This Prediction From Electronic Arts Should Terrify GameStop Investors

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The threats facing GameStop (NYSE: GME) are well-documented at this point. The retailer relies on new and used video games for the majority of its sales and profits, but software sales are increasingly migrating to digital channels -- depriving the company of its biggest and most profitable revenue stream. In order to prepare for this trend, GameStop is undertaking a diversification effort that aims to build up sales of pop culture merchandise, mobile hardware, and wireless and entertainment service packages.

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The company's growth businesses have promise, but it needs the video game component to continue putting up solid results in order to bide time for the transformation. However, based on a big prediction from Electronic Arts' (NASDAQ: EA) most recent earnings call, that's a luxury GameStop might not have.

EA sees radical change on the horizon

In Electronic Arts' July 27 earnings presentation, CEO Andrew Wilson made the prediction that the video game industry would undergo more change in the next five years than in the past 45 years combined. That's a bold statement and one that could spell big trouble for GameStop's video game retail business.

Specifically, EA is working on projects pertaining to cloud, streaming technology, artificial intelligence, and virtual human companions that could prove hugely disruptive to the retailer's business model. Wilson even laid out a basic timeline for the emergence of those technologies:

For many of those things, we actually think the time horizon is about five years-plus. But things like cloud and streaming, we believe it's probably in the two to five year time frame. When we think about subscription, we're already seeing return from that. And the combination of that with streaming on that two to five year time horizon could be very meaningful in terms of revenue addition for us.

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The two to five year window for the rise of streaming technology is especially significant, because it almost certainly covers the launches of the next-generation hardware platforms from Sony and Microsoft -- if in fact they take the form of traditional hardware platforms at all.

In 2015, Electronic Arts launched a partnership with Comcast to stream games to the telecom company's X1 cable boxes. This proved to be short-lived, as the project was shut down roughly a year later, but the possibility exists that the next gaming platforms will diverge wildly from the typical console model. Sony already runs a gaming service that allows users to stream less complex games to their PlayStation 4 consoles and PCs, and while it's likely that there will be at least one more traditional hardware generation, expanded streaming offerings are pretty much guaranteed. 

Why a streaming revolution hurts GameStop

Last quarter, GameStop's combined new and used game sales accounted for 57% of the top line and 71% of gross profit, respectively. While its collectibles and tech brands segments have been growing at a solid pace, the type of timeline EA is projecting for major industry disruption would likely be calamitous for the specialty retailer.

The transition of game sales from physical mediums to digital downloads is already accelerating, with last year's 10% sales migration roughly doubling the rate from previous years. Currently, GameStop is trying to make headway with its own digital sales platform, with revenue for the category climbing 28% year over year to reach $46.1 million (or roughly 3% of sales) in its June-ended quarter. But the company will face an uphill battle claiming a piece of a subscription-based streaming business when other companies control the content.

Will EA's bold prediction become reality?

The good news for GameStop is that a lot of the necessary technology for a mass shift to streaming-based delivery for high-end titles isn't there yet. And it's not a certainty that it will arrive in the time frame that EA projects. Streaming games at high resolutions is a much more technologically difficult proposition than streaming video, and there are still challenges such as bandwidth restrictions imposed by cable companies and the lack high-speed internet in every market.

The streaming push might also be somewhat at odds with other growth drivers in the industry such as e-sports. Competitive gaming typically hinges on quick and precise player actions, and solving the issue of lag will be difficult.

That said, it's clear that big shifts are underway in the video game industry. Whether the medium really does change more in the next five years than in the previous 45 remains to be seen, but GameStop investors need to keep in mind that headwinds could quickly evolve beyond those currently posed by digital downloads.

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Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool’s board of directors. LinkedIn is owned by Microsoft. Keith Noonan has no position in any of the stocks mentioned. The Motley Fool owns shares of GameStop and has the following options: short October 2017 $22 calls on GameStop. The Motley Fool recommends Electronic Arts. The Motley Fool has a disclosure policy.