AFP/Getty Images This should be a great time for GameStop (GME). This month’s introduction of Sony’s (SNE) PlayStation 4 and Microsoft’s (MSFT) Xbox One should ring like dinner bells drawing diehard gamers to GameStop’s stores.
GameStop has assembled a network of 6,488 small-box locations across 15 different countries to cash in on moments like this. It has hosted midnight release parties for both consoles, and with demand exceeding supply, it’s a safe bet that a lot of prospective buyers will be circling around their local GameStop locations as new systems arrive throughout the holiday shopping season.
However, this may not be as jolly a holiday season as bulls were expecting this time.
GameStop delivered blowout quarterly results on Thursday morning. Sales and earnings clocked in ahead of expectations, but the stock still opened sharply lower because the chain served up a weak profit outlook for the new quarter.
It has been seven and eight years, respectively, since Sony and Microsoft updated their consoles, and because of that, the holiday season is supposed to be huge for GameStop. The retailer is forecasting comparable store sales to grow by as much as 9 percent, and that may seem low since these new platforms aren’t cheap. The Xbox One sells for $499. The PS4 fetches $100 less, but that price doesn’t include the $60 camera accessory gamers will need to buy to get it up to speed with motion-based operations.
However, the real shocker in GameStop’s report is that it’s only looking for a profit between $1.97 a share and $2.14 a share. Even at the high end, we’re looking at earnings that are short of the $2.16 a share it earned a year ago and the $2.15 a share that Wall Street was expecting.
The two likely culprits for the soft bottom line are weak software and pre-owned sales. And it remains to be seen if either of those two categories will truly bounce back.
Thinking Outside of the Xbox
Hardware has always been GameStop’s lowest margin business. The markups are meager, leaving GameStop to make its profits in new software, as well as its even higher margin business of buying back used games and gear to refurbish and resell at a healthy markup.
It seems as if GameStop is being let down on both fronts.
Software sales may have been strong in the third quarter — fueled by the record-breaking success of Take-Two Interactive’s (TTWO) “Grand Theft Auto V” — but they may be holding back now. This shouldn’t come as a surprise. The new consoles come with meaty hard drives made for dialing into their digital marketplaces for downloads. Buying physical software at the neighborhood GameStop store is so 2012. Sony and Microsoft are also playing up their new consoles’ non-gaming entertainment features — primarily how they play nice with live TV and streaming content. A lot of system buyers may be spending more time using them for surfing the Internet or watching videos than they are playing games.
The outlook gets even more ominous for GameStop’s vital resale business.
The PS4 and Xbox One incorporate new chip architectures that make the systems incompatible with older games. In other words, gamers may be reluctant to trade in their Xbox 360, PS3, and related titles, because they’ll need them if they want to play the games that they own. Sony and Microsoft plan on offering cloud-based solutions, but nothing beats having discs that don’t eat up storage or Internet bandwidth.
We have been seeing GameStop’s pre-owned business starting to falter in recent quarters. Even in the otherwise awesome third quarter, with software and hardware sales soaring 43 percent and 15 percent respectively, GameStop’s pre-owned revenue slipped 2 percent. Those who figured that there would be a spike in trade-ins as gamers saved up for the new costly systems were wrong.
This leaves GameStop in an uncomfortable spot at a time when it should be roaring. The stock had more than doubled in anticipation of how it would cash in on the new consoles this year. Now, we’re told that GameStop won’t earn as much this holiday shopping season as it did a year earlier when the stock was trading for half the price.
With gamers bypassing disc-based software and refusing to buy or sell used games and gear that’s being rendered obsolete by the Xbox One and PS4, maybe these new systems weren’t what GameStop investors were hoping for.
Motley Fool contributor Rick Munarriz has no position in any stocks mentioned. The Motley Fool recommends Take-Two Interactive. The Motley Fool owns shares of GameStop and Microsoft. Try any of our newsletter services free for 30 days.