Overheard at E3: Sony Tells Microsoft, "Wii Have a Problem."

by Tony D'Altorio

Overheard at E3: Sony Tells Microsoft, "Wii Have a Problem."

by Tony Daltorio, Investment U Research

Friday, June 25, 2010

Video game production makes for an enormous global business. And according to PriceWaterhouse Coopers' annual Global Entertainment and Media Outlook, it's set to get bigger. The report foresees it expanding up to three times the size of the recorded music market by 2014.

As online, mobile and casual gaming expands, so does consumer spending in the industry. According to the Outlook, that will grow at an annual rate of 10.5% through 2015... marking the strongest annual growth in the entire media sector, with revenue rising from $51 billion to $84 billion by 2014.

That's good news for the three big video game device makers: Microsoft (NASDAQ: MSFT), Sony ADR (NYSE: SNE) and Nintendo ADR (OTC: NTDOY). Each of them suffered in 2009 as U.S. sales fell and global growth sputtered to a mere 2.2%.

And this year hasn't looked much better so far. April marked the fourth worst month on record for video game sales in the U.S. The NPD research team notes that console sales fell by 37% and software by 22% year-on-year.

Much of that hit came from hard-core gamers ignoring new titles. They were too busy focusing on multiplayer online battles from existing games such as Call of Duty: Modern Warfare 2.

So in order to generate future sales, the Big 3 have to turn to entirely new customers... the kind of people who never would have thought about playing video games before Nintendo launched the Wii.

Playing Catch-Up With Wii

The current generation of consoles were launched at the annual E3 show in 2005. And at this year's E3, they didn't showcase any completely new ideas. Instead, they designed new features and peripherals to extend the old model's lives and broaden their appeal.

  • Microsoft, for one, launched a marketing blitz for its new motion-detecting Kinect controller for Xbox 360.

  • Sony, meanwhile, revealed games that exploit the capabilities of its new Move motion controller and new 3D features in the PlayStation 3.

  • And Nintendo showed off its own 3D version of the DS handheld console that works without special glasses.

Of the three, Nintendo is definitely the one to beat. So far, it has sold 70 million consoles worldwide. That's twice as much as the PlayStation 3 and 30 million more than the Xbox 360. And even now, going on four years later, the competition is still playing catch-up.

For example, Microsoft hired Rob Matthews last year, the man who launched the Wii for Nintendo in the U.S., as its head of consumer marketing. Matthews sees an upbeat future for the company's Kinect. He thinks the controller will appeal to mainstream consumers instead of just the hardcore gamers usually attracted to the Xbox 360.

And on Sony's end, the Move controller follows very precise detection of player movement. Peter Dille, head of marketing for Sony PlayStation in the U.S., thinks it addresses flaws in the larger technology.

"Hardcore gamers looked down their noses at motion gaming... because it's not terribly precise or challenging," he says. He believes that the Move controller will satisfy everybody across the board.

That could be. But while both it and the Kinect may take bites out of Wii sales, Nintendo has already leapt ahead again.

Nintendo's 3D Version of the DS Console

Nintendo has a knack of giving its fans what they want, which means that the company gets its profit. And that, of course, means that its shareholders come out on top too.

Over the past five years, it has delivered EBITDA margins of about 25%, far outpacing its rivals.

Its new 3D handheld device, the 3DS, seems to continue that same trend. The successor to the best-selling DS handheld, it comes with a touch screen, a second screen and three built-in cameras. It doesn't require special glasses to play the games, and it can show 3D films or take 3D photos.

Though no price has been mentioned yet, it will likely sell for something close to current, top-of-the-range DS models at $190.

So far, software game publishers have given the 3DS more support than Nintendo has gotten before. That will give the product a great chance of coming into the marketplace with a lot of momentum.

Nintendo's stock - which is currently worth less than half its $100 billion peak - could benefit as well. Currently, it trades at about 18 times consensus forecast earnings, putting it back at pre-Wii valuation levels.

The Future of the Video Gaming Industry

Still, for all of Nintendo's triumph, Yves Guillemot sees a larger potential in the technology being developed right now. He says that "better interfaces and the use of 3D will lead to the future of consoles, where we will be easily interacting with the screen and everybody will be able to play."

He should know, considering his position as CEO of the games publisher, Ubisoft. So his emphasis on the word "everybody" points to the industry's moves to incorporate casual players.

If Mr. Guillemot is correct, recent developments could usher in a new generation of players altogether. And that could give the video game industry exactly the boost it needs to move past its biggest sales slump ever.

Good investing,

Tony Daltorio

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