Editor's Choice

Microsoft Admits Defeat

Alexander is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Microsoft (NASDAQ: MSFT) has admitted defeat. The company is now saying that it will allow used games, and it will not require an internet connection to play video games. So we can all breathe a sigh of relief if we fall into the category of gamers without internet, or video gamers who need to buy video games used.

Xbox One is not dead yet

I remain optimistic on Microsoft going forward. I don’t really anticipate the company to cut prices on the Xbox One until the first or second quarter of 2014. I believe that the company will take advantage of the pent-up demand for its console product in the very early stages of its launch then promptly cut prices to a level that’s similar to the PlayStation 4. This puts Sony (NYSE: SNE) in the awkward position of earnings lower gross-margins that cannot be made up for with higher unit sales. Sony won the consumers, and Microsoft won the heart of shareholders, it’s a twisted turn of events.

Going forward, I believe that the Xbox One could be a compelling home entertainment console even with the additional $100 price tag. This is driven by the fact that it’s currently the top-selling product in Amazon’s video gaming section of the website.

<img alt="" height="443" src="http://g.fool.com/editorial/images/51840/6-19-13-msft-pic-1_large.png" width="728" />

Source: Amazon

Currently the PlayStation 4 is in the number 3 spot, which implies that while Microsoft did an awful job of managing its public relations, at the very least the company hasn’t fallen out of the good graces of its loyal customer base. Currently the Xbox 360 has 47% market share and is by far the most popular console. I didn’t think that the loyal customer base would get up and leave just because the product is a $100 more than PlayStation 4, has to be connected to internet, and wouldn’t support used games. But thankfully, due to its recent changes in policy, the only thing gamers have to gripe about is the $100 extra it costs to buy a Xbox One.

Biggest advantage of Xbox One

We know that the Xbox One will come with three operating systems preloaded onto the console. Of the three operating system's there's one that looks distinctly similar to the Windows 8 operating system. Engadget speculates on the operating system, but admits to not knowing how much of the Windows 8 Metro experience will be carried over to the XBox One.

While some opponents of the operating system argue that it drains system memory and lowers the power of the gaming system, I think that it’s possible for the console manufacturer (Microsoft) to re-coup the lost opportunity in gaming performance through sales of applications within the Windows Store. I believe that there's a very real possibility of the XBox One becoming an alternative computer.

I also think that the Xbox live subscription membership is going to come in handy as it will be giving users two free games per month. This will drain the demand for GameStop’s (NYSE: GME) used games. Currently the Xbox live user-base could be estimated to be 67 million (based on life-time console sales), and of that amount there are 40 million Xbox live subscribers. Interestingly enough there are more Xbox live subscribers than there are Netflix subscribers, and believe me, a Netflix subscription buys a lot. So we can only imagine the potential of this subscription driven business model. It will most likely have greater economies of scale over Sony’s PlayStation Plus.

I am also a fan of Sony

I believe that Sony did exceptionally during the E3 conference. The company introduced a lot of new products and features that will be unique to the console. The company has built the purest gaming device and built features around that. The company also included social features into the gaming experience to make it Facebook friendly. I am a little concerned of the practical utility of the device though. The Xbox One has the potential of being an alternative computer (or be similar to one.) This could give it an edge when compared to Sony's PlayStation 4.

On the bright side, Sony has adopted strong policies that have favored the perception surrounding the company. The lower price of the Sony PlayStation 4 product could be recouped with the sale of video games going forward. However, it would take a lot of video game sales to make up for the lost $1.5 to $2 billion opportunity cost that I have estimated.

I believe that the real upside is in the Sony mobility segment. The recent release of its Sony Xperia Tablet Z could lead to substantial growth opportunities. I estimate that the Sony Xperia Tablet Z to contribute $600 million to $1.2 billion in net income. Sony also projects that its smartphone segment will grow revenues by 27% for the current fiscal year. Investors could earn substantial returns based on the growth of the Sony mobile segment.

GameStop stock getting a bid underneath it

GameStop at the time of writing is rallying by 6.02% on the session. This is because of Microsoft’s sudden change in policy for used games. Used games represent 48% of the company’s gross profits. However, just because the next-gen console supports used games doesn't mean that the publishing studios do.

<img alt="" height="447" src="http://g.fool.com/editorial/images/51840/6-19-13-msft-pic-2_large.jpg" width="708" />

Source: Statista

Going forward the number of physical retail games are on the decline. GameStop could be in significant trouble going forward because the game studios are providing up-front discounts on digital video games. This will result in an immediate decline in the amount of physical discs in circulation. This will also lower the amount of used game sales thus allowing video game studios to earn greater profits over the long-term.

Analysts on a consensus basis anticipate GameStop to report a 1.3% decline in earnings for the 2013 fiscal year. The company could be met with even greater pressure if game studios offer even greater discounts in the next generation.

Conclusion

Stick with Microsoft and Sony. Don't ignore the weakness in GameStop’s business strategy. Just because Microsoft changed its policy on used video games doesn't mean the video game studios will want to support that.

More from the Motley Fool

It's been a frustrating path for Microsoft investors, who've watched the company fail to capitalize on the incredible growth in mobile over the past decade. However, with the release of its own tablet, along with the widely anticipated Windows 8 operating system, the company is looking to make a splash in this booming market. In a new premium report on Microsoft, a Motley Fool analyst explains that while the opportunity is huge, so are the challenges. The report includes regular updates as key events occur, so make sure to claim a copy of this report now by clicking here.


Alexander Cho has no position in any stocks mentioned. The Motley Fool owns shares of GameStop and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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