Video game retailer GameStop Corp. (NYSE:GME) today authorized a boost of $500 million in its share buyback program, replacing a $300 million authorization made in September 2010, and about half of which remains. The September authorization didn’t push the stock much higher — the trend in GameStop’s shares has been essentially flat since September.

GameStop has relied on packaged software sales, both new and used from its 6,606 bricks-and-mortar stores. But the market is moving toward digital games. Electronic Arts Inc. (NASDAQ: ERTS) noted in its earnings release earlier this week that sales of its digital games jumped by 39% in the third quarter. GameStop’s offerings in the digital world are unlikely to make up for lost sales of packaged software.

Through its aggregation website, Kongregate.com, GameStop claims 13 million users who spend more than 23 million hours a month playing its games. GameStop introduced its Kongregate Arcade app and collection of free mobile games for Android-based smartphones in mid-January, but Google, Inc. (NASDAQ: GOOG) almost immediately removed the app from its Android Market Market for what Google claimed was a violation of its developer agreement that prohibits apps from downloading other programs.

Within a week, Kongregate and Google had sorted things out, but the app is now virtually indistinguishable from just using the smartphone’s browser to play the games.

What GameStop doesn’t emphasize is that the Kongregate Arcade games are all free. So 13 million users having 23 million hours of fun are not adding anything to GameStop’s revenues or profit.

Because GameStop sells packaged games from developers like Microsoft Corp. (NASDAQ: MSFT) and EA, it can’t offer those games online. To make money in the digital world, GameStop is going to have to develop compelling, competitive online games of its own. That would be a good use for $500 million, but instead the company plans to use the cash to buy back more stock.

GameStop’s main concern should be how to replace lost sales from packaged goods with downloadable online games for smartphones. Buying back stock is just a bone thrown to shareholders.

The company’s fourth fiscal quarter ended on January 30th and the company hasn’t yet announced a date for its earnings release. Analysts are expecting EPS of $1.56 on revenue of $3.72 billion. In its third quarter, GameStop reported EPS of $0.37 on revenue of $1.9 billion. The company’s share price is up about 2.75% before noon today, to $20.04, solidly in the stock’s 52-week range of $17.12-$25.75.

Paul Ausick

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