Microsoft: Xboxs $1B-Plus Loss Makes it a Sale Candidate, Says Nomura (Correction)
November 25, 2013, 12:18 P.M. ET By Tiernan Ray
Following word from Microsoft (MSFT) that it sold a million units of the Xbox One in the first 24 hours that the device was on sale, from Friday morning, Rick Sherlund with Nomura Equity Research, who ordered a unit on Friday, today reflects on the prospect of Xbox as Microsofts means of expansion into the consumer market.
After playing Call of Duty, Forza 5, and Battlefield 4, Sherlund, who has a Buy rating on the shares, runs through the profit and loss on the device first:
We have estimated 4.2 million Xbox One console units may be sold in the December quarter, but this may be ambitious given there is competition from Sony PlayStation 4 at $399 vs retail price of $499 for Xbox One and the product will only be available for a bit less than 6 weeks and in 13 countries. Xbox One includes the Kinect voice and motion sensing device in the higher price versus Sony. We suspect the number will be between 3 4 mil units, but have not altered estimates at this early stage. If there is demand for 4 million units, it is not clear there can actually be supply of this volume in the next 6 weeks. We believe Microsoft may lose about 5% 10% on the Xbox One console for a negative gross margin versus break-even to a small profit on the Xbox 360. This is also likely true for Sonys PlayStation 4, since early in the console cycle, companies tend to price below costs and drive costs lower over time as production increases to scale and component costs tend to fall [
] Overall, after we include sales and marketing, R&D and G&A costs, we think Xbox is likely to lose money this year, and after the allocation of corporate level expenses likely loses over $1 billion.
Throw in the losses from the Nokia handset division, which Microsoft is acquiring for $7 billion, We estimate the entire Entertainment and Devices Division (we still like the traditional structure) will lose money this year, even after nearly $2B of royalty income from licenses of IP from Android phones and tablets.
Sherlund concludes Xbox is not Microsofts lever to the consumer market, and that it would be a good candidate to spin-off to shareholders:
We hate to be a damper on the feel good moment in the launch of Xbox One, and no disrespect to the terrific success of the Xbox team, but we have made the point previously that the business is just not that strategic to Microsoft if they need to narrow their focus and return greater value to shareholders [
] It is just not enough, in our view, to cement Microsofts position in the consumer market when much of the broader video and music content is now already in your iPad or iPhone and available for mobile usage. Will Xbox One drive greater usage of Bing for search in the home? Maybe the presence in the home of Xbox permits searches and web surfing from the TV entertainment center. Is there a desire to have the Windows Phone or Windows tablet be an extension of Xbox Ones services and game play coordination? Sure. But is this enough to counter the encroachment of smartphones and tablets into the consumer space? , Not really, in our view. The growth in video games is on tablets and smartphones and the music and video content is already on the move in mobile smartphones and tablets. Sure, its nice to watch this on the big screen too, so we are not saying there is no market for this, just that it is probably not enough to cement Microsoft in the consumer space relative to disintermediating smartphones and tablets. There are other ways to get video and music; they are already on your tablet. Our apologies to the Xbox team for saying we thought it might lose as much as $2b this year; it is not that bad, but if new management asks for volunteers to get the band back together for a spin-out, it worked pretty well for Expedia [
] With the top 2 layers of management already reassigned or off to other endeavors, getting the band back together is potentially awkward since Xbox does not exist as a business unit any longer; it is now broken up and distributed across functional areas.
Microsoft shares are up 6 cents at $37.63.
Correction: A prior version of this report referenced a Neutral rating on Microsoft stock. In fact, Sherlund maintains a Buy rating on the shares; the Neutral rating is his overall view of the software sector. My apologies for any confusion caused by the error.
http://blogs.barrons.com/techtraderdaily/2013/11/25/microsoft-xboxs-1b-plus-loss-makes-it-a-sale-candidate-says-nomura/
