GameStop Is Not Blockbuster, Which Could Be Bad for Short Sellers

NEW YORK (TheStreet) -- Many believe GameStop (GME) is fading faster than Blockbuster Video, but company fundamentals signal that the video game store may be around longer than you think.

Short sellers have beaten up on GameStop this past year, pushing its share price down nearly 30% off of its 2013 highs, while also taking on a 26% short float of the company's shares outstanding.

The thesis for GameStop's demise revolves around the idea that most of their business is migrating online.

Digital purchases were shown to have accounted for about half of the $1.5 billion spent on games in May, according to industry-tracking research firm The NPD Group.

The worry, however, may be overblown at this point, meaning GameStop's share price -- about $40 in mid-afternoon trading Friday -- is severely undervalued.

GameStop's sales increased throughout the 2008 recession, and have stayed flat the past three years. Even as gaming has gone digital, the company managed to maintain consistent market share.

GME Revenue (Annual) Chart
GME Revenue (Annual) data by YCharts

Unlike Netflix's (NFLX) takedown of Blockbuster, the video game industry requires some physical presence. The constant release of new game consoles and the trading in of used games, which bears some resemblance to the swapping of sports cards, requires a centralized location.

GameStop has made itself the "cool" hangout for these gamers. Its customer base is comprised of nearly 7 million members in its loyalty program. Members can qualify for discounts on purchases and better deals on trade-ins.

Meanwhile, unlike the culture at book stores, such as Barnes & Noble (BKS), where patrons simply go to browse at books and magazines, at GameStop they tend to walk away with product in hand.

Gamers can go and purchase a used game for nearly half the price of the new version, then resell it when they are done, netting GameStop a nice profit, and leaving the gamer happy to be walking away with cash in their pocket.

The business model has proven successful as gross margins were a robust 47% on sales of $2.33 billion for its off-price video game products in 2013.

GameStop has also taken care of its shareholders as revenue remained flat by reducing shares outstanding and initiating a dividend. Shares outstanding have fallen consistently the past five years due to a share buyback program, which has in turn increased earnings-per-share.

Similarly, the company last year initiated a dividend which yields a healthy 3.28% with a payout ratio under 40%.

GME Shares Outstanding Chart
GME Shares Outstanding data by YCharts

Steady sales and efforts made to take care of shareholders by management led GameStop's share price to form a double bottom pattern in 2014.

The $35 mark provided solid support for prices, and it looks as if the video company's stock has begun to trend higher in recent weeks.

Considering the confluence of a steady fundamental picture, improving technicals and a large number of short sellers, GameStop's share price could spike higher as the shorts begin to get stopped out of positions moving against them.

GME Chart
GME data by YCharts

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At the time of publication, the author had no position in any of the funds mentioned.

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This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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