Money Matters - Simplified

Something Doesn't Add Up at GameStop


Shares of GameStop (NYSE: GME) opened 6% lower, after the video game retailer posted disappointing fiscal second-quarter results.


Net sales and earnings climbed 3% and 4%, respectively -- landing just short of Wall Street expectations.

An optimist would argue that at least GameStop is growing, a healthy contrast to the dreary sales figures that the industry itself has been spitting out for more than a year. This isn't just brainless expansion of a fading concept, either. Comps actually clocked in 0.9% higher during the period, with GameStop targeting positive comps for the entire fiscal year.

The retailer's aggressive share buyback is also inflating bottom-line results as the 4% increase in net income turns into a respectable 13% climb, to $0.26 on a per-share basis.

However, something still doesn't feel right. GameStop missed Wall Street's bottom-line number for the quarter, it's hosing down its profit target for the current quarter, yet it's somehow sticking to its full-year guidance of $2.58 to $2.68 a share in earnings. It doesn't add up.

GameStop is willing to show its math. It expects to take a hit this quarter as it rolls out its PowerUp Rewards customer loyalty program nationwide and beefs up its in-store download offerings. It sees those moves paying off during the telltale holiday quarter, boosting earnings by the $0.03 a share that it's currently talking down. It's also banking on Microsoft's(Nasdaq: MSFT) new motion-based Kinect platform to fuel fourth-quarter sales.

Here is where I begin to search my Crayola box for Burnt Sienna Skepticism.

Let's start with the downloadable content initiative. Digital delivery is inevitable, but isn't it all about home-based convenience? We shook our heads when Blockbuster proposed having movie buffs bring in memory cards to preload with flicks three years ago. Barnes & Noble(NYSE: BKS) is hoping that Nook owners can come in for free e-book browsing, but it underestimates e-reader owners if it expects to sell physical books as impulse items. GameStop's digital teases are temporary. In a few years, most die-hard gamers will be downloading their diversions directly from software publishers.

Even Kinect -- no slam dunk at its $150 price tag -- is hardware that encourages users to become digital subscribers through Xbox LIVE Gold memberships, allowing them to communicate with family and friends.

GameStop has been too busy building its empire -- 6,549 small boxes and counting -- to address its relevance come, say, 2015. Microsoft and Apple (Nasdaq: AAPL) are riding high off their download marketplaces, and video games will buckle to digital distribution the way that music, movies, and books have. It's only media.

We will still need hardware, but that's GameStop's lowest-margin business. Why can't price leader Wal-Mart (NYSE: WMT) or consumer electronics giant Best Buy (NYSE: BBY) fill the same void?

Good luck telling a GameStop apart from a RadioShack in five years!

GameStop bulls will argue that the retailer is still growing and now selling at a ridiculously low seven times this year's projected earnings. However, this is the same value trap that found GameStop itself paying more for its repurchased stock over the past few months than it could have if it had waited.

The company couldn't call bottom. Bulls haven't been able to draw the line. GameStop's cash-rich balance sheet prevents it from being on a long road to zero, but why do I get the feeling that we'll get closer still when GameStop finally owns up to the reality that it's going to miss its fiscal year guidance?