GameStop Acknowledges Move To Online Gaming Poses Business Threat

Leading specialty video game retailer GameStop may downplay the threat that digital and online gaming poses to its packaged business, but regulatory filings show that the company is keenly aware of business hazards associated with the rise of digital distribution. In its report on fiscal 2008, over a year ago, GameStop updated its language about threats to its business model. In particular, we observed that GameStop broadened its description of the threat posed by software distributed online to include consoles and, presumably, handhelds. Previously that section of GameStop's 10-K had referred only to PC software. That segment of GameStop's filing has been expanded yet again, and the language is even more interesting. The relevant section is included below in its entirety: Technological advances in the delivery and types of video games and PC entertainment software, as well as changes in consumer behavior related to these new technologies, could lower our sales. While it is currently only possible to download a limited amount of video game content to the next generation video game systems, at some point in the future this technology may become more prevalent. If advances in technology continue to expand our customers’ ability to access the current format of video games, PC entertainment software and incremental content for their games, as well as new types of browser and casual games through these and other sources, our customers may no longer choose to purchase video games or PC entertainment software in our stores. As a result, sales and earnings could decline. While the Company is currently pursuing various strategies to integrate these new delivery methods and competing content into the Company’s business model, we can provide no assurances that they will be successful or profitable. The words “consumer behavior” are new to GameStop's filings. This suggests that the company has moved beyond simply noting the existence of online channels of software distribution to the recognition of a shift in consumer behavior. GameStop caters to the core gamers, the ones who buy one or more games per month, and these may well be the gamers who most quickly shift to online distribution for their software purchases. That is, GameStop is clearly positioned to extract revenue from core gamers who purchase via retail, but that means they are also the ones most hurt if these gamers start downloading their games instead. This is also the first time that GameStop has mentioned browser games and casual games in its 10-K filings. As games like Farmville take up more of the recreational time of GameStop's potential customers, the company foresees a possible decline in its earnings. While the company already does sell some games through its website as direct downloads, we would suggest that it consider investing some part of the $500 million it still has on hand (left over after the recent $247 million stock buyback) in buying a larger stake in the production and distribution of games. With the purchase of a middle-tier publisher or other industry intermediary (like one or more of the larger, existing software distribution services) it is possible that GameStop could ensure its survival well beyond the point at which the market tilts more toward the online channel than the retail channel. GameStop's efforts in this direction have been small. In November 2009 the company completed the purchase of a controlling interest in Omac Global Media Limited, described as “an online video game developer and operator”, and also known as Jolt Online Gaming, and the creators of Trukz and Legends Of Zork. This cost the company a mere fraction of its cash reserves ($3.8 million). According to the company's business and growth strategy, it will “continue to make significant investments in e-commerce, online game development, digital kiosks and in-store and Web site functionality” to increase its stake in the digital business. In his notes on GameStop's latest results, Wedbush Morgan analyst Michael Pachter said he believes that the decline of physical media could take another decade to complete. In that scenario, GameStop will continue to generate strong margins amid a growing video game retail industry.