Yet, two trends are rendering GameStop a redundant chain with hundreds of unproductive stores. First, users can now download their games directly from the Internet and second, game companies are going directly to the gamers.
GameStop's stock has fallen by 49% over the past three years. The company has tried to transform itself into a chain that is less dependent on game sales. It launched the Spring Mobile, Cricket, and Simply Mac stores, which sell AT&T (T - Get Report) supported phones and service plans, in an attempt to diversify. There are also products sold from the Apple (AAPL - Get Report) stable as well.
But the secular decline in gaming revenues and the cyclical nature of hardware sales makes the stock risky.
GameStop's mobile and electronics segment contributes just 11% of overall revenue. Further, these are highly competitive areas.
The company's top line has been volatile since 2012 when it ended with a record-high $9.5 billion in sales. In 2017 fiscal, GameStop posted a more than 8% drop in revenues.
The growing online gaming trend has negatively impacted GameStop. New sales of video games suffered, as expected. Moreover, the sales of pre-owned popular games also slipped.
In Q4, new hardware sales dropped 29% and new software sales fell by 19%. Pre-owned sales too dropped 6.7%.
Just like the music business, digital downloads of games have spiked in recent years, dealing a death blow to the likes of GameStop. Since video games sales are critical to it, the company's total revenue has missed analysts' estimates in seven of the past 10 quarters.
Looking ahead, new gaming consoles from Microsoft (MSFT - Get Report) and Nintendo (NTDOY) this year are not expected to help as much as they once did. Additionally, Microsoft and Sony (SNE - Get Report) are courting gamers with gaming platform subscriptions at low monthly fees, a move which further hurts GameStop.
The company, like Best Buy (BBY - Get Report) , is in a race against time to reinvent its business model. While Amazon (AMZN - Get Report) has a presence in the personal electronics market, eBay (EBAY - Get Report) is heavily into collectible sales. GameStop is unlikely to achieve the kind of scale and network effects to again be a $9 billion in annual sales company.
The management's promised turnaround game plan doesn't really inspire confidence. Store closures could be helpful to an extent, but the company's strategy to pay dividends and maintain the 7% yield may face huge challenges as cash flows from its video games business starts to dry up. Free cash flow, once in the $600 million levels has dropped below $400 million in fiscal 2017.
Though the company has enough cash to pay off most of its $815 million debt, poor earnings growth expectations for next year of 2.1% and a not-so-good credit rating means GameStop could be required to pay more interest to take more loans when required in future.
GameStop's 6.4 times forward valuation seems like a value trap because of the decline in gaming sales. Unless the decline in its core video game business slows, expect the valuation to remain compressed.
Editors' pick: Originally published April 4.
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