from the comfort of your living room.

    Last month VirnetX (NYSEMKT:VHC) filed a complaint against Microsoft that targets Skype technology which is not included in the original limited license Microsoft signed with VirnetX after a $200 million dollar settlement a few years back. VirnetX contends that Microsoft's Skype acquisition was after the original license was signed between the two companies. With over 663 million registered users spanning multiple platforms, Skype will be an integral part of the user experience of the Xbox One.

    Several examples of damaged user experience have surfaced over the past year such as when Apple (NASDAQ:AAPL) switched out Google (NASDAQ:GOOG) maps for its own application, and the uproar was global. I do not view Microsoft as removing Skype from Xbox one due to the dispute between the two companies and I view the intellectual property dispute between Microsoft and VirnetX being settled soon. The president and Ceo of VirnetX Kendall Larson also shares my opinion.

    Kendall Larsen, VirnetX CEO and President. "We look forward to quickly resolving this matter."

    With a new agreement between VirnetX and Microsoft, VirnetX will profit from it's genuine inventions and Microsoft will benefit through the advanced technology the company provides, although is already infringing upon. This example shows that with the debut of Xbox One company's other than Microsoft will be profitable such as the software creators and those companies that provide invaluable technology for the system.

    Conclusion

    Xbox One will propel the user's gaming experience well into the future. Although the merits of the system have been discussed heavily in various articles across the web, the impact Xbox One will have on other companies can not be overlooked. The marketplace assigns value on companies depending on various aspects of the individual business and its competitors. A parallel of Gamestop and Microsoft may be the demise of Blockbuster with the growth of Netflix (NASDAQ:NFLX). I would not want to be an investor in Gamestop going forward as the future of the company looks too unstable and unfitting in the future.

    Disclosure: I am long VHC.

    Additional disclosure: Always do your own research and contact a financial professional before executing any trades.

    Themes: Technology Stocks: GME, MSFT, VHC, NFLX, VZ, ATVI, WMT, EA, GOOG, AAPL
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