It seems like every day we are getting new updates on who is losing money, and how that means our favorite consoles and games are doomed (well, it’s more like we get quarterly reports every 3 months, but work with me here). It’s hard to know what to believe and what’s just click-bate, especially when most of the people reporting the numbers are gamers who don’t fully understand what’s going on themselves. I don’t blame game sits for not providing context as they simply pass along some information that’s about video games and no one is claiming to be an expert. I'm not either. But I do know my way around a balance sheet, and know a thing or two about investigative reporting. My goal here, as always, is to dispel ignorance and provide objectivity so I’ll be focusing on disproving commonly held notions rather than trying to pass myself off as an investment banker and provide stock advice.
Before I start, let me speak to the most common statements that get tossed around when talking about a company’s balance sheet, which are complete rubbish.
They are just lying about the numbers
As near as makes no difference to impossible. As publicly traded companies, they have to submit to diligence are their books are open to review at least 4 times a year. Due to both heavy regulation and a pretty strong desire to get the numbers right, a quarterly report is generally prepared by an independent firm and your own accountants at the same time, and any discrepancies are investigated. It is a very serious crime to publish numbers you know to be false. It’s a reasonably serious crime to publish numbers that are wrong even if you thought they were right.
But they have billion in assets!
Imagine you own a retail store. You have a ton of assets; you have the store itself, you have the point of sale system, you have computers, you have office furniture, you have fixtures. When you start losing money, can you go and sell your point of sale system to generate some quick revenue? Obviously not, as it’s essential to running you store. So are the computers, the fixtures, and the store itself. You might be able to sell the furniture, but just this simple thought experiment shows the problem with that logic; even with a billion in assets, the amount you can sell without drastically impacting your ability to make money in the future is going to be a very small percentage. Also your outstanding stock NEVER counts and an assist; if people wanted to buy your stock, you wouldn’t have a problem.
So let’s take a look at the big three, asking 3 important questions: Are they making money from gaming, are they DOOOOOOOOOOMED, and would they ever sell off their consoles.
Sony
Once a giant of manufacturing, innovation and sales, Sony’s decline over the last 10 years has been as tragic as it has been spectacular. In 2000, Sony had a Market Capitalization* of almost $82 billion, making it one of the largest and most valuable companies in the world at the time outside of the energy sector. They had positioned themselves as the cutting edge of numerous technologies including digital cameras, camcorders, MP3 players, and personal computers. Sony TVs were considered among the best money could buy, with good reason. Even at this stage, the PlayStation seemed an unstoppable force, taking market share from Nintendo at a rate higher than anyone expected and fending off any encroachment from the original Xbox. However due to a string of poor decisions, declining PC sales, decline in demand for high end electronics, competition from Samsung and Apple, and dozens of other factors, Sony today has only $17 billion Market Capitalization and is suffering yearly loses in the billions.
Is Sony making any Money from gaming: It comes and goes. Recently no, but that’s changing.
People often talk about PlayStation “keeping Sony afloat” but that has simply never been the case. The original PlayStation and the PlayStation 2 were money makers for sure, but at a time when Sony was extremely successful in other areas. By the time Sony started to decline, PlayStation was contributing to losses. The PlayStation 3 was not well received at launch and was sold well below cost despite being extremely expensive. The PSP was a disappointment, never approaching the sales targets Sony had set for it. By the time PS3 started to gain momentum and move units, the disastrous PSV was cutting into the bottom line. It has yet to reach its first year sales target, despite being 3 years old. SOE has been the only consistent bright spot, but has never made enough to truly make a difference with Sony as a whole. But things are starting to turn around with the PlayStation 4. This year’s PlayStation profit of almost $300 million US may be first yearly profit in almost a decade, but it’s a very impressive number well beyond even the most aggressive estimates. It’s hard to call a single data point a “trend”, but the market seems to be extremely receptive of PlayStation right now, and I think we can expect this profitably to continue with upward momentum in the near future.
Is Sony in any real danger - Very much so.
Look, we all love PlayStation and it’s easy to think of Sony as “too big to fail” ... but they are not in good shape. The easiest to understand indicator of a company’s overall health is “Levered Free Cash Flow” which is the most basic terms is the amount of money a company will have left to spend (or give back to investors) after it pays off all its debts that are due. Sony’s Levered Cash Flow sits at -8.87B, meaning Sony needs almost 9 billion more cash than they are expected to bring in to pay for obligations like rent, wages, interest, and non-renewable loans, while they only have 7 billion in the bank. If they cannot raise that outstanding 1.9 billion in cash some other way they will enter default protect and essentially be bankrupt. But that’s not going to happen just yet. Sony is a well structured company and is able to sell valuable assist from one area without impacting others. Still, selling $23 million in assists a day simply to survive is not sustainable for any real amount of time. The “already sold” list includes a HQ in Tokyo and 250 million in shares in other companies, as well as Sony’s E-book and PC business. Not really anything people on a gaming site are going to care about, but It won’t be long until they are forced to sell something much harder to ignore.
Would they ever sell PlayStation – Almost certainly not. And who would buy it?
PlayStation is very healthy right now and is extremely valuable. Forbes rates its value as a brand higher then Sony itself, and I think it’s easy to see why. An educated guess at an acquisition price for PlayStation is in the double digit billions, which keep the potential buyer list extremely low. Microsoft and Nintendo can both afford that, but what’s the benefit? You rarely buy your competitors because Investing 10 billion in their own brands is the smarter play if you have the money to burn. Amazon and Google are both already invested in the console game with systems focused on the market they care about, content distribution. While they might pay for PSN, having to buy the hardware and software business to get it is just a waste of money. The same could be said of FaceBook, who might be interested in the social side of things but already have “gaming hardware”. This leaves private investment funds, and they traditionally shun video games like the plague. So let’s firmly put this speculation to bed; Sony isn't selling PlayStation.
Even if they want to.
It’s far more likely they will sell their phone business to Samsung or Microsoft, which will raise more than enough capital to keep them afloat until they can restructure and truly cash in on the success of the PS4.
Nintendo
Oh Nintendo, you crazy little games company. With their 4th straight year of loses totaling almost 2 billion US dollars there has to be a lot of hurt to go around. Worse, by their own sales estimates it looks like there is no chance for the Wii U to fully recover, they have no new hardware on the shelf to replace it with, and the DS isn’t paying the bills any more. It’s easy to assume that Nintendo is in just as bad a bind as Sony ... and unfortunately that’s about the only thing that’s easy to do. Where Sony and Microsoft have the decency to neatly categorize everything in a logical fashion (Sony Music, Sony Movies, Sony PlayStation, Xbox Entertainment), Nintendo’s corporate stature is an a misrepresented and tangled mess. We tend to think of Nintendo and Nintendo of America interchangeable and that's lead is to think of Nintedo has just being a games company. Nintendo of America is just selling games and systems (and owes a baseball team. Because why the hell not?), but the global company has a hand in everything from hotels, a taxi company, restaurants, food, candy, TV shows and movies without any clear department structure that makes it easy to track who is making and losing money, . Given that Nintendo of America has seen double digit percentage stock price decreases (and hundred million market cap. loses) on days where Nintendo's global stock has seen an increase, it's clear that games are a unexpectedly small price of the Nintendo Pie.
Nintendo also owns this small little PRIVATE company which I’ll get to soon, and because it’s not publicly traded I can’t simple look at its balance sheet and tell you what’s going on with it ... and that’s a problem.
Is Nintendo making any Money from gaming: Mother of god, yes
But 4 straight years of losses! I know. But the Wii U is failing! I know that too. But software sales are plumping! I know, I know, I know. Like I said, with Nintendo it’s not that easy. Remember that small little private company I was talking about? It’s called “The Pokémon Company” and it’s not really small or tiny. By all estimates it is worth considerably more than Nintendo on its own or Sony’s global operations, at about 23 billion US. It’s hard to accept, but nevertheless true: For all the next gen hype and market share debate, for all the $100 million controllers and games with $500 million budgets, even the most conservative estimates put Nintendo’s profits from licensing it’s video games characters as generating more money than Sony, Microsoft and Nintendo themselves make selling gaming hardware and software. Combined.
So why is Nintendo posting a lose? I wish I could tell you. But without access to the balance sheet for the Pokémon company to make some educated comments about how their profits are being reported by Nintendo, or where the money is going, I can’t really say. And that only compounds the fact that it’s hard to say where Nintendo’s money is coming from or going to, given its lack of structure. For all we know, they could be losing a billion a year in a bad hotel deal, or own a race car driver who is under performing. Wouldn't surprise me one bit. What I can say without doubt is that game related sales (because selling a plushy of Pikachu is a game related sales) are extremely profitable for Nintendo when you look at the big picture.
Is Nintendo in any real danger – Not even close.
Nintendo has around $8 billion US in the bank, making them one of the richest companies in the world (top 25) when it comes to cash on hand. Nintendo could support itself without operational income anywhere from 25 to 35 years, and that’s without having to sell another assists. Most importantly, when compared to Sony, Nintendo’s burn rate** is extremely high, and they could shut that off at any time in order to balance things out.
Would they ever exit hardware (sell off isn't really a valid question for Nintendo) – No, but there is a strong “crazy” factor at work here.
Let me introduce you to Seth Fischer. Everything you have ever heard negative about Nintendo’s current operations, including calls for the CEO to step down, calls to move out of hardware, calls to sell on mobile platforms ... Seth is personally (and generally solely) responsible for. A US investor in charge of Oasis Management, Seth bought into Nintendo because he thought the Wii U would be another Wii. This hasn't made him very popular with people who’s money he used to do that, and he has been doing everything he can to get Nintendo to follow a more “US” approach to profit. He has influence in the US media, and we generally read stories about the crazy things he wants to do (like add micro transactions to Mario 3D world) as “Nintendo investors urges ....” when that’s simply not the case. The board of directors, as a whole, have complete confidence in Iwata. Sure, the Wii U is far from a hit ...but he also brought the Wii and the 3DS to the market. The Wii is the best selling home console of all time, and given time, the 3DS should overtake the original DS to be the best selling handheld as well. So he’s got that going for him.
That said ... Nintendo is crazy! It’s hard to predict where they will be even a year from now because more than other company in this article they have the money and freedom to just bet it all on a whim, and the historical data shows that every 8 years or so they like to do exactly that.
Microsoft
What can I say about Microsoft? Comparing there balance sheet to Sony or Nintendo is like comparing a major league baseball player to some guy on the company softball team. Currently the 23rd most valuable company in the world, Microsoft holds its own against banks, automotive giants, and power companies. It’s annual sales total more than the combined value of the entire video game industry. They are worth 17 Sony’s or 23 Nintendo’s. Microsoft is so rich, they could buy Nintendo AND Sony at current estimated market value (not subsidiaries or assists) with the cash they have in the bank and it wouldn't even drop them down a spot on the “most cash on hand” list. So big fish in a small pound has never been more accurate.
At the same time, the Xbox is a tiny fish in a vast ocean. Contributing less than 1% of Microsoft’s bottom line, it’s not uncommon to make it though earning calls without it even being mentioned. It’s a big deal to all of us because we are gamers ... but it can’t be overstated how little most of the people at Microsoft care about it. Put in perspective, Sony make more of its total bottom line as a percentage selling magnetic storage tapes then Microsoft makes from Xbox, and when was the last time you saw a tape backup at E3?
Is Microsoft making any Money from gaming: Maybe? Probably not though
Xbox entertainment has finished in the green every quarter since 2007, which seems to be a clear cut indicator that I just lied to you with the headline up there. But I didn't ask if Xbox was profitable, I asked if Microsoft was making money off gaming. From day one Microsoft has envisioned the Xbox as a content delivery platform and monetized it in ways that go beyond gaming, and they have done a fantastic job of it. While the average PlayStation 4 owner spends almost 90% of the time the console is on playing games, the average Xbox One owner spends less than 40%. The other 60% of the times they are using apps, buying movies, buying TV shows, or buying music. Unlike Nintendo who shipped all that non-gaming profit off to a subsidiary, Microsoft just reports all under the same line and the profits roll right into “Xbox Entertainment”. That makes it impossible to tell how much money they are making from games, but I’m not going to let that deter me.
Doing some quick math it’s easy to figure the answer is “not much”. Xbox Live Gold subscriptions alone are bringing in $700 million with almost no overhead, but Xbox is reporting profit numbers much lower than that. In fairness, these are the people who spent $100 million to make a controller worse, so we can assume they have a burn rate** even higher then Nintendo. Bottom line on the bottom line is that Xbox is making money, and it looks like a fair bit of money ... but games seem to be a loss leader in the overall strategy.
Is Microsoft in any real danger – No.
Obviously. They are going to make 22 billion in profit this year and have 80 billion in the bank. I’m done. (for maximum effect, please picture me dropping a microphone to the ground as you read this)
Would they ever sell Xbox – Why not? Also ... why?
I don’t think there would be any objection to selling Xbox from the board, and if the motion was tabled it would more than likely carry. As I talked about just last week MS started off more of a branding exercises then anything else, with a secondary goal of content distribution. The Xbox investment, on this level, might better be served today focusing on cell phone and mobile destitution. Not only is that where the money seems to be, but it fast becoming a better way to reach the youth demographic as the average age of gamers is going up every year (by about ... .one year ). But the much more important question is why would they sell?
With 80 billion in the bank, they have too much money*** and selling off Xbox to raise capital would just be counterproductive. Microsoft is actively looking for more ways to increase its brand awareness and product diversity, regardless of how much of a gamble they are, as they are in the same boat Google was when they bought a thermostat for no good reason, or Facebook was when they bought OR for about 10 times what it was worth. They are not going to give away something they already have, especially if it’s in the green.
The final word
So there you have it. 3000 words to tell you that regardless of what you read in the latest “The sky is falling” article, we can expect more of the same for the conceivable future. Sony is struggling, Nintendo is stumbling, and Microsoft keeps doing their thing, but it’s all going to work itself out without any major shake down. No one said it better than Mr. Kevin Butler ... Long Live Play. And that’s exactly what’s going to happen, regardless of where you like to do your playing.
*Market Capitalization – The poor man’s “What a company is worth”, Market Cap. Is the value of each share multiplied by the number of shares issued. It has no direct translation to value, but is a strong indicator of the trending of what a company is worth (as it goes up or down, so does the worth of the company)
**Burn Rate – The rate at which you tell your R&D, marketing, and other controllable spending to “burn” though money. Companies with high burn rates are good investments because in hard time they can just “turn off the taps” and stop investing so much in these areas.
***Too much money - This is very much a real thing. Money is volatile. If the US dollar went down 5 cents, Microsoft would lose 4 billion in cash. Having this much cash on hand also means you haven’t been able to found ways to leverage investments, and shows you don’t have people in place to manage your cash flow. It’s a very poor indicator.
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