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GameStop’s Business Model is Rapidly Deteriorating

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GameStop's Business Model is Rapidly Deteriorating

There are a few things happening here. GameStop Corp. (NYSE:GME) is running around in a bunch of different directions and while each seems to be met with initial success, the longer term success is questionable at best. Their newest initiatives seem to be taking them away from gaming which validates the bear thesis to a point that their current model is unsustainable. Further, it says that their drive to digital either isn’t working OR isn’t going to deliver the same profits as their previous physical game/trade in model does.

Trade-ins are still the bread and butter of this company. Until they find something that drives constant traffic and dollars, they will continue to shrink as gamers move to digital. To this point they have not found it. These newest plans won’t either.

Let’s first deal with their most recent foray and then look back at some previous ones for clues as to how this ends……

From “The Verge“:

“Why would a retailer have a factory? This was a big bet on the future,” says CEO Paul Raines. It’s one of many such bets: GameStop also bought electronics reseller BuyMyTronics in March of this year, along with several companies to help it begin to digitally distribute games across both desktop and mobile ecosystems.

For a company like GameStop Corp. (NYSE:GME), finding new businesses, particularly digital ones, would seem to make sense. They could ensure a future for a company whose brick and mortar presence — stemming from the need for physical discs and cartridges — might not be guaranteed indefinitely.

Surprisingly, though, the chief executive tells me that future-proofing GameStop wasn’t the aim. These new initiatives were originally born to “fill a trough” in the company’s core business, he explains. “We’re coming off the longest console cycle in history,” Raines reminds me, referring to how the next Xbox and PlayStation aren’t expected until 2014. “It’s putting pressure on everybody.” In other words, the other ventures are a short-term way to boost the balance sheet and please investors while current-gen console sales taper off. But when GameStop store shelves get filled with the next generation of game machines, Raines says it’s not clear whether there will still be room for electronics too, and the new BuyMyTronics subsidiary gives GameStop an alternative way to sell them.


Raines sees refurbished electronics as more than a short-term experiment — “I think we passed the experiment phase in December,” he says, citing a projected $200 million in mobile device sales this year. He’s merely not sure when and where those electronics might actually be sold. Due to the ubiquity of the company’s physical locations, he believes that GameStop stores is a “superior trade collection point” for electronics, but that doesn’t mean there will necessarily be a dedicated electronics section in future GameStop stores.

He claims it’s also not about the product so much as the Buy-Sell-Trade model where GameStop’s expertise lies: “We could trade in shoes if we wanted to.”

GameStop has to reverse-engineer every single device it decides to refurbish, and figure out the best, most cost-effective way to do so. “When we first started refurbishing hardware, we asked, ‘Where are the training manuals going to come from?’ ‘Training manuals? What training manuals?’” Daughtery quips. The iOS department has been operational for six months, but for Android, things are more tenuous. Android refurbishment operations began only six weeks ago at a single table, and it’s a learning experience. Manufacturers don’t provide instructions on how to disassemble their products, and they rarely give GameStop hardware in advance. “As soon as the public can get it, we’ll reverse engineer it and break it down,” Daughtery tells me.

This will be, and has been very successful out of the gate. Why? There are not many people who refurbish out there and most people have a few old broken devices sitting around. (I have a few ipods the kids have broken in a drawer in my office). So, there will be an initial surge of people taking advantage of the program. But, after the surge, there will be a precipitous drop as the low hanging fruit has been picked.

Additionally, if this does become a viable business, it will not be very long before competition enters the space in a major way, shrinking margins. Think Best Buy Co., Inc. (NYSE:BBY) or Amazon.com, Inc. (NASDAQ:AMZN)? Best buy is desperate for additional revenue/foot traffic and a program would help that and Amazon could offer free/reduced repairs to Prime Members to further boost subscriptions there? Think about it, if Apple Inc. (NASDAQ:AAPL), Microsoft Corporation (NASDAQ:MSFT) or Google Inc (NASDAQ:GOOG) think they are losing revenue due to a repair/resell program how long before they enact their own? Either way, I am highly skeptical this becomes a significant long term business. This is especially so if they plan for it to replace the inevitable shrinking of the game trade-in business

This also begs the question: What is Gamestop? Are they a gaming destination or are they morphing into a reseller of second hand electronics and whatever else they can refurbish….Are they a glorified GoodWill?

So now lets look at some past deals $GME made that despite initial successes are now petering out.

Kongregate was supposed to be GameStop’s play for mobile, delivering free-to-play games with a little help from Adobe Flash. It worked well enough to start: the Kongregate Arcade app has over 500,000 downloads on Android and a 4.5-star rating. Now that Adobe has abandoned Flash for mobile, though, the future of Kongregate Arcade doesn’t seem so bright: Bartel calls the app a “brand-building exercise,” rather than a commercial product. “Flash not being a part of mobile going forward will have an impact,” Bartel admits.

Really? That isn’t what they said when they bought it

Acquiring Kongregate strengthens GameStop’s digital platform and its commitment to become the gaming aggregator of choice.

J. Paul Raines, Chief Executive Officer of GameStop, said, “Kongregate advances GameStop’s digital strategy by providing a gaming platform for casual, mobile and browser games that can be promoted and played by our existing gamers. We welcome the Kongregate team to the GameStop family.”

GameStop President Tony Bartel added, “Combining Kongregate’s expansive catalogue of games with our well known consumer brand, powerful marketing and strong customer relationships, means that even more gamers will be able to enjoy their games anytime, anywhere and on any device.”

Kongregate co-founder Jim Greer expressed his excitement regarding the acquisition and offered that, “To date, our company’s unique DNA has given more than 8,500 game developers the tools to make their games social, reach a huge audience and make money from over 30,000 innovative games. This includes access to virtual currency and robust community features such as leaderboards, player achievements, profiles, multiplayer, dedicated game forums, and a site-wide leveling system. Our community will only be enhanced with GameStop’s close relationship with millions of passionate gamers.”

In November 2010 they said of Kongregate:

Dan DeMatteo, Executive Chairman, commented, “Several technology and consumer initiatives have entered the market, each of them strengthening our core business and establishing GameStop as the retail leader in providing consumers with exciting ways to experience video gaming. The PowerUp Rewards™ Loyalty Program, Kongregate.com, in-store digital content sales and a re-tooled gamestop.com were all implemented to expand market share and increase our share of wallet.

Sure sounds like it was intended to be a commercial product.

So I guess the difference between an acquisition being a “commercial product” or “brand building” simply comes down to whether of not the acquisition actually makes or loses shareholders money? Would have been nice if they told shareholders when they bought it “we don’t expect this to be a “commercial product”” …….but it sure sounds like they did.

UM, a bit off the subject, but if that is the case (it isn’t a commercial product), then when do we get the goodwill writedowns for it? I may have missed them but I’m more a than a little sure they have not taken any yet. The acquisition is clearly impaired at this point if it is no longer a “commercial product” so under even the most liberal interpretation of GAAP impairment tests it must be written down.

Take a look at $GME’s balance sheet. They carry a shade over $2B in Goodwill…..which is just a shade under the company’s current market cap of $2.2B. That is a Goodwill write-down red flag….. a major one. The test for Goodwill is what the asset could receive on the open market. What $GME is telling you is the acquisitions they have made are worth what the entire company is being valued at. I call BS

Put it another way, GameStop is telling you their business ex acquisitions is only worth $200M (the diff between goodwill and their market cap).

We’ll see when they report this Q. Back to the article

GameStop’s publicly reported that Kongregate’s overall business doubled last year, and increased another 50 percent in the first quarter. Bartel’s still interested in the potential of Kongregate games on mobile, but he’s not quite sure that the web and HTML5 are mature enough platforms yet. “Needless to say, Kongregate is going to change. As the platform continues to evolve, Kongregate will evolve to let those games take place.”

GameStop recently bought Spawn Labs as well, which is still working on a streaming game platform to rival OnLive and Sony’s recently-acquired Gaikai. At first, Bartel doesn’t seem too keen on discussing the platform. “The technology works great,” he tells me. When I bring up Sony’s recent aquisition, his eyes light up a bit. “We’re feeling very good about our investment, that’s what I’ll say.”

When I ask when the service will launch, though, Bartel begins to hedge, hinting that Spawn’s time hasn’t come yet. He tells me about how the service would require a huge investment to start, and how there isn’t necessarily a commercial opportunity worth pursuing at this point.

Then why buy it? Where they just window shopping one day and thought it would be nice to have? The reality is below….

Then, the truth comes out. GameStop isn’t sure how to scale the service, because the basic idea hasn’t really evolved since day one: Bartel tells me that the Spawn Labs service still requires that the company hook up a real physical game console for each and every remote player. It’s a plan that has some major pros and cons. On the plus side, it’s completely platform-agnostic, so GameStop could use the system with any console or game, right out of the box. The minuses are tremendous, though: Spawn would have to physically change out discs for each new wave of games, and lose a lot of the latency advantages OnLive and Gaikai have by virtualizing and overclocking PC games inside of dedicated servers.

Moreover, GameStop could face legal challenges. Late last year, a US district court issued a permanent injunction against a startup named Zediva, which had a bright idea at the time: it would offer a streaming movie service to its customers by buying physical DVDs and playing them from real optical drives. GameStop is no startup, but the parallel is hard to deny

Be VERY VERY careful when management starts giving you what I think are BS reasons why small deals aren’t working. You then are obligated to REALLY look at the reason and what they are telling you about larger deals and initiatives.

If they aren’t being totally upfront about the smaller, seemingly insignificant stuff, can you take what they say about the larger stuff at face value?

By: valueplays

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