Retail Middlemen Vanishing Into the Internet

People are buying things again, and they have been for a while. After all this time it is finally starting to make sense. Things might actually be picking up, though the labor market is still pretty awful. There are a few macroeconomic events that could bring the world to its knees, but let’s save that for another time. Retail is shifting online, but I want to see if there is still some life in physical stores. Obviously some stores will always be around, but others might not be so lucky.

GameStop Could Flare Before Snuffing Out

The next generation of video game consoles is on its way, which is why I think GameStop (Nasdaq: GME) might get a bit more air underneath its wings. I am not saying it is going to become hugely profitable, but when the consoles start coming out, good news might flow out of GameStop. The share price has proven surprisingly resilient despite GameStop losing money. I once pondered whether there was room for GameStop in today’s market, and I now don’t think there is.

GameStop lost almost $350M in the last 12 months. That is net income TTM, which means that it’s as of the last earnings report, which was in October. The company has no debt, but only $366M in cash. I expect losses to continue, though the next earnings will have the holiday season factored in. Even if they look good, the long-term trend is troubling. Digital sales of games are increasing rapidly. The last physical PC game I bought was StarCraft 2: Wings of Liberty in 2010. I got a digital pre-order for Heart of the Swarm.

Image may be NSFW.
Clik here to view.Publishers are also pushing back against used games, which delivered massive margins in days yonder. Forget the plans to have certain content require a purchase of a new game, now there are plans to tie a game to a specific console though that might not be implemented. Publishers are going to do everything in their power to make sure the concept of used games dies and remains buried.

Most game sales are going digital, whether through a platform like Steam or directly from the publisher. Used games are disappearing. Physical games and equipment have low margins, and face stiff competition from Amazon.

Nix the Middleman, Go With Publishers

I am an Activision-Blizzard (Nasdaq: ATVI) game and stock fanboy. I love their games, and I think their stock is great. I might be position-free at the moment for various life-based reasons, but Activision would be right on top of my “to buy half, write covered calls, and write cash-secured puts for the other half” list. I think I have mentioned that Activision has over $4B in cash, but just in case I’ll mention it again. Activision has over $4B in cash. It is also the only video game company to have a dividend.

Heart of the Swarm is upon us. It will bring in a lot of revenue. Activision will probably have another Call of Duty game around the holidays, and that will bring in a lot of revenue. Skylanders as a franchise crossed the $500M revenue mark.

Activision is jumping into the mobile space with the launch of the Activate platform with Skylanders at the tip of the spear. I also think that Disney Infinity will bring more attention to Skylanders and help increase revenues. Just like how the Monday Night Wars in the 1990s actually created wrestling fans instead of just dividing existing fans up, though division happened later and one company folded. Initially, viewership grew as a whole because of the competition. I think Activision goes higher from these levels.

Best Buy Does Have a Chance

Back to retailers who might be finding themselves irrelevant. I think Best Buy (Nasdaq: BBY) does have a good chance of clawing itself into relevance. Best Buy has a less specialized business than GameStop, but is facing stiff competition from Amazon. Specialty retailers would normally be better off, but GameStop faces direct existential threats to its business that are unique to much of the entertainment industry, like digital media and streaming.

Best Buy needs to make serious changes. One thing I can think of is becoming more like an electronics gallery, and carrying more products that have custom specifications instead of general one-size fits all stuff. Examples would be high quality cameras or speed cameras instead of only ten standard digital cameras. Best Buy will be carrying the Leap Motion, exclusively I believe. Best Buy will also need to grow its online business.

Year-to-date the stock is up over 70%. Not sure it deserves that much of a gain yet. It is taking steps, but certain changes are double-edged. The price match program, while increasing sales might drive the company into lower margins or deeper losses. Best Buy only recently became unprofitable and its most recent quarter was profitable.

Its losses for the previous 12 months are around $250M, which is not terrible considering the $1.8B in cash. Also, those are earnings, but operating cash flow is $1.422B over the same period. Its debt-to-equity ratio is 0.62, which gives the company some flexibility. It also has a 3.7% dividend yield, and the next dividend is in April 2013. The company is not hurtling towards bankruptcy, but concerns remain. Best Buy is a high-risk play and with the stock having risen so much, I wonder if there is any near-term rewards.

Conclusion

I always like Activision-Blizzard for making awesome products that everybody wants. The Heart of the Swarm launch party around the world was amazing. I watched the live stream. Best Buy is a long shot for those who love to take risks. The reward is not as high as it could be, since the stock is already up so much. However, Best Buy is not posting heavy losses so it did not take much of a beating. I worry about GameStop and I would stay away until something that can carry the company in the long-term shows itself.

Additional Riffing:

I just got done playing through the campaign of Heart of the Swarm. I have a few complaints, but overall it is a fantastic game. Blizzard has done it again. I was also live streaming the worldwide launch party, and man there is a lot of enthusiasm for the game. The live stream had almost 100k people at certain times. I wasn’t even tracking the North American launch. I fell asleep.

GameStop sponsored the launch too. I just do not think there is room for GameStop anymore. The entire entertainment industry is changing. Best Buy has it easy, because internet retailers are not eliminating the very nature of physical retailers. GameStop’s business was selling games and used games. Games are going digital. Even console games seemed headed for that eventually.

Used games are being vilified and destroyed. I half expect publishers to buy used games and destroy them, at least then they will not take another sale downstream. It is understandable. Brand new games sold used are like $5 less than the actual retail. GameStop does not give you much for a used game, but they get a lot. People finish games fast. You can start seeing used copies like a week after it is released. Definitely puts pressure on sales. GameStop is being directly attacked by the future. The other part of the business that is consoles and accessories is low margin anyway, and Amazon is winning there. Best Buy could offer the same accessories and a whole lot else while eliminating redundant overhead. Poor GameStop. Best Buy has trouble ahead too, but it is doing fine for now. It is not in dire straits, but it can’t stay the course and expect success.

I prefer Activision-Blizzard with its awesome games!