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Can GameStop Hang On Until the Console Upgrade Cycle Reboots?

After a disastrous third quarter earnings report, no one really expected GameStop's (NYSE: GME) holiday sales to be particularly good, but was there anyone thinking they would have been this bad?

Sales cratered almost across the board. The magnitude of the drop even caught management by surprise, as it was forced to cut the guidance it issued just last month. It's clear the video game retailer desperately needs the console upgrade cycle to begin in earnest soon.

However, that catalyst is still almost a year away. Investors may be wondering if GameStop can hang on until then, especially considering the retailer is essentially a "fourth quarter" company that generates a disproportionate amount of its sales and earnings in the last period of the year. Let's take a closer look at whether it can beat the clock.

Image source: Getty Images.

The naughty list

GameStop got a lump of coal in its Christmas stocking. Global sales plunged 27.5% to $1.83 billion for the nine-week period that ended Jan. 5, as comparable store sales tumbled 24.7%.

It said its results were "indicative of overall industry trends impacting the video game industry and driven by an accelerated decline in new hardware and software sales, particularly in the month of De­­­cember." People just aren't buying games and gaming gear anymore, though much of the blame is being placed on the looming upgrade cycle.

Microsoft (NASDAQ: MSFT) and Sony (NYSE: SNE) will be introducing new Xbox and PlayStation gaming consoles, respectively, later this year. Many people are simply holding off on purchasing new gaming hardware and software until the latest equipment and titles are available.

GameStop didn't break out sales from each of its merchandise categories, but CEO George Sherman said in a statement, "[T]he accelerated decline in new hardware and software sales coming out of black Friday and throughout the month of December was well below our expectations."

It doesn't bode well at all for the full fourth quarter report. The one bright spot was the Nintendo Switch platform, which continued to see sales growth. This is giving GameStop confidence that when the new consoles arrive, sales will follow. But first, the business has to hold out that long.

There's still a future

Don't worry, it will. It won't be pretty, but GameStop will still be there at the end. How much the console upgrade cycle will improve the retailer's position -- and for how long -- remains to be seen, but GameStop can manage its business and expenses until the next Xbox and PlayStation are on its shelves.

GameStop operates around 5,600 stores, but it doesn't own those locations, choosing instead to lease the space. The terms of the leases run anywhere from one to five years, but they tend to average around two years. As a result, should it become financially necessary, GameStop would be able to close a large number of stores relatively quickly. It can also cut other expenses if required (and is doing so).

Moreover, GameStop has a healthy balance sheet and generates positive cash flow, despite declining sales. As of last month, it anticipated generating between $200 million and $220 million in adjusted free cash flow for the full year.

Not much to look forward to

GameStop should be able to ride out this arid sales period without fear of going under and be ready when the upgrade cycle begins. However, that doesn't necessarily mean it has a bright future.

The industry is moving inexorably towards online and digital download gaming; it is not returning to a physical media environment. There may always be -- or at least for the foreseeable future -- a market for physical games and equipment, because not everyone is embracing the new reality. But both Microsoft and Sony are building hardware that is designed for the brave new world of gaming, and every year more consumers decide to abandon physical media.

The industry has evolved vastly since Xbox One and PlayStation 4 were released in 2013. GameStop has not. Even its vision for revival, such as turning its stores into destinations where gamers can try out the latest titles, isn't so much a reimagining of what the GameStop of tomorrow will be, but rather a repurposing of what it currently is.

The video game retailer will make it through this year and beyond, but that doesn't mean it's a company that an investor would want to own.

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Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Rich Duprey has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Microsoft. The Motley Fool recommends Nintendo and recommends the following options: long January 2021 $85 calls on Microsoft and short January 2021 $115 calls on Microsoft. The Motley Fool has a disclosure policy.


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