December 19, 2014 - 9:58am EST by
2014 2015
Price: 33.00 EPS 3.50 4.10
Shares Out. (in M): 109 P/E 9.5 8.1
Market Cap (in $M): 3,600 P/FCF 7.3 6.5
Net Debt (in $M): -20 EBIT 634 739
TEV (in $M): 3,580 TEV/EBIT 5.6 4.8
Borrow Cost: Available 0-15% cost

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  • Disintermediation
  • Electronics
  • Secular decline
  • Monopoly


GME is a beaten up retailer that has survived for years despite perpetual skepticism that a digital evolution will render sales of physical video games obsolete. The company has survived an industry-wide secular decline thanks in large part to its virtual monopoly in used video games which carry very lucrative 50% gross margins. Unlike the sales of new video games, which areis currently in a decline, many investors expect the used game category to continue growing under the belief that it is more immune than new games to erosion from digital penetration. As a result, used games have become the backbone of GME’s economic model with gross profits from used games contributing well over 100% of the company’s expected $900MM in EBITDA. Unfortunately, next year both Sony and Microsoft will deliver a death blow to this business by launching streaming services for older titles.

There have been a number of articles and VIC submissions outlining the various arguments for and against GME over the years so rather than rehashing these views, this write-up will focus on the key changes that have occurred in the past six months that have undermined the incumbent bull thesis dismissing the threat to used games from digital penetration. starting with the disruption of the bull thesis on used games which hindered the penetration of digital into older games until only recently. This thesis was contingent on the validity of three assumptions. First, consoles are unable to could not store a large number of digital games, requiring consumers to keep games on discs if they want to play different games without constantly downloading and uninstalling files. Second, downloading a game takes longer than a consumer is willing to wait, particularly if they have a slow internet connection. Third, physical games have a perceived trade-in value of $20 which lowers the net cost of a new $60 game to $40, making it cheaper than a full-priced $60 digital equivalent.

With the emergence of next generation consoles and new technologies, all three of these impediments have been removed. First, new consoles can now store a greater number of titles (1), well more than what the average gamer owns at any one time (2). Second, both Sony and Microsoft have deployed pre-loading software this summer (3), enabling customers to download games at their leisure well in advance of the official release date but get instant access at midnight (4). As a result consumers can bypass the antiquated experience of standing in line outside a store for hours (5). Third, both Sony and Microsoft are regularly offering $10-15 store credit for games purchased through their online platform (6). Such discounting, among various other promotions (7), disintermediates the perceived $20 trade-in value of a physical copy while further locking customers into a publisher’s digital ecosystem.The full potential impact of downloading and streaming on the physical game space has yet to be fully understood by the investment community. PlayStation Plus and Xbox Live Gold are the two largest game subscription services offered by Sony and Microsoft, respectively. Each service provides substantial discounts to digital purchases as well as a number of free digital games (8) for only $4-5 per month. Since the launch of new consoles, however, the breadth of these offerings hasve dramatically ramped up as Sony and Microsoft duel for share, further increasing the value proposition of subscription services (9). As an example, for the month of December PlayStation Plus subscribers can download free copies of the following (10):

  • Injustice (currently $19.99 new and $17.09 used at GME)
  • Secret Ponchos (PC game not sold by GME but $14.99 on Steam)
  • Hitman HD Trilogy ($19.99 new and $17.09 used at GME)
  • Deadly Premonition ($39.99 new and $17.99 used at GME)
  • Final Horizon (Not available elsewhere)
  • Titan Attacks! (PC game not sold by GME but $9.99 on Steam)

Keep in mind that this represents just one month and that over the course of a year subscribers get access to a tremendous number of titles, many of which they would have otherwise purchased in a store. These offers appeals the most to aggressive used-game consumers, those who constantly purchase and resell used titles, by providing them with a massive catalog of older games that they can download fromchoose from to download. While the investment community is aware of that the risk that of rapidly inflecting sales of digital new games poses to both new and used physical games, quite a few investors are not even remotely familiar with these subscription-based services. In fact, references to “PlayStation Plus” or “PS Plus” in GME transcripts or sell-side coverage in the past six months areis almost nonexistent.

This scant coverage also applies to the latest efforts by Sony and Microsoft to push digital subscription adoption even further. Sony has been beta-testing a streaming service called PlayStation Now (11), which has nearly 700 older games (12), and Microsoft is working on a secret project codenamed “Arcadia” which appears to be a very similar concept (13). Both services let consumers rent legacy games for 90 days by immediately streaming purchases to their legacy or next generation consoles. Thus, rather than purchase a used game from GME for say $11 and resell it later for $1 (14), this service allows budget conscious customers to pay $10 for the same experience minus the physical hassle. Last month, PlayStation’s blog announced that PlayStation Now would launch subscription-based pricing for this service with more details coming “soon” (15). In all likelihood, both companies will officially launch streaming subscription services sometime next year, giving consumers instant access to immense back catalogs of titles. These services will appeal the most to GME’s best and most reliable used game customers, who will transfer their highly lucrative used game purchases permanently to digital. In short, this is the used video game industry’s equivalent to Netflix.

Last quarter GME missed expectations and lowered Q4 guidance as sales of older games on legacy consoles were much slower than expected. Management and the sell-side are at a loss for an explanation, largely because they simply are not attuned to the rapidly evolving behavior of hard core gamers who are converting entertainment dollars and time to subscription-based services. As digital disintermediation increasingly propels this evolution, GME is likely to continue missing earnings expectations while investors struggle over the right multiple to apply to earnings that are in a rapid decline.


  • Buyout: The stock is cheap and a buyer may not appreciate the headwinds facing the company
  • Q4 Earnings: The company may have appropriatly lowered the bar for the holiday when it missed Q3
  • Streaming Timeframe: Consumer adoption of streaming services may slow materially and thus EPS expectations in the near-term may be acheivable. 
  • Business Transformation: Non-game concepts are expected to represent 10% of EBIT in 2016 but the company may try to more aggresively move in this direction.
  • New Financing: GME is now providing credit financing to customers. This typically provides a sales tailwind for a year until it annualizes. 



I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


Competitive announcements and continued earnings misses. 

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