Shares of GameStop fell 4 percent on Thursday after posting disappointing quarterly results. Things aren't as bad at GameStop as its fellow suburban strip mall staple RadioShack. Sales at GameStop are growing again. GameStop has a cash-rich balance sheet; RadioShack is saddled with debt. However, there are still plenty of reasons to worry that GameStop's peaking with a model that will be less relevant in the coming years as gaming companies deal directly with players.
Level 1: Funky Financials
GameStop's holiday quarter was a bit disappointing. November's debut of the Xbox One ($100-plus) and PlayStation 4 ($400) were supposed to deliver a major boost to the chain's cash registers. However, despite a huge 88 percent surge in hardware sales, GameStop's net sales only inched 3.4 percent higher.
Sales of new software shrank 24 percent. Sales of used games and gear also dipped slightly, and that's a surprise because one would figure that folks would be trading in their older systems and games to pay for the Xbox One and PS4 boxes.
The combination of strong hardware sales and weakness everywhere else doesn't play well on the bottom line. Most retailers sell hardware at lean markups. Their profit margins lie in the subsequent software sales. GameStop also scores even better margins with its pre-owned business since it can refurbish used games that it buys at a pittance and resells at higher prices.
The end result is that while net sales inched higher during the quarter, operating profits, earnings and adjusted earnings all clocked in lower than a year earlier. GameStop missed Wall Street's profit estimates.
Level 2: Murky Future
GameStop's guidance for the new year isn't very comforting. It is targeting total sales to climb 8 percent to 14 percent for all of 2014. However, its guidance for profitability -- calling for earnings per share to clock in between $3.40 and $3.70 -- is woefully short of the $3.76 that Wall Street was forecasting before the report.
More importantly, they're also establishing direct relationship with the game makers. The popularity of app marketplaces and cloud-based computing makes it easier for developers to reach directly to players. That's huge, especially since they get the last laugh on GameStop because they never warmed up to the chain's resale business.
Software developers only make money on new software sales. They get shut out every time that GameStop resells a once hot title. Digital delivery is not only a cheaper way for developers to sell their wares (with unlimited inventory), but it also nips the resale market in the bud.
Game Not Over
This isn't necessarily the end for GameStop. It's still very profitable. Its clean balance sheet will afford it several shots at reinvention. However, assuming that sales and earnings will continue to grow after folks upgrade to the new Xbox One and PS4 is dangerous.
Video games may follow CDs and books as the next form of media to go digital, crushing the chains that rely on the sale of physical media. And it will be a hard game for GameStop to win.
Motley Fool contributor Rick Munarriz has no position in any stocks mentioned. The Motley Fool owns shares of GameStop. Try any of our newsletter services free for 30 days.