FORTUNE – How much trouble is GameStop (GME) in?
On Monday, the Grapevine, Texas-based video game retailer trimmed its previously light earnings forecast for the latest quarter — a period that includes the last holiday season — after witnessing an unexpected decline in software sales for older home consoles like Microsoft’s (MSFT) Xbox 360 and Sony’s (SNE) PlayStation 3. (GameStop also reduced its earnings for the year.) Although the company reports that revenues climbed 9.3% to $3.15 billion and same-store sales increased 10.2%, shares tumbled 20% that day, their biggest drop in 11 years, and have yet to fully recover.
“I don’t think they anticipated how dramatic the decline would be,” admits Michael Pachter, an analyst for Wedbush Securities. Looking ahead, Sean McGowan, an analyst for Needham & Company puts it simply: “I doubt 10 years from now GameStop is going to have 4,000 or 5,000 stores.”
On the surface, the news could be taken as a bad omen. Could GameStop suffer the same fate as retailers like Blockbuster and Circuit City before it? After all, more consumers are playing inexpensive games on their smartphones and tablets. With last fall’s launch of the PlayStation 4 and Xbox One, gamers can now bypass a trip to their local store entirely and download an entire 40-plus gigabyte game in an hour or less. And efforts like PlayStation Now, which will allow millions of gamers to stream and play select software to their devices by the end of the year, augur an era where even “downloads” may soon become passé.
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But GameStop is hardly doomed, argue analysts. Indeed, McGowan foresees more store closures but also sees GameStop evolving and following in the footsteps of Netflix (NFLX), which grew from being a purely distribution service to generating original content. GameStop could grow similarly, taking a more hands-on role with the execution of game content and capitalizing off those efforts. For instance, when PlayStation Now rolls out later this year, stores could actively sell service subscriptions and receive a cut of the sales transaction.
As for those lackluster software holiday sales, expect them to rebound somewhat later this year as more games arrive for the newest consoles. And over the next decade, Pachter argues digital downloads will never supersede sales of physical media and instead max out at 50% of GameStop’s overall software revenues. Unlike music or movies, far too many gamers enjoy trading back their games for in-store credits that go toward future purchases. (Indeed, Pachter says 30% of all games purchased are traded later on.) So digital or not, a substantial contingent of gamers will continue to buy physical media because they know they can trade it in for the next new thing.
Translation: Physical media for videogames might just have a few extra lives left.