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Microsoft: The Gaming Business Takes Off – Microsoft Corporation … – Seeking Alpha

(Source: Flickr creative commons)

Microsoft finally shows some strength in the video game market

Microsoft (MSFT) has been competing with Sony (SNE) in the gaming industry for about 17 years since the first Xbox was released. The company has had its ups and downs over the period, but the last five years were not very successful for MSFT: Sony with its PlayStation 4 clearly outperformed Microsoft’s Xbox One in the game console business. Hence, as of January 2017, Microsoft sold only 26 million devices, while Sony’s sales were shy of 60 million.

To turn around the situation, Microsoft released a new, better version of Xbox One (One X) in November last year. The console is claimed to be the most powerful console on the market, and it supports native 4K and 60 frames-per-second for most games. In short, Xbox One X provides more smooth image and better quality of in-game textures for the same games.

While in November Sony still shipped more console units than any other company, such as Microsoft and Nintendo (OTCPK:NTDOY) despite the launch of One X and Switch, Microsoft drove more spending than any other platform in the month, and its $500 price tag certainly helped.

Xbox One also generated more sales in November than in any previous November to date. In short, sales have been robust for both platforms.

As a result, total video games hardware sales amounted to a hefty $1.15 billion in November, up 52% year on year.

(Source: Extreme Tech)

Moreover, it is reported that in December Xbox One outsold PS4 for the first time, according to NPD data. Notably, Nintendo Switch was still the top-selling platform in the month.

The results are seen in Microsoft’s Q2 FY 2018 report. While 98% growth in Azure is clearly something that drives the price of Microsoft stock at the moment, gaming revenue also demonstrated solid growth. The sales for the segment increased by almost 9% year-on-year and doubled sequentially, driven by a 14% increase in hardware sales. Moreover, Xbox Live active users went up by 6 million users in just three months, which is an impressive number and indicates the platform is finally getting momentum. Importantly, these users will continue to generate recurring revenue for the company, buying games and paying for the subscription. This is why the future of Microsoft’s gaming business looks bright at the moment.

(Source: Q2 earnings call slides)

The main reason for the good numbers is the launch of Xbox One X. The console finally gives Microsoft some competitive advantages over Sony, despite the lack of good exclusive games. Thus, Sony’s enhanced version of PlayStation 4 (PS4 Pro) is less powerful than Xbox One X, which leads to the fact that 60 FPS are rarely supported by the console, and 4K resolution is not “native” but upscaled (additional pixels are added artificially by software). For an average user, an upscaled resolution will unlikely look very different from a “native” one, but the increase in frames rates clearly enhances the experience.

Why the gaming industry is important for the company

The success of Xbox One X is important for Microsoft since the video game market has a very bright future. The popularity of esports drives the stocks of major publishers higher, but big platforms such as those by Microsoft, Sony and Nintendo also gain from the trend significantly.

ChartATVI data by YCharts

Hence, the video game industry “closed out 2017 with yearlong total sales rising 11% Y/Y to $14.59B,” while the latest generation of Xbox/PS is 18% ahead of the PlayStation 3/Xbox 360 team.

Esports also became a buzzword in 2017 among investors, thanks to the success of such titles as Activision’s (ATVI) Overwatch. In July 2017, the company sold the first seven franchises in its Overwatch League, “the first major global professional league with city-based teams.” Newzoo expects the overall industry will grow at a 35.6% CAGR over the next three years, reaching the level of total revenues of $1.5 billion by 2020.

(Source: Newzoo)

My estimation is that the total market size for esports will be even higher in 2020, since more publishers are moving into the field. For instance, Electronic Arts (EA) is set to launch its e-league for FIFA game and will also partner with Magor League Soccer for FIFA 18 World Cup. Notably, EA’s FIFA franchise had “42 million players during the calendar year,” which means the future FIFA league will not lack popularity.

As a result, Microsoft will gain from the trend, especially in light of the launch of its powerful console. I believe hardcore players will choose Xbox One X to play most esports titles as the platform provides higher resolution and frames rate, which is important for competitive games.

Microsoft’s future steps: M&A and services

One very probable future step for Microsoft is to acquire a video game publisher or major development studio. It was rumored earlier this week Microsoft was considering the acquisition of Electronic Arts, which moved EA shares higher. However, this move is unlikely: EA’s market cap is $40 billion, which does not include an acquisition premium, which would be about 30% for the industry. My opinion is that the price tag of $50 billion is too much for Microsoft, even though its cash pile would allow the company to spend this amount of money – the company has more than $140 billion in cash and cash equivalents, according to the Q2 report.

However, such rumors usually mean that Microsoft is indeed interested in buying a gaming company. Polygon outlines a list of studios that “could help Microsoft solve its exclusive game problem,” which includes Valve, PUBG Corp., which is “riding high with its PlayerUnknown’s Battlegrounds,” Bethesda, and others. It is very likely the company will try to buy a studio that can develop new exclusive IPs for Microsoft’s platform, as the lack of exclusives is one of the main problems of Xbox at the moment.

As for other steps, Microsoft is likely to push its subscription services. Xbox Game Pass, which allows people to play over 100 games for a monthly fee, can become a solid source of revenue for the company in the future, as NPD predicts video games subscription revenue will grow exponentially in 2018.

Microsoft also claimed during the earnings call it decided to “release exclusive game content on the Xbox Game Pass simultaneously with global release,” which should increase the value of the subscription for members and partners.

The shift toward games-as-a-service also will likely boost Azure popularity further. In order to gain from this, Microsoft acquired PlayFab, a complete backend platform for live gamers. Therefore, the company is likely to develop its future games in this direction:

Finally, we just acquired PlayFab, which serves more than 700 million gamers with more than 1,200 games from companies like Disney, Rovio and Atari. It’s a complete backend platform for mobile, PC and console game developers to build, launch, and scale cloud-connected games, extending our investments in Azure to provide a world-class cloud platform for the gaming industry.

Final words

Overall, Microsoft managed to revive its video game platform successfully during its second quarter of FY 2018, thanks to a good start of Xbox One X. The results were evident by the Q2 numbers, as gaming revenue increased by almost 9% year-on-year, driven by 14% growth in hardware. Moreover, the number of Xbox Live active users soared by 6 million from 53 million AU to 59 million AU. This is a big step for the platform which will help Microsoft gain from the increasing popularity of video games and esports in particular.

It can be expected Microsoft will continue to push into the market. The next logical step would be to acquire a game studio that would develop exclusives for Xbox and Windows, attracting more users to the platform. It was rumored MSFT was considering EA as a possible target, but my opinion is this game publisher is too big and expensive at the moment. Besides, EA focuses on multiplatform franchises, while exclusive IPs should be more attractive for Microsoft. Other studios or publishers are more likely to become final candidates for M&A.

Moreover, the corporation should focus on gaming services like Xbox Game Pass, which can become solid sources of revenue for the company in the future. Among other reasons, this is important due to the fact that digital game sales are associated with high margins, while also cloud-based games will boost Azure revenue further.

My detailed analyses of Microsoft, EA, Activision, and other tech companies can be found on my profile page. If you like my article and would like to stay up to date on the next one, you can click the “Follow” button next to my profile.

Disclosure: I am/we are long ATVI.

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.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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