During Microsoft's (NASDAQ:MSFT) second quarter, the company sold a total of 1.1 million video game consoles, including both the Xbox 360 and the Xbox One. This was only a 10% increase in unit sales year-over-year, a surprisingly small increase that was partly due to excess retail inventory. But looking at unit sales over the past few months, Microsoft has bigger problems than excess inventory, with Sony's (NYSE:SNE) PlayStation 4 and even Nintendo's (OTCPK:NTDOY) Wii U trouncing the Xbox One. The situation looks dire for Microsoft.
A price cut was not enough
Microsoft released a version of its Xbox One console without the Kinect peripheral on June 9 for $399, $100 less than the version with Kinect and the same price as Sony's PlayStation 4. This lower price helped sales of Microsoft's console, but the PlayStation 4 is still soundly outselling the Xbox One.
Prior to the Kinect-less version of the Xbox One, the console was averaging around 40,000 units per week. This rose about 50% to 60,000 per week after the lower price was introduced, but that's still roughly half of the weekly sales of Sony's PlayStation 4.
Even Nintendo's Wii U, which was selling extremely poorly in May with less than 30,000 units per week, is now about even with the Xbox One after the release of Mario Kart 8 at the end of May. The blockbuster game led to a few weeks of extremely strong sales for the Wii U, and it helped to reignite interest in the Wii U console.
Why is the Xbox One still selling so poorly? Part of the problem is that third-party titles simply perform better on the PlayStation 4. The recent hit Watch Dogs, for example, runs at a resolution of 900p on the PlayStation 4 at 30 frames per second, but is limited to 792p on the Xbox One. It may be difficult to tell the difference for most people, but this is the kind of thing that undecided gamers look at before buying a console. So even though the prices are now the same for both consoles, Sony's PlayStation 4 still has a significant advantage.
Is it time for Microsoft to ditch the Xbox?
With the Xbox making up a tiny portion of Microsoft's revenue, even a successful console wouldn't have much of an effect on the bottom line. CEO Satya Nadella recently laid out Microsoft's strategy, classifying the company as "a productivity and platform company for the mobile-first and cloud-first world," and the Xbox doesn't really fit in with this vision.
Although Nadella defended the Xbox, Microsoft is an enterprise facing company first, and the Xbox appears to be more of a distraction for the company than anything else. The Xbox is neither mobile-first nor cloud-first, and it might make sense for Microsoft to spin-off the unit.
On the other hand, the Xbox gives Microsoft a gateway to the living room. The Xbox One was pushed from the beginning as more than just a gaming machine, and with Google, Apple, and Amazon making plays for the living room, having an established brand could be valuable for Microsoft, allowing the company to push its services through the console. This strategy requires the company to be able to actually sell the console, though, something that it's struggling with currently.
The Xbox is not a large part of Microsoft. The computing and gaming hardware segment recorded revenue of $9.6 billion during fiscal 2014, with the Xbox accounting for about $6.7 billion of this total. That's 7.7% of Microsoft's total revenue, but the gross profit from the whole segment represents just 1.5% of Microsoft's total gross profit. In other words, the Xbox is not a significant source of profits.
Whether the Xbox unit is spun-off or kept, it will have little direct impact on Microsoft's bottom line. But a spin-off or sale could generate billions of dollars for Microsoft that could be used for share buybacks, thus boosting per-share earnings. Keeping the unit won't accomplish very much of anything, except for lowering the company's margins, so for investors, getting rid of the Xbox would have positive implications.
Even after a price cut, Microsoft's Xbox One is getting dominated by Sony's PlayStation 4, and Nintendo's resurgent Wii U is battling it for second place. There are pros and cons to a potential Xbox spin-off, but with the Xbox not quite fitting in with Microsoft's new strategy, removing a distraction might be the best course of action for Microsoft.
Disclosure: The author is long MSFT. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
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