NEW YORK (
) -- Everyone is wrong about
While the bears would lead you to believe the video game chain will go the way of
, a smaller camp of investors predict that thanks in part to its unique digital strategy, GameStop will become to video games what
has become to movies.
But to equate GameStop to either of these mega-brands would be inaccurate.
Instead, GameStop is carving out its own niche, providing content via a bevy of platforms, including in-stores, digital downloads, casual mobile games and streaming.
Wall Street has been adamantly predicting the demise of GameStop, with shares off 25% from its 52-week high of $28.66.
GameStop naysayers believe, like Blockbuster, which was purchased out of bankruptcy by
, GameStop will be unsuccessful in its digital shift and its store base will become obsolete.
That's because the company's very model -- selling video games and consoles -- was thrown into question amid the recession, when sales of new software and hardware plunged.
GameStop vs. Facebook: Farming For Profit
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But while GameStop's same-store sales were in negative territory for the second quarter, they are expected to be positive for the year, and the firm's profitability is growing with the help of its digital content.
GameStop's digital business surged 69% in the second quarter and the company is forecasting it will earn close to $500 million in digital revenue this year. GameStop's gross margins also expanded 250 basis points for the three-month period, with 50 basis points of that coming from its digital segment.
Ultimately, the company foresees the digital business hitting $1.5 billion by 2014 and analysts predict the segment will become 20% of total sales.
"Wall Street is missing the magnitude of what GameStop is doing with digital," says Janney Capital Markets analyst Tony Wible. "It will be a powerhouse to digital. It's about putting the right content in front of the right people at the right time. GameStop can potentially sell digital content better than it ever was able to sell physical games."
In Contrast to Blockbuster
Before Blockbuster fell off a cliff, the company wasn't growing. It was reporting negative same-store sales and its balance sheet was in shambles. Needham analyst Sean McGowan says GameStop is still a few years off from that point -- and that's only if management just sits by, watching.
Unlike Blockbuster, GameStop's management got the memo.
"GameStop will avoid being Blockbuster because Blockbuster happened," McGowan says.
The video game chain is taking preemptive measures, aggressively promoting DLC (downloadable content) and utilizing its PowerUp rewards program to better understand its core customers.
"The strategy of our digital businesses is to sell content in stores," GameStop's Chief Executive Paul Raines told
. "Two years ago, people thought we couldn't sell digital content in stores. We made hundreds of visits to people on the West Coast talking about this idea. Our fundamental hypothesis was that the consumer needs help discovering digital content, and if you can help them pay for it by allowing them to trade in their old games and give them PowerUp points, it's a compelling proposition."
According to a recent survey conducted by GameStop, 50% of consumers who have purchased digital content from the retailer have never done so before. And 85% of those surveyed say purchasing DLC from GameStop stores is a very good experience.
"It is clear we are introducing DLC to mom and dad," Raines says. "We are bringing digital content to people who have never seen it before."
Yet the success of selling DLC in stores is a bit puzzling. Why would shoppers drive to a store to buy something they can purchase from their homes? One reason, says the company, is that consumers are wooed by the prospect of funding DLC purchases with trade-in credits and earnings rewards points, which only can be done on premise.
Purchasing DLC in-stores also strips out some of the inevitable complications.
"If you go online to buy digital content, it is far more complex than the app store because games are bigger files," Raines says. "It is clear people want to be educated on gaming; what's the right genre of games for them and their kids."
GameStop is proactively transforming its stores into entertainment centers -- something Blockbuster never quite figured out.
"There's a lot more discovery and less inventory in stores," Raines says. "We know there is going to be demand for physical games for a pretty long time. There are over 100 million installed consoles out there; there is a used business that will continue."
"One of the things that's important to understand about digital media, many people think consumers are binary -- they are either full physical or full digital," said Raines. "But the truth is in this category consumers exhibit hybrid behavior. They want to buy some physical games; they want to go to a store and learn about digital content. We will sell them some digital content in store. We might sell them a mobile phone app from our casual game site, and they might play while at work on their PC at Kongregate.com.
"All of those behaviors really are what the consumer is telling us they would like to have the freedom and flexibility to do. Our ability to serve them in all platforms and tie them together with a loyalty program is really our secret sauce and our core strategy going forward."
Flexibility With Physical Stores
GameStop's real estate growth will be net zero in 2011 and 2012, according to Raines, while analysts predict the company will begin announcing store closures within the year.
"If there is less demand for stores we have a model that allows us to close stores and allow us to relocate them," Raines says.
And it's this more-than-6,500 store base that also makes GameStop's story different than that of Netflix. Netflix can only ever be digital, while GameStop can adopt the hybrid model Raines outlines. Of course, which of the two will thrive remains to be seen.
GameStop's recent acquisitions also taps the company into the social, mobile and streaming spaces. The retailer has bought Kongregate.com (a casual gaming site that sells ad-based and currency-based games), Impulse (a PC download business) and Spawn Labs, a streaming technology that will launch in 2012.
Spawn Labs is expected to be the game-changer. "We believe this product has the potential to reshape investor opinion, especially as it will likely see integration with consumer electronic devices that expand the market opportunity," Janney Capital Markets' Wible says.
Sure, the technology is bound to have some kinks -- analysts point to how clunky Netflix was when it launched its streaming service in 2007. But Spawn Labs lays the groundwork for GameStop's growing front of digital content delivery, representing the company's commitment to offering customers high-quality games across a variety of Internet-enabled devices, from smartphones to TVs.
Outside of its digital strategy, GameStop is also covering its bases. Sales of used games rose 12% during the quarter, its strongest period in the segment in several years, which Raines credits to its loyalty program.
The PowerUp program, which launched in May 2010, boasts 12.5 million members and accounts for about 25% to 30% of total U.S. transactions in the game industry.
"We see PowerUp as a vital element in the GameStop story that will fuel digital growth, targeted promotions and profitable store consolidation," Wible says. "The data from PowerUp helps assure that GameStop will play a vital role in digital growth and should promote multiple expansion in the stock."
Reported by Jeanine Poggi in New York.
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