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GameStop Is Either a Canny Cannibal, or It's Whistling Past the Graveyard

Can GameStop resell digital games?
Last week GameStop (GME) announced that Q1 revenues from downloadable games were up 53 percent. That puts it on track for $450 million in revenues from these sales alone. But those impressive numbers pose a problem for the company, since nearly half of its annual profits come from the re-sale of used video game equipment -- and you can't resell a downloaded game.

The sale of used video equipment (overwhelmingly games) is incredibly lucrative, and in fact is the main reason GameStop is as profitable as it is. Although used games brought in only 26 percent of sales last year, they accounted for 46.2 percent of profits. If the GameStop had to rely on new equipment sales, it would be close to broke. New goods were 60 percent of sales but only 28 percent of profits.

The downloadable worm in the apple
So the move to selling downloadable games and content should give the company -- and investors -- some pause. Company executives defend the move with a "rising tide raises all ships" argument. During last week's earnings call, GameStop Dan Dematteo said, "Do not assume that all digital [downloadable] gaming is cannibalistic with what we sell in our stores. For us, new packaged good sales continue to grow."
It's worth noting that the company really has to move to downloadable digital, as some other very big players have recently gotten into the used game sector. In the past two years, Walmart (WMT), Best Buy (BBY) and Amazon (AMZN) have all started buying and selling used video games. Because none of them rely as heavily on them for profits as GameStop does, they'll most likely be able to offer better prices.

GameStop is betting heavily on digital as can be seen in by its recent acquisitions, two of which have yet to be completed. Once finalized, the acquisition of Spawn Labs will allow GameStop to provide a cloud-based streaming game serviceâ€"similar to OnLiveâ€"and the puchase of Impulse will allow it to compete with Steam, a streaming service on the PC side.

Given Steam's market penetration, as well as the success of its games -- like the recently released Portal 2, GameStop better hold on to those old video games for awhile.

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