Photo: Nicola Barts

Why did GameStop fail?

Key Points. The ongoing decline in used-game sales has pushed GameStop's gross margin well below that of other retailers. High operating expenses tied to thousands of small stores make it hard to turn a profit. GameStop is closing stores and moving beyond video games as it attempts a turnaround.

fool.com - These 2 Charts Show GameStop's Biggest Problems - The Motley Fool

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GameStop (GME -0.49%) the stock is a comeback story for the ages. The beaten-down video game retailer delivered incredible gains for investors who bought in before the frenzy early last year. GameStop the company, however, is another story entirely.

A low-margin affair

GameStop primarily sells video game consoles, physical copies of new games, and used games. That last category has historically been the most lucrative for it, although the company stopped disclosing used-game sales and gross margin by category in early 2020. With gaming going digital, the used-games business has been in decline. Since game consoles and new games aren't exactly big moneymakers for retailers, GameStop's overall gross margin dropped to 22.4% last year. That's down from 29% in 2017, and it doesn't compare well to other retailers.

Small stores are expensive to run

A low gross margin wouldn't be a problem if GameStop kept a tight lid on operating expenses. But the nature of the business makes that impossible. Unlike electronics retailer Best Buy, GameStop operates a large number of small stores. The company runs over 4,500 stores globally, many of them in malls and outdoor shopping centers. In contrast, Best Buy operates just over 1,110 stores and generates nearly nine times as much annual revenue as GameStop does.

Running all those stores is not cheap.

While Best Buy can make up for a low gross margin by being ultra-efficient at running its big-box stores, GameStop doesn't have that option. The business worked when high-margin sales of used games were strong, offsetting the low margins of other products. It's not working anymore.

What's GameStop doing to fix this?

The company is broadening its catalog of products, and it's having some success. Sales related to PC gaming, including accessories and gaming laptops, soared 150% last year. E-commerce is also a big focus, and the company has been closing stores to reduce costs. It is also working on some non-fungible token projects, which certainly have some potential. The good news is that GameStop has a ton of cash to fund its turnaround. The company has nearly $1.3 billion in cash and less than $50 million in debt. It can lose heaps of money, like it did in 2021, for years before liquidity becomes a problem. The bad news, at least for investors, is that GameStop's market cap has inflated to around $14 billion. That's about two-thirds of the market cap of Best Buy. Even assuming the best-case scenario, its valuation requires some serious mental gymnastics to justify. Can GameStop make a comeback? Sure. But judging from these charts, the company has a lot of work to do, and a successful turnaround might not translate into a higher stock price.

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