GameStop is a leading bricks and mortar retailer of video games. This business is in a slow decline due to online competition. The short thesis is simple… and quite subjective. Online delivery of video games offers more value than physical delivery of games. It’s cheaper, more convenient, and the copy of the game can’t get damaged or lost. In my opinion, it’s inevitable that most video games will be distributed over the Internet. GameStop’s revenues and profits will be a fraction of what they are today.
Unfortunately, predicting GameStop’s future revenues will be incredibly difficult as there isn’t a historical precedent to base predictions on. Inflection points are hard to predict precisely. However, GameStop’s high valuation provides some margin of safety. If GameStop makes $400M after-tax annually (this is a little generous) and has a market cap of $6B, then its P/E ratio is 15. That P/E ratio is too high if GameStop’s revenues were to shrink to a fraction of what they are today.
