Microsoft's Xbox Can Dethrone Google

| About: Microsoft Corporation (MSFT)

Bill Gates wrote an essay back in January of 1996 that was titled "Content is King", and he couldn't have been more correct. Google (NASDAQ:GOOG) was built with this premise is mind. Microsoft (NASDAQ:MSFT) provided the medium and Google's profits hounds, Adsense and Adworks, ran like ravenous dogs devouring and consuming advertising market share at every opportunity. Old line traditional content providers-- like TV, Radio and Print-- were forced to change their businesses, many going bankrupt in the process. Microsoft and Google both know the game is about keeping users entertained, and both have built empires designed to achieve this goal. If this premise holds true, then Google's ultimate defeat will come from the company that captivates the most users in entertainment, and correspondingly converts this experience into advertising dollars. No one has yet been able to match this formula with the same success, although social media giant Facebook (NASDAQ:FB) is giving it a try. However, I believe the next Google will be Microsoft, and this is how it could happen.

XBOX Google out.

Since its inception, Microsoft has sold 77 million Xbox units and claims 46 million Xbox Live registered and paying users world wide. Microsoft recently announced a new Xbox that will further integrate television and mobile applications, in its pursuit to be the main focal point of entertainment in the home. The key to overtaking Google will be in Microsoft's ability to introduce advertising into its most captivating content. Xbox's 46 million users are now spending 21 hours a week on Xbox Live, and Gartner pegged the online gaming subscription spend at $21.4 billion for 2013 and $28.2 billion for 2015, revealing a 27% compound growth rate.

Table 1: Total Gaming Market Spending, 2010-2015 (Millions of Dollars)

2011 2013 2015
Gaming Hardware 17,797 24,621 27,354
Gaming Software 44,730 51,129 56,512
Online Gaming 11,899 21,453 28,298
Total 74,426 97,204 112,163

Source: Gartner (June 2011)

Gartner's numbers don't pay tribute to "in-game advertising" of Massive Multiplayer Online Role Playing Games (MMORPG), largely because it has not been deployed in premium games, as of this writing. However I believe we are on the verge of crossing that threshold.

Acquire the top MMORPG content providers.

Just as Google acquired Youtube, Microsoft should acquire Activision Blizzard (NASDAQ:ATVI). Looking back at the top 50 MMORPG games, it's easy to see why Activision Blizzard should be the first and primary acquisition. Six of the top 10 best selling XBOX games belong to Activision Blizzard. ATVI currently trades with a $17.2 billion dollar market cap on $5 billion in sales. In examining the first quarter 2013 sales, significance is drawn to the revenues of $343 million for Playstation and $383 million for XBOX, respectively. Breaking this down for illustration purposes only, a $40 incremental unit purchase could effectively translate into 8.5 million purchased copies designed for Playstation. Imagine a scenario where 8.5 million Playstation users have to pay dramatically more than Xbox users for the next version of Call of Duty®.

Microsoft taking possession of Activision Blizzard could change the current market dynamic of gaming consoles and subscription users. Further, looking closely at Activision's financials, none of the sales revenue is derived from in-game advertising. However, Gartner claims that the "freemium" model is growing quickly in less bandwidth demanded online games, as opposed to subscription based games. Control of Activision Blizzard and introduction of in-game advertising models would force Google to look to other less attractive alternatives as a response to a potential migratory loss of advertiser base.

Lockup the Patents

Key to adding profitability value and defeating Google, is the underlying patents that drive the applications in question. On March 27, 2013 Microsoft began a dialogue postponing Vringo (VRNG) initiated litigation against Microsoft's search advertising efforts. Vringo holds 2 key patents that were deemed by a jury last year to be the primary drivers behind the success of Google's search engine. With billions at stake, Google has hotly contested this in U.S. Federal district court, while continuing to lose ongoing post trial judicial verdicts, with little hope of beating Vringo's I/P Engine unit. The Vringo patents are instrumental in Microsoft's expansion into search advertising and CEO Steve Ballmer is certainly watching this litigation closely.

Vringo's latest 949 Reply to the ongoing post trail Royalty Motion all but cements a potential billion dollar verdict, and closes the door to Google's federal district level actions. Integration of a Google Adworks style clone product, within the "in-game" XBOX content, is not unreasonable. However, achieving this feat would require Microsoft gaining a Vringo settlement that would include the necessary license agreements. This appears certain now as all parties await Federal Judge Raymond A. Jackson's ruling and a possible appellate action.

Activision Blizzard comes with its own baggage in the form of a lawsuit originating from Worlds, Inc (OTCQB:WDDD). Worlds has a federal court action against Activision that could have deep ramifications in the form of willful infringement and harsh royalty payments, based on key MMORPG patents. However, Activision is not alone in this problem as Microsoft, Sony (NYSE:SNE), Walt Disney (NYSE:DIS) and many other content providers could easily join their ranks, falling victim to Worlds' patent infringement claims. The Worlds patents cover computer architecture for three-dimensional graphical multi-user interactive virtual world systems. The upcoming June 27, 2013 Worlds vs. Activision Blizzard Markman hearing could become crucial to the entire MMORPG industry. Depending on the success of this hearing and Microsoft's ultimate strategy, it is possible that Worlds could play a significant role in the future of "in-game" MMORPG advertising.

Conclusion: Microsoft's Xbox content strategy must include "in-game" advertising

Microsoft must once again lead, not follow, if Google is to be dethroned. Potential acquisitions like Activision Blizzard, followed by a strategy that includes "in-game" MMORPG advertising, could bring Microsoft billions in uncharted revenues. Online search advertising built Google and it's only natural that the market franchise into new directions. Google will see "in-game" advertising coming and will counter, potentially going after Sony's Playstation and acquiring Electronic Arts (NASDAQ:EA) or Ubisoft (OTCPK:UBSFY).

When Google senses potential market share bleeding off, it is quick to react. One look at Google Glasses illustrates just how committed Google is to holding our attention-- even if it's only ¾ of an inch from our eyes. However it cannot control content, especially in mediums like Microsoft's Xbox. If Steve Ballmer listens and learns from the wisdom Bill Gates imparted years ago, he will exploit the opportunity of "in-game" advertising quickly. This could be the last opportunity to do so, before one of the MMORPG content providers or Google itself plunders this last frontier of advertising

Disclosure: I am long VRNG, MSFT, OTCQB:WDDD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.