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Video Games Industry: From The Big 3 To The Big 7 Soon?

|Includes:GME, MSFT, NTDOY, Sony Corporation (SNE)

With Valve's likely announcement of a "Steam Box"...

kotaku.com/looks-like-well-hear-about-va...-1356094018

...we may have soon four new players in the (living room) game console race...

- Valve

- Amazon (rumored)

- Google (also rumored)

- Apple (possibly an updated Apple TV with an SDK?)

...in addition to the existing three:

- Nintendo (NTDOY ADR, oldest remaining entrant)

- Sony (SNE ADR)

- Microsoft (NASDAQ:MSFT)

While (with the exception of Valve) these new consoles will probably be targeted at more casual players than the existing game consoles it will still put pressure on the existing "Big 3" game console makers. What does this mean for their valuation going forward:

- SNE and NTDOY shares looked attractive in early 2013 (even more so in case you also shorted the JPY in addition to holding Japanese equity as a foreign investor). I would now be very cautious on these two names going forward. I'm still long SNE with a small position (but mainly because of reasons outside the SCEE division*).

- As for Microsoft, MSFT can continue to cross-subsidize its console/devices division. This Entertainment and Devices Division is 10-15% of the entire MSFT (likely to grow once NOK handsets are merged into MSFT in 2014 and higher in holiday quarters). SNE can also modestly cross-subsidize its games hardware provided it can (finally) stop the long bleeding at its electronics division.*

- That leaves NTDOY as the weakest player going forward despite its popular game franchises (Mario, Zelda, Pokemon...). While it may be pre-mature to presume NTDOY will "do a Sega" soon (exit the hardware business) it has more formidable competitors than ever - also because its quasi-monopoly in the mobile gaming space is being eroded by smartphones and tablets. NTDOY is being attacked on two fronts: in the living room with the four new entrants above and the smartphone space by two of those giants (GOOG and AAPL providing Android and iOS).

NTDOY is still looking like a value trap even with a price of "only" 10-15 USD per ADR. I might have another look in case it falls well below 10 USD.

A bright spot for NTDOY might be China slowly lifting is console sales ban over time - I asked this very question to well-known sector analyst Michael Pachter a few weeks ago ( discussed in his video answer here at minute 3:20).

(SNE has much less to lose in mobile due to already dismal market share in dedicated mobile devices with the PS Vita - and SNE does produce its own smartphones/tablets as a hedge into the future.)

- Lastly, it's important to note that both SNE and MSFT will lose less money this generation on hardware because they are implementing more standard PC hardware ingredients as well as selling more services on a subscription basis (SNE will also move to a fee model with PS4, online gaming will no longer be free as it was with Playstation3):

Sony expects to recoup PlayStation 4 hardware loss at launch

PlayStation 4 hardware will make a loss at launch, but Sony expects to immediately recoup the costs when a typical user also buys a PlayStation Plus subscription and at least one launch game.

Eurogamer has heard from well-placed sources that Sony expects to make an approximate $60 loss per $399 unit sold. When presented with the figure, Ito denied it - but only because the company expects a typical user to buy a console with these other items.

www.eurogamer.net/articles/2013-09-20-so...-launch

www.extremetech.com/gaming/166458-ps4-pr...-day

MSFT might have to unbundle its Kinect sensor (unlikely) or eat more losses as the PS4 looks more popular with gamers in pre-orders so far, the $100 is an important psychological price difference between the PS4 and Xbox One (the delta is even higher in other currencies around the world).

Both new systems will put additional pressure on Wii U sales from NTDOY in 2014 - Wii U sales are already dismal in 2013 and well below earlier company estimates.

- In addition, the four potential new console entrants might speed up the transition to digital games and downloads compared to traditional packaged games sold at Gamestop (NYSE:GME) and other retailers. There will likely be additional pressure on expensive ("AAA titles") games at $60 - resulting in fewer of these blockbusters and riskier bets or risk reduction with sequels: Fewer new franchises and a few "sure" cash cows milked with regular sequels and DLC (current examples include Call of Duty, Battlefield or Grand Theft Auto).

The long-term outlook for physical game retailers (GME) and traditional game developers with high cost structures/headcount focused on packaged sales and low digital sales looks bleak beyond the current console generation - this will play out slowly over a few years. GME, for example looks over-valued beyond 2018+ at current prices above 50$.

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* Many people (including investors) may be surprised SNE actually made most of its profits in life insurance/fin services in recent years:

www.nytimes.com/2013/05/28/business/glob..._r=0

www.splatf.com/2011/11/sony-profits/

Disclosure: I am long SNE.

Stocks: SNE, MSFT, NTDOY, GME