Let's review the history of Netflix as summarized by this piece from the New York Times. Netflix was founded in 1997 and from its beginnings had an eye on digital, not mail order, distribution. In 1997, I don't believe I owned a DVD player, yet Netflix already envisioned a future beyond DVDs. This allowed it to negotiate favorable contracts with the studios who like the rest of us lacked the foresight to realize how valuable these rights could become. It's no surprise that studios are now either extracting massive amounts of money from Netflix or digitally distributing their content themselves. Netflix had a massive first to market advantage and while the company won't be going away in the near future, it will certainly face more competition.
If anyone is familiar with Gamestop, they will know a comparison to Netflix is offbase. The game industry is less mature than the movie industry and therefore has had the benefit of watching what has happened between Netflix and the studios. Gaming studios will not make the same mistake and if they do, it certainly won't be in Gamestop's favor. Why? Publishers have a long tradition of hating Gamestop since Gamestop's used game sales take money out of the company's profits. Additionally, Gamestop bears almost zero marketing expense as the publishers do most of the heavy lifting. Have you ever seen a Gamestop TV commerical? No, but EA has had Super Bowl commercials for its games. The publishers have adopted new strategies like the online pass (a one time code required to activate certain features of a game) to counter used game sales. The publishers will look to squash Gamestop whenever possible.
There are two things that makes this comparison so far off base. First, Gamestop isn't a digital company: Per its most recent 10K, it has 6,670 stores around the world. Netflix never had a single store. Second, Gamestop doesn't do great selling new games- its margin on those is 7.3% (FY ended 1/29/11), a far cry from its overall margin of 26.8%. Where do the rest of the profits come from? "Buying low and selling high." A whooping 46.2% of Gamestop's profits came from the sale of used video game profits. Nearly half its business! Gamestop relies on a steady stream of people who either don't care or don't know how to get the best possible price for their used gaming equipment. Buy a new game, play it for a week or two and you'll likely be able to sell it back to Gamestop for $25-35. They will then turn around and resell it for $55 and likely do so quickly. Both consumers are leaving money on the table as copies of recently released, used games trade on marketplaces like eBay for $30-45. That's not to fault the consumer, as there is some value in Gamestop's convenience. It is, however, a huge concern for Gamestop going forward. There are no used digitally downloaded games. Once the game is downloaded, it's on the user's hard drive until he deletes it. He cannot resell this to a friend, Gamestop, or anyone else. If Gamestop were to become a digital distributor, it already loses 50% of its business.
Could there be a Netflix like growth story for video games? Sure, there already has been- www.steampowered.com. Gamestop might be able to establish a presence in this industry, but it won't grow nearly as quickly as Netflix, nor will it get such favorable distribution rights, if it gets them at all. I won't even begin to think about how short sighted the idea of a video game retailer developing a tablet. One of the research analyst's ten points of comparison is that Gamestop, like Netflix was during its rise, is one of the most shorted stocks on the board. In fact, as of March 31st, Gamestop was the 38th most shorted stock in the whole market with 26.8% of outstanding shares short and a short ratio (short shares/avg. daily volume) of roughly 6. Netflix saw its short ratio approach 9 over the past year, but the shorts have gotten squeezed out with its continued rise.
So what are we left with? Netflix was a forward thinking company that saw about ten years into the future, compared to Gamestop which was caught flat footed by digital distribution and entered the market in August of 2010. Less than one year ago! Gamestop is a massive retail chain that is thinking of developing new hardware while Netflix has never had a retail presence and placed a heavy emphasis on software (see various streaming methods- XBox, iPad, Roku, etc). But, the research analyst forgets about these obvious differences instead arguing:
Netflix was heavily shorted.
Netflix thrived and burned the shorts.
Gamestop is heavily shorted. Gamestop will burn the shorts.
It's clear this is a flawed argument. Sure Netflix may have outlasted the shorts (to this point), but short sellers are typically able to generate high returns. Albert Pujols doesn't get a hit everytime (as his early season slumps show).
I am short Gamestop and opinions like this continue to drive Gamestop higher, I will likely add to my position.
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