In Focus: GameStop
There may be no better feeling for a business owner than seeing a large demographic start to shift in your favor. For example, a company that specializes in faux fur or faux leather couches had to be excited when more of the society started to care about the treatment of animals and nature. Chipotle's market value increased as more Americans became health conscious, and began to question and analyze what they ate.
For video game companies the numbers started to look really really good in the early 2000s. At that time, a population of people who started playing video games on the Nintendo Entertainment System back in the 80s were beginning to graduate college and enter the "real world." A good portion of that generation, Generation X, still played video games, and now they were going to be able to financially support their own gaming habits. No more relying on mom and dad for games.
This was going to be a huge windfall of profits for gaming companies. My self for instance, by the mid 2000s, I could comfortably afford to purchase a few brand new games a month, and maybe more if I decided to cut back on something. Gaming companies were looking forward to this, and it's continued growth as more young adults stayed connected to gaming. GameStop (GME) created a hiccup in the grand plan of the gaming companies by allowing gamers to buy and trade pre-owned games.
If you aren't aware of how it works, a customer walks into GameStop a week or two after a game is released, and asks for that game title, the GameStop employee by default sells them a pre-owned version of that game, unless the customer specifically requests a new game.
Through GameStop, brand new games were bought, played, and then sold back to GameStop. GameStop would then resell the game for a profit to another gamer, and the gaming companies only saw money from the first sale of their brand new game. To couple insult with injury, for game titles that were really in demand, GameStop would sell those used titles for only slightly less than the cost of a brand new copy.
GameStop circumvented billions of dollars from gaming manufacturers. Instead of someone like me buying two new games a month, I was often buying two used games a month, and only buying a new game when I was compelled to play a game right away, which wasn't often, because the real world left me with little time for gaming.
Operation Get Them The F*ck Out of Here
By the late 2000s and early 2010s the gaming companies had had enough of GameStop. As the Xbox One and PS4 were in the works, one of the issues both Microsoft (MSFT) and Sony (SNE) took on together was how to stop or slow the pre-owned game market.
The easy answer was to stop producing physical games, and instead just make everything digital. That ideal at the time would have mimicked the music industry, which had seen CDs all but disappear, but video games are much larger files than a full length Jay-Z album, and digital storage was getting cheaper, but it wasn't cheap at that time. Also, the internet infrastructure was still sketchy in many places around the world, and not everyone had access to high speed internet. A full game download over a bad internet connection could take hours to complete.
Microsoft flirted with an idea of a digital lock that would bound one game to one system, making it impossible for the game to be played on any other system after it was played on and matched to its host system.
Essentially, the GameStop problem was solved by gaming companies creating downloadable content or DLC. Now gaming companies sell to consumers what they say is a completed game, but then charges the consumer to make character upgrades or obtain tools that can make the game play easier or more fun. DLCs are purchased while playing the game, and have allowed game companies to get even more money out of consumers ($60 to purchase the game, and then more money spent on DLC), and it's caused gamers to keep games longer, because DLCs can extend the life of a game by adding difference levels and challenges, which again, the gamer has to pay for to access.
In addition to the DLC, the rise of smartphone gaming has been a thorn in the side of GameStop. Also, digital space is now the cheapest it's ever been, making digitally distributed games an option for gamers. Both Sony and Microsoft's newest consoles come in versions especially made for digitally distributed games. In these models, there is no CD drive to insert a physical game.
DLC, mobile gaming, and digitally distributed games together has been able severely hurt GameStop's stock price. In late 2013 the stock was trading above $55 per share, and it entered 2020 trading at under $6 per share, an 89% drop in a little over six years.
Today it appears GameStop's stock has gotten it's swagger back. The stock closed last week at $65.01, it even halted trading on Friday January 22, 2021 due to the volatility in the stock. Traders ran the stock up to as high as $77 per share on the day.
The GameStop's hype started last summer when Chewy (CHWY) co-founder Ryan Cohen's investment firm RC Ventures bought a 9% stake in GameStop. In the past week Cohen secured a board seat at GameStop, which played a big part in the week long rally in GameStop's stock.
Cohen helped build Chewy into a real player in the pet care space, which prompted PetSmart to acquire the company for over $3 billion. Investors are looking to Cohen to do it again, but this time with GameStop.
There's also a massive short squeeze that played out, that also contributed to the rocket-like rise in GameStop's stock price. The short squeeze occurred when investors who were short GameStop had to buy the stock to cover their positions as the stock price started increasing. The rapid buying of GME by short sellers to cut losses or prevent bigger losses helped to drive the stock price higher. A Barron's article suggests that GameStop short sellers have lost nearly $3 billion betting against the stock in 2021, ouch.
My concern about the newfound love for GameStop centers around the company's problem, and what investors believe is GameStop's problem.
Chewy has been applauded for its ability to survive against Amazon (AMZN) (It's too early to say they've beaten Amazon). Because GameStop is considered a brick-and-mortar retailer, I believe investors see Amazon as the problem, which is understandable because Amazon is the problem for most brick-and-mortar retailers. Unfortunately, Amazon is not GameStop's biggest problem, and I say unfortunately because GameStop's problem is much bigger.
GameStop is disliked by the gaming industry. They're the partner none of the other partners care for. EA, Sony, Microsoft, Ubisoft, TakeTwo, Activision, they all win big with GameStop gone. With GameStop as we know it now gone, the plan I discussed earlier goes back into motion, and video game playing adults are back to buying new games all of the time, with a few going to eBay for pre-owned games. How does Cohen and his firm fix this issue?
Personally I'm out on this one, I'll watch it all play out from the sidelines. We won big shorting GameStop back in 2017, but I'm not ready to short it here. Investors should beware here at $65 per share. If you believe you see a solid pathway towards success for GameStop, and you believe that pathway leads to the company being worth more than $4 billion, then by all means, invest a way. To me, at this price level, it feels that the best possible plans for GameStop have already been incorporated into the stock price, not leaving much value to invest in at this time.