Analyst: GameStop Expanding Digital Distribution, Could Acquire

Major U.S.-based video game specialty retailer GameStop is primarily fueled by the sales of physical video games. The company has made clear that it isn't worried about the rising impact of digital distribution, a business model that circumvents brick-and-mortar retail. But while GameStop may downplay the threat of digital distribution, it is nevertheless working on building up its digital business in preparation for the future. In a recent investor meeting with GameStop management, hosted by analyst firm Lazard Capital Markets, the company gave some indications of how it expects to make money from digital models down the line. Analyst Colin Sebastian believes that GameStop may be planning to "up-sell customers with online points cards," "expand the company's digital distribution platform for PC and casual games," and "make a strategic investment or acquire an aggregator and/or developer of online games." A physical games retailer buying an online portal is a unique prospect, but it would be in character for GameStop, Sebastian said. He added: "GameStop historically has used acquisitions to expand into new markets, and digital is likely no exception. We believe a natural fit for a specialty game retailer would be a partnership with or acquisition of an aggregator of online games, which could be marketed toward the company’s core gamer customer base." GameStop also sells Xbox Live point cards, a model that blends retail and online distribution. At retail outlets, customers buy Microsoft Points, the currency used to buy content for download via Xbox Live. GameStop management claimed to have 45 percent market share of total point card sales, Sebastian said. The pre-eminent physical retailer also has plans to host in-store kiosks where gamers can buy downloadable add-on content for games at physical retail locations, and have that content delivered to their online accounts via the Internet. "We believe the merchandising strategy for add-on content (such as map packs) makes sense given that 70 percent of online gamers are also regular shoppers at GameStop," Sebastian said. Digital distribution sales on GameStop's website have doubled in 2008 vs. 2007, Sebastian said, and are expected to double again this year. The company also recently appointed a new head of digital media to helm the company's digital business, a sign that the retailer is looking beyond discs and cartridges, which are seeing poor year-on-year results currently. Elsewhere, Sebastian said that demand for the recently-introduced, cheaper, redesigned PlayStation 3 is strong among GameStop customers. Management expects "a meaningful near-term lift in unit volumes," with product hitting shelves by the end of the week. Echoing other analysts' predictions, Sony likely won't be the only company with a lower-priced console. "We continue to expect an Xbox 360 price reduction and SKU realignment in the near term, while Nintendo may stick to promotional bundles in order to drive demand this holiday," he said. Finally, while the digital distribution strategy at GameStop is "taking shape," the used games business continues to boom. Game publishers sometimes lament how used video games are hurting the sale of new games, but GameStop claimed that "70 percent of trade-in credit at GameStop is spent on new product sales." Sebastian also noted, "Importantly, internal data suggests that the cannibalization of new game sales from used is fairly limited, as only 4 percent of used sales are games released over the prior two months." In the fiscal year ended in January, GameStop reported that 23 percent of its total revenues came from used games and hardware, out of the $8.8 billion total. But 48 percent of total gross profit came from the used business. Sebastian noted that a price-conscious consumer in a tough economy is particularly attracted to GameStop's used offerings.