Video-gaming retailer GameStop (NYSE:GME) will report earnings for the third fiscal quarter of 2012 on Thursday, 15th November. Operating earnings for the first half of the year were down 19% as declining sales were observed across the industry. Physical retail software sales fell by 28% in the first two quarters of 2012.  The industry bucked the decline somewhat in the third quarter as sales fell by 19%.  Titles such as Electronic Arts (NASDAQ:EA) Madden NFL 13, FIFA Soccer 13 and Activision Blizzard’s (NASDAQ:ATVI) Skylanders Giants helped in this respect.
We expect the company’s focus on used games and digital revenues to mitigate the effect of declining physical sales.
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The video game industry has been observing a shift from physical CDs to online downloads of digital games. Microsoft’s (NASDAQ:MSFT) next generation console X-Box 720 is rumored to be disk-less, relying on digital downloads. Electronic Arts, one of the biggest publishers in the world, recently reported that digital revenues as a percentage of its net revenues have increased from 33% in 2011 to 46% at the end of the third quarter. Along with added convenience for users, digital downloads are also good news for publishers and distributors as the margins involved with online sales are higher since manufacturing costs are not involved. The digitally distributed video game market has grown by over 200% since 2010 and we expect this growth to pay-off for GameStop. 
GameStop’s digital revenues have been growing at a very high rate over the last few years approaching 40-50% growth. The company competes with digital distribution platforms like Valve Corporation’s Steam, Elecrtonic Arts’ Origin and GameFly’s Direct2Drive.
Used Games Better Than New Games
Even as brick and mortar retailers go out of fashion, used games still remain popular. Used game products contribute to more than half of GameStop’s profit despite accounting for only a third of the net sales. This is because the gross profit margin for used game sales is significantly higher than new video games. (47% vs 21%) Despite the double digit industry wide decline in sales, used game sales through GameStop in the first six months of 2012 were only down 6%. Third quarter figures will be particularly interesting as the annual additions to popular franchises like FIFA and Madden were released this quarter and might have had a residual effect of the sales of their predecessors.
Used video game products account for nearly 40% of our price estimate for GameStop, the division has been helped greatly by the PowerUp Rewards customer loyalty program. But with an industry shift to digital downloads, we expect sales to decline in the coming future.Notes:
- GameStop Q3 Earnings: Watch For Used Products Growth, Margins, Seeking Alpha, 13th November, 2012 [↩]
- Video Games sales in U.S. October 2012, NPD Group, 9th November, 2012 [↩]
- Market Shares of Digital Distribution Platforms in 2010-2011, Deals4downloads [↩]