On September 17, 2013, the Rock Star Games division of Take-Two Interactive Software (NASDAQ:TTWO) will launch its much-anticipated Grand Theft Auto V (GTA V) game for play on the Microsoft (NASDAQ:MSFT) Xbox 360 and Sony (NYSE:SNE) Playstation 3 consoles. Interestingly, this blockbuster event was scheduled to arrive prior to the November launch of next-generation gaming machines out of both Microsoft and Sony. The Xbox One and Playstation 4 will not accommodate immediate backwards compatibility, where players can enjoy old games on the new systems. Going forward, cloud servers at Microsoft may allow for backwards compatibility between Xbox One and Xbox 360. Analysts have also been speculating that the Grand Theft Auto V platform will ultimately expand to PC gaming networks.
Be advised that the supply chain gaps in timing surrounding the release of Grand Theft Auto V may leave a bit of cash on the table at Microsoft, in terms of Holiday Season Xbox One sales. Microsoft shareholders, yet again, may largely find themselves unable to cash in upon a near cult-like entertainment movement. Ironically, the imminent success of Grand Theft Auto V and the Xbox line will expose the central flaw embedded within the Microsoft business model. Microsoft remains beholden to a deteriorating personal computer market. As such, Microsoft stock is dead money and should be immediately sold.
The Grand Theft Auto Franchise
The Grand Theft Auto franchise is notable for its satirical spin upon American values and embrace of mayhem. Earlier versions of Grand Theft Auto featured one protagonist who completed criminal missions in order to rise through the ranks of the underworld. As adjuncts to these central missions, characters dated women, modified vehicles, patronized nightclubs, owned real estate, and engaged in shootouts against police. Popular Grand Theft Auto games have been set within mythical Liberty City, Vice City, and San Andreas environs. These role-playing settings were effective stand-ins for modern day New York City, Miami, and Southern California. To date, Take Two Interactive Software has sold more than 125 million game units of the Grand Theft Auto series. In terms of units sold, Grand Theft Auto rivals Wii Sports, Call of Duty, and The Sims as the most popular gaming franchise of this generation.
Set in Southern California, the GTA V storyline has now expanded to include three central characters, instead of one protagonist. As always, players will complete point-of-view missions to advance through the criminal underworld. A new feature will enable main characters to invest portions of their respective takes into individual stocks trading upon the spoofed BAWSAQ stock market. Rock Star Game managers have indicated that Microsoft X-Box 360 consoles will require 8GB of free space, in order to run the large and complex Grand Theft Auto V. The GTA V package will include two discs for installation and game play. SanDisk (SNDK) sells 8GB and 16GB flash drives for the X-Box 360 to accommodate GTA V gamers.
Take Two sold 11 million units of predecessor Grand Theft Auto IV during its first month of launch into May 2008. That year, Microsoft sold 28 million X-Box 360 units. At the time, Aaron Greenberg, Microsoft Xbox director of product management, described the performance as the "biggest year ever in Xbox history." By the end of this year 2013, The Grand Theft Auto V launch will help Microsoft Xbox 360 to surpass the Nintendo Wii as the best-selling console of this current generation. Yusuf Mehdi, Microsoft VP of Interactive Entertainment Business, has set a 100 million unit installed base for the Xbox 360. From there, Mehdi has projected a wide range of between 400 million and 1 billion total unit sales for the Xbox One. Contrary to the much-deserved awards, accolades, and hype, however, Grand Theft Auto V and the Xbox platform will have a negligible effect on the Microsoft bottom line and stock price.
Microsoft Business Model
Microsoft categorizes its businesses according to Windows, Business, Entertainment and Devices, Server and Tools, and Online Services operating segments. The Entertainment and Devices group does include sales of Xbox consoles, games, and accessories. The Windows operating system, of course, remains the driving force at Microsoft. Roughly 75% of Microsoft Windows division sales are made directly to original equipment manufacturers, such as Hewlett-Packard (NYSE:HPQ), Dell (NASDAQ:DELL), and Lenovo. From here, Microsoft Business is the headline segment above Office software running Word, Excel, and Power Point programs. Office software has historically generated more than 90% of sales at the Business division. Overall, 80% of sales within the Business division are made to institutional business buyers, rather than individual retail customers.
During the latest 2013 fiscal year ended June 30, 2013, Windows and Business operating segments combined to generate $44 billion of the $77.8 billion in revenue at Microsoft. The Windows and Business divisions were responsible for earning respective $9.5 billion and $16.2 billion in 2013 operating profit at Microsoft. For the sake of comparison, the Microsoft Entertainment and Devices division accounted for a mere $848 million in operating profit upon $10.2 billion in 2013 revenue. The prior year, in fiscal 2012, Entertainment and Devices generated $380 million in operating profits off $9.6 billion in operating segment revenue. Microsoft posted operating profits of $26.8 billion and $21.8 billion for fiscal 2013 and 2012. Be advised that Microsoft recently announced plans to purchase Nokia's mobile business for $7.2 billion. Nokia handsets and devices already posted $100 million in operating losses through the first half of 2013.
Due to the law of large numbers, a record shattering Grand Theft Auto V release and uptick in Xbox sales would literally do nothing to move the needle at Microsoft. Investors should also recognize the idea that little real synergy now exists between operating system, server, smartphone, and gaming platforms at Microsoft. The IT professionals, teenage girls, and hardcore gamers who drive these aforementioned markets share little in common with each other. The halo effect above Microsoft Xbox consoles will not convince mass consumers of popular culture to abandon Apple iOS and Google Android in favor of the latest premium Windows phone.
Research firm Gartner has issued dire warnings concerning the future of the PC industry throughout the summer months of 2013. According to Gartner, global PC shipments declined by 10.9% during the second quarter of 2013. The firm reported that the PC consumer market in Western Europe collapsed by 25.8% within the same Q2 2013 time frame. Meike Escherich, Gartner principal research analyst, already said that the looming Windows 8.1 "will not fully compensate for the ongoing PC decline."
The Bottom Line
On September 10, 2013, Microsoft stock closed out the trading session at $31.90 per share. This stock price calculates out to $270 billion in market capitalization. For the 2013 fiscal year, Microsoft banked $21.9 billion in net income. In terms of valuation, Microsoft now trades for twelve times trailing earnings. On the surface, this metric may appear relatively cheap. The stock market, of course, is a pricing mechanism that discounts future growth. Legendary investor Peter Lynch believed a stock to be fairly valued if it maintained a price-to-earnings-to-growth ratio of one. At Microsoft, net income growth has followed no discernible trend over the past five years. If anything, Microsoft revenue and net income may be described as flat through the past decade and into the near future.
Microsoft is effectively a utility that dominates a particular niche and generates mountains of cash flow. Instead of being leveraged for growth, equity capital will be returned to shareholders through larger dividend payments and stock buy back plans. As an income investment, Microsoft is now competing against the likes of consumer staples stocks, such as Altria (NYSE:MO) and Coca Cola (NYSE:KO), and even FDIC insured banking deposits. Microsoft is now a strong sell, because the potential risks of permanent PC market collapse far outweigh the potential rewards of a revolutionary Grand Theft Auto V launch and consequent increase in Xbox console sales.
Disclosure: I am long KO, MO. 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.