GameStop’s (NYSE:GME) third quarter earnings showed signs of a shift in the video game industry from physical sales through brick and mortar retailers to online digital downloads. Total global sales declined by 9% over the prior year to $1.77 billion but digital sales increased by 32% over the third quarter of 2011. The decline in sales looks good when compared to the rest of the industry, retail sales in the U.S. fell by 19% in the three months ending September. 
Time For A Change
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GameStop is a big player in the U.S. video games market, with over 44% of the software market share. The company is greatly influenced by market trends. One such trend is the decline in new game sales which has been brought about by the fact that Microsoft’s (NASDAQ:MSFT) X-Box 360 and Sony’s Playstation 3 are in the waning phases of their product cycles. New software sales in the U.S. declined by 19% in the last quarter, with GameStop’s sales falling 12%.
Nintendo’s next-generation console, Wii U, has recently been released in the U.S. Although the new platform has generated massive fanfare, with over 1.2 billion titles reserved by GameStop pre-launch, the gaming landscape has changed considerably since the last console was released. Tablets, smartphones and online gaming facilities such as those offered by Zynga (NASDAQ:ZNGA) now offer gamers the ability to play their favorite video games on the go. Wii U’s success in the coming months might help gauge the future of the traditional video game industry which has been declining in the last few years.
GameStop also reported over 500,000 customers in its Wii U reservation wait list. The next generation of consoles, including the X-Box 720 and Playstation 4 which are expected to release within the next two years will help GameStop buck, at least temporarily, a declining trend observed in new video game hardware that has been observed over the last few years.
Old Influenced By New
GameStop reported a 9% decline in used games sales, primarily due to lower new title sales in the last few quarters which led to a lower inventory build. As new game sales decline, inventory will also decline, leading to a subsequent fall in used-video game products. To improve the situation, GameStop has introduced pre-owned and new mobile devices to 268 of its stores in the U.S., dedicating an average of 15 linear feet per store to mobile devices. Sales in the converted stores have increased by about 7%. Mobile devices accounted for 10% of the pre-owned trades in the last quarter. As the gaming industry has already adopted these devices, it makes sense for GameStop to follow suit and ride the trend. This might help mitigate the effect of a declining inventory, particularly in the long-term.
Although the gaming industry has seen a decline in the last few years, we remain bullish on GameStop. This is because the company has seen an increase in high-margin pre-owned games and digital business. Used game products still account for 28% of GameStop’s sales. Mobile sales, which also have high margins, increased by 50% year-on-year to $43.2 million in the last quarter. We will shortly update our model to account for third quarter earnings.Notes: