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According to Newzoo, the worldwide gaming industry will reach $116 billion in 2017, up over 10% from the previous year. In addition, that number is set to grow at an 8.2% annual rate over the next few years, to over $143 billion by 2020.
As you may expect, many gaming-related companies have ridden that wave to tremendous gains; however, one gaming stock has gone in the opposite direction: GameStop (NYSE: GME). It has shed almost half its value over the past three years, trades at a bargain-bin valuation of just 4.6 times trailing earnings, and has a sky-high 9.5% dividend yield. So what's going on here?
GME 3-Year Total Returns (Daily) data by YCharts.
Physical goes digital
The main fear surrounding GameStop is that digitally downloaded games will eventually replace the physical discs GameStop has traditionally sold. In addition, GameStop is a brick-and-mortar retailer, a sector that has been roiled by the increasingly digital economy.
GameStop has begun selling digital games, but digital revenue makes up only about 1.9% of its total revenue, and management has tacitly acknowledged that digital downloads represent a long-term threat. Between 2014 and 2016, GameStop's revenue from console sales declined 31.1%, and new game sales declined almost 20%. However, that trend looks like it will be broken this year -- the 2017 introduction of the Nintendo Switch, the first new system to come along in three years, turned GameStop's console and new game sales positive in the recent holiday period.
Is GameStop stock cheap enough to buy? Image source: Getty Images.
Management also doesn't believe physical games will be going away. In a recent conference, CFO Rob Lloyd explained that about 30% of games are downloaded digitally today, though certain select titles have launched at over 50% downloads. Even on these titles, Lloyd said, GameStop gets a large share of the remaining industry purchases. In addition, management believes there are barriers to full-on digital disruption, due to the amount of storage space digital games take up, as well as the time they take to download.
In addition, many gamers depend on physical trade-ins at GameStop, where they can receive as much as a 33% credit for new games, and GameStop believes there is a core group of gamers who depend on this trade-in credit to keep purchasing new titles.
Trying to diversify
Still, if digital disruption does begin to accelerate, GameStop has made a big effort to expand its non-game business segments, which now encompass roughly 40% to 45% of sales. The company has acquired its way into three new lines of business: collectibles; AT&T franchises; and Simply Mac stores, which are mini Apple stores in smaller communities that don't warrant an Apple-owned store.