GameStop Stock Is To NFT & Crypto As Zynga Was To Social & Mobile (NYSE:GME)

GameStop (GME) has an identity crisis. Over the last five years the company’s primary business model slowly became at odds with a growing segment of players and software developers. And everyone following the stunning GameStop story understands how digital downloads and direct-to-player live services have meaningfully impacted revenues at the older-school, middleman retailer. Of course to address this, the various management groups over those years have tried reinventing the company, albeit with mixed results and significant balance sheet stress.

The company’s latest pivot surrounding an NFT digital asset marketplace and crypto gaming is a needed addition and shift in the company’s model. The concept is decidedly adjacent to existing categories, like collectibles. It is not particularly at odds with current management’s focus on hardware and could directly address GameStop’s loss of share as players increasingly spend on live services.

But a question remains about how successful NFTs and crypto will be for the company; put simply, how will it really work? The buzz around NFT’s and crypto in gaming is somewhat reminiscent of the “social” and “mobile” craze that swept the space a decade ago. Some big names from that time struggled and provide a cautionary tale for investors about getting caught up in the fanfare without making realistic projections or conceptualizing how the new model will actually work.

Before considering NFTs and the details of the recent partnership between GameStop and Immutable X, it is useful to briefly look at one example from the social/mobile trend mentioned above. Though slightly smaller, when Zynga (ZNGA) went public in December of 2011 it had a comparable market cap to gaming mainstay Activision Blizzard (ATVI). Zynga games were ubiquitous on Facebook (FB), which was soon going public as well, and 2012 was setting up to be a transformative year for iPhone adoption. On the surface, Zynga was perfectly positioned to benefit from the social and mobile shift.

So how did Activision thrive while Zynga floundered? Put briefly without nuance, Activision games were designed for gamers and empowered quality social interactions; Zynga’s were designed for casual players and to be viral through social updates. And there was a growing realization at the time… the details of how the “social” aspects actually work would be a factor in success.

Call of Duty’s success rests with its multiplayer component, and World of Warcraft is inherently massively multiplayer. The level of social interaction in these games is also much richer than what occurs in the average Facebook game. This difference between the depths of interaction is often hard to understand for analysts and commentators who have not played the games.

Activision’s Careful Social Strategy, seekingalpha.com, 12/16/2011

For Zynga, even direct association with the social trend wasn’t productive because their model did not meaningfully strike at its main value, which is the richness of the interactions between the gamers.

Thinking About NFTs From GameStop

As is the case more broadly with GameStop initiatives, it is hard to understand the particulars of where the company is going with its digital asset marketplace strategy. Without making a judgment on the policy, note that GameStop has increasingly adopted a low transparency practice regarding investor relations communications. Gone are slide decks and Q&A sessions associated with earnings reports. There wasn’t the usual holiday update this year and the various releases are uniformly terse and no longer contain e-commerce sales data. Lastly, category reporting has been reduced and comingled to the point it is about half as useful for projecting revenues or weighing strategic changes as in back years.

Though any added color concerning the NFT marketplace project was limited, GameStop’s SEC filing provided basic facts about the new partnership with Immutable X. Main takeaways include:

… Immutable X [a high-throughput, low-cost layer 2 on Ethereum] will become a technology partner and platform for the Company’s non-fungible token (“NFT”) marketplace.

Digital Worlds [a company associated with Immutable X] hereby commits to: issuing [developer] grants of USD$100 million in token value over the 24 months from the date of this agreement in addition to the grants made under this Agreement.

… [a] grant of up to $150 million in IMX tokens to [GameStop] upon the achievement of certain milestones.

GameStop will not integrate any blockchain protocol, other than Ethereum Layer 1 and Loopring [a different layer 2 on Ethereum similar to Immutable X] into their NFT marketplace without first having integrated Immutable.

In the event Milestone 3 [the NFT platform launch] is not met by the Platform Launch Deadline (and subject to any Extension Period), then GameStop must pay to Digital Worlds (or their nominee) USD$25,000,000.

Immutable X Fee Structure – Primary Sales Fee – 2% of the initial sales price. Secondary Sales Fee – 2% of the secondary sales price.

[Note: square brackets information is author added for clarity.]

While information out of GameStop was limited, Immutable X Co-Founder & President Robbie Ferguson made multiple press appearances following the partnership announcement. In one instance, Ferguson returned to Bankless on YouTube and held a lengthy discussion on the GameStop partnership.

From my perspective, the most important aspect of the agreement is the developer grants as they allow GameStop to be more directly connected to content. This is something unseen to any large degree since the company sold Kongregate in 2017. Around the 23:30 mark of the above-linked video, Ferguson begins to discuss the topic. He goes on to say:

… we’re going to earmark one hundred million dollars of that to game companies specifically who want to build on Immutable X’s APIs and platform and order book and distribute via GameStop’s marketplace.

While many other topics were expanded on, at about the 19:22 mark of the interview Bankless tried to elicit how the GameStop NFT marketplace would work. Interestingly, Ferguson answered with the following:

We really view the future of trading as occurring not only in these giant aggregators but also inside these games themselves because that is often where the best experiences for a player to sell something might occur.

So importantly, Ferguson sees in-game NFT trading as the most “frictionless” choice for players and note that a prime benefit of Immutable X is the ability to enable this option for developers. This bias toward in-game trading may be somewhat problematic for GameStop as it will tend to make its digital asset marketplace peripheral to the gaming ecosystem, especially over time. As an aside for those interested, Immutable X sells/trades the NFTs they enable on their own digital asset marketplace as well (link here).

This NFT trading in-game bias could turn out to be somewhat similar to the digital downloads issue that has been a primary driver of GameStop’s struggles. Consider the following. Players can, and do, purchase full game digital downloads through retailers, and GameStop sells them. But the larger majority of players frictionlessly purchase games through their platform store or direct from the developer’s store, cutting out GameStop. And developers are incentivized to sell digitally direct to players to expand their margins on full games. Plus selling direct increases attachments of related live services. To some degree, this same dynamic likely evolves with NFT sales as players choose to trade in-game and developers choose to come to market independent of GameStop.

Finally, similar to shelf space at a retail location, smaller and newer developers will likely utilize the GameStop marketplace for marketing exposure while entrenched developers with known franchises won’t need or particularly want a lower margin listing with GameStop.

GameStop is to games, as Amazon is to books?

It is easy to be skeptical of GameStop’s ability to navigate the innovative and emerging NTF, crypto gaming and Web 3.0 space. Since activist investor and now Chairman Ryan Cohen took the reigns last year there has been a marked shift in focus from games and gaming to greater attention on user experience and product fulfillment. Cohen appears to be taking pages from the Chewy (CHWY) playbook he used when successfully co-founding the e-commerce, pet products retailer over a decade ago.

Senior hires under Cohen primarily include marketers, web designers, fulfillment specialists and customer care experts with technology experience, mostly from Chewy or Amazon (AMZN). But notably absent are any additions from the gaming industry.

1. VP Business Development for Blockchain Kurt Bierbower: 4 years experience in crypto custody and trading platforms, with GMO Internet through December 2021.
2. Chief Executive Officer and Director Matt Furlong: nine years at Amazon, recently a Country Leader and oversaw Amazon’s Australia business, previously with Procter and Gamble (PG) in brand, marketing and sales.
3. Chief Technology Officer Matt Francis: recently Engineering Leader at Amazon, previous experience with QVC and Zulily.
4. Chief Growth Officer Elliott Wilke: seven years at Amazon, prior experience with Procter & Gamble in brand management.
5. Senior Vice President of Customer Care Kelli Durkin: previous Chewy Vice President of Customer Service.
6. Senior Vice President of E-Commerce Neda Pacifico: previous Chewy Vice President, prior experience with Amazon.
7. Vice President of Supply Chain Systems Ken Suzuki: previously Zulily Vice President of Supply Chain Technology.
8. Vice President of Fulfillment Josh Krueger: previous fulfillment experience at Amazon, Walmart (WMT) and QVC.

The concern is that, while admittedly focused on technology, the strategy is still geared to frictionless delivery of physical goods. And relatedly, when challenged by the shift to digital downloads and live services, GameStop’s answer is to fix the customer experience on the website and focus on customer care. From the outside, this response looks ill-suited as a solution to the problem.

As a final example consider the following. During new CEO Matt Furlong’s first earning report remarks last September, he talked about GameStop’s new operating principles. The following blurb captures Furlong’s main point.

We are focused on positioning GameStop to scale while obsessing over competitive pricing, expensive [sic] selection, and fast shipping. Our actions included continuing to add technology talent across the organization, including individuals with experience in e-commerce, UI, UX, operations, and supply chain.

We also continued to expand our fulfillment network by adding a 530,000 square foot facility in Reno, Nevada. This new facility, which is expected to be operational next year, will position us to further expand selection and expedite shipping. With this addition, the Company’s fulfillment network will span both coasts of the continental U.S. for the first time.

And remarkably, nowhere in the comments were “games” or “gaming” even mentioned. A similar omission can be seen in a purported copy of the operating principles disseminated to the team, which can be found here.

Final Thought

We believe net sales is the primary metric by which stockholders should assess the Company’s execution.

CEO Matt Furlong, Q2’21 Earnings Call, 9/8/21 (link above)

From a strategic sense, it is fair to ignore the mix shift toward low-margin hardware sales that is pressuring earnings. It is fair to ignore growing SG&A costs as GameStop spends to execute its new strategy. And it is fair to look at net sales as the primary metric of longer-term success, as Mr. Furlong suggests. But it is also necessary to make a qualitative assessment of those net sales, including a look inside the product categories.

Over the first nine months of 2021 collectibles revenues have meaningfully bounced back relative to the COVID-19 impacted results during the same period of 2020. More importantly, Q3’21 was also ahead of Q3’19. But the question remains if this category can top a billion dollars annually in the foreseeable future, especially if another period of collectibles fatigue strikes later this year or in 2023.

Hardware and accessories sales for the first nine months of 2021 were up 45% over the same period in 2020. But it is important to note that this comparison basically contrasts the first year of the new hardware cycle with the last year of the prior cycle, as the Xbox Series X and PlayStation 5 were both launched in November of 2020. Beginning with the just-finished Q4, which is usually reported at the end of March, look for growth rates in net hardware sales to be cut in half. This is despite the expansion of subcategories like PC gaming and consumer electronics.

Lastly, net sales in the high margin software category were down a percentage point over the first nine months of 2021 when compared to 2020. This flat result is the outcome of a dynamic tug of war. On one side there is renewed excitement, and attachments, accompanying the boom from the new console releases and the reversal of the harshest COVID-19 effects from the middle of 2020. On the other side is the ongoing effects of the continued move by players to download digitally and spend on direct from developer live services.

The importance of the software issue can’t be overstated. Think back to a year ago, was it conceivable that revenues in GameStop’s core profit center would be down for the year? The ongoing secular shift to digital, coupled with a shift in management focus, is taking the games, and game, out of GameStop.

Authors Note: GameStop may have already sold a significant portion of the IMX tokens they received through the milestone grants. This was widely reported, including at Benzinga and The Block, and substantiated with data from Etherscan. If true, this action is hard to understand or explain as it is viewed to undermine the IMX platform and its existing game developers. If you have further information or understanding please comment below.