GameStop Not Significantly Impacted by Digital Until 2017, says Analyst

Over the last year or so GameStop executives have repeatedly downplayed the impact that digital distribution will have on their video game empire, while at the same time the company has made moves to become the "world's largest digital aggregator."  Now Ben Schachter of Broapoint AmTech has initiated coverage of GameStop (a "Buy" rating and $33 target), and he agrees with the retailer that its business won't be affected much by the digital revolution for many more years. Ultimately, Schachter doesn't see much impact on GameStop until 2017.

"There is little doubt that over time more and more media content will be delivered digitally to the home. However, the question of the timing of this trend is critically important as it relates to GME's stock. In our view, it is unlikely that digital downloads will have any meaningful impact to GME's business this console cycle (which we think will run through at least 2014). Technologically, full game downloads to a console are feasible already (and there is already a small library of full-games available on Xbox Live), but limited hard drive space (we estimate approximately 70% of current-generation consoles have no hard drives) and bandwidth limitations (full games can be 20GB+) create significant barriers," Schachter pointed out. "These barriers will obviously change over time, but the timing of the replacement cycle is key. Even if one assumes that by 2014 all new consoles have capabilities that eliminate storage and bandwidth concerns (which we believe is unlikely), it will still take several more years before these consoles have significant household penetration."

He continued, "We also note that consumers attribute a value to having a hard/physical product that can be sold, traded, and is portable. GME's own study put the residual value of physical game disc at approximately $10-20 dollars vs. a download-only version of a game. Bears believe many of the issues that have impacted the music industry over the past few years will eventually hit the video game business. In our view, a key issue that is often lost in the discussion over digital distribution of video games is its impact on the ability of game publishers to market their games at physical retail locations. The retail channel remains critical to the sales experience for games.

"If proof is needed that this still matters to game publishers, one needs to simply look back to the relative failure last year of Grand Theft Auto IV's download-able content. The Grand Theft Auto (GTA) franchise is among the most well-known and successful brands ever created in the video game industry, yet having digital-only distribution of a product tied to GTA's most recent console title led to very disappointing sales. The bottom line is that retail still matters. Having said all that, the headline risk surrounding digital distribution will always weigh on GME's valuation. Investors should expect to see many, many announcements about fully download-able video games in the coming years. This will be one of the primary factors that may limit multiple expansion for GME."

While some in the industry believe that GameStop's rapid growth will soon hit some major hurdles, Schachter remains bullish on the retailer. "The bottom line is that GME continues to defy the naysayers. For years, the bear case has remained the same: that some combination of competition in Used, store over-saturation, inventory build-up, and/or digital distribution will kill the business of a video game specialty retailer. However, year after year, GME continues to grow and execute against plan as it defies the competition and conventional wisdom about its store openings," he said.

Also see: Can GameStop Survive a Digital Future?