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I wrote an article in July about Sony's (NYSE:SNE) PlayStation 4 (PS4) and what effect it may have on Sony's revenue and its contribution to earnings. This article will focus on how Microsoft (NASDAQ:MSFT) may be affected in 2014 by its new console, the Xbox One. A note in advance, projections on console sales have been released since my Sony article that would reduce growth estimates and earnings of the PlayStation platform.

The Business Segments

Microsoft's six business segments reported annual revenue of $77.849 billion in the 2013 fiscal year. The chart below shows a breakdown of revenue contributions (in billions USD).

Table 1.

Segment

Revenue

Percentage of Total Revenue

Microsoft Business Division

$24,738.00

31.78%

Server and Tools

$20,295.00

26.07%

Windows Division

$18,680.00

24.00%

Entertainment and Devices Division

Xbox 360 Platform

$7,100.00

9.12%

Skype & Windows Phone

$3,113.00

4.00%

Online Services Division

$3,284.00

4.22%

Corporate and other

$639.00

0.82%

Similar to Sony, Microsoft's Xbox platform, a subdivision of Entertainment and Devices (EDD), only accounts for 9.12% of total revenue. Using the same methodology of predicting the PS4's impact on Sony, I determined how the Xbox One launch may affect Microsoft's EPS, revenue, and operating margin.

In 2006, Microsoft's EDD grew 36%. The company reported that 85% of this growth was attributable to the Xbox platform, meaning 30.6% of growth was from the Xbox. However, Xbox One sales are expected to be lower than the previous generation so I will reduce the growth estimate to 25%. Table 2 shows a breakdown of the Xbox platform growth.

Table 2.

Growth Estimate of Xbox Platform

25.00%

2013 Revenue

$7,100,000,000

2014 Revenue

$8,875,000,000

2014 $ Growth

$1,775,000,000

Microsoft's Yusuf Mehdi has stated that Microsoft plans to either break even or operate at a low margin for the Xbox One. Optimistically assuming Microsoft maintains a 5% margin, we get a contribution of $0.053 earnings per share. Table 3 shows my inputs.

Table 3.

Margin

5%

Net Profit

$443,750,000.00

Shares

8,329,956,000

EPS

$0.053

A key difference between how the PS4 will benefit Sony to how the Xbox One will benefit Microsoft is the estimated earnings per share from the respective consoles. As previously stated, my Sony projections need updating based on new console sales and news that the PS4 will not be sold at a profit. Regardless, the Xbox One will likely not make a significant impact on earnings for Microsoft.

Revenue and Operating Income

To see how much the Xbox One may be able to contribute to total Microsoft revenue growth, I used this revenue forecast of $82.9 billion and the 25% Xbox platform growth rate. Table 4 shows a breakdown of revenue growth.

Table 4.

2014 Total Rev. (TR) Estimate

$82,900,000,000

2014 $ Growth

$5,051,000,000

2014 $ Growth from Xbox

$1,775,000,000

% of TR Growth from Xbox

35.14%

With these revenue estimates, the Xbox One may account for just over 35% of Microsoft 2014 revenue growth. I estimated that the Sony's 2014 revenue growth will consist of 29% of PS4 related sales. It appears that non-gaming divisions of Microsoft will experience less growth than Sony's non-gaming divisions.

Microsoft's 2014 operating income may be in much better shape than Sony's 2014 operating income. After the Xbox 360 release, Microsoft took less than three years for its EDD to post an operating income of (versus Sony's four years). This is primarily attributable to Sony selling the PS3 at a larger loss than Microsoft sold the Xbox and the PS3's lackluster sales. Microsoft's EDD posted losses of $1.329 billion in 2006, $2.016 billion in 2007, and an operating income of $267 million in 2008. While it is unknown how much of a loss the PS4 will be sold at, Microsoft wants to at least break even on the Xbox One. This will greatly reduce the EDD operating loss of 2014, but we must take into consideration additional marketing and research and development costs of launching a new console.

Conclusion

Microsoft's Xbox One will likely play a larger role in revenue growth than Sony's PS4, as well as limit an operating loss for the Xbox platform. Unfortunately, this significant income is heavily diluted by the number of outstanding shares and will likely not provide a sizable contribution to earnings in the short run. Microsoft is taking a huge risk in sacrificing market penetration for a higher operating margin. While this may give a small boost to short-term earnings, it will likely hurt revenues in the long run.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Source: The Impact Of Microsoft's Xbox One On Fundamentals