Microsoft Loses $2 Billion Per Year On Xbox, Analyst Says

[Andy Chalk]

Microsoft Loses $2 Billion Per Year On Xbox, Analyst Says

Analyst Rick Sherlund believes that staggering losses on the Xbox business are being masked by Android royalties.

It's hard to make money making game consoles but the assumption, as I understand it, is that if a company can power through the lean early years, it'll eventually figure out how to start turning a profit on the things - not a lot of profit, perhaps, but at least a little bit.

According to Nomura analyst Rick Sherlund, however, Microsoft isn't quite over that hump just yet. It is, in fact, bleeding money at an alarming rate, but nobody's noticed because the losses are masked by Android licensing revenues.

"If we start with the overall traditional [Entertainment and Devices Division] business that actually loses money before corporate allocations and back out the nearly $2 billion 95 percent gross margin Android phone royalties, we conclude that Xbox platform plus Windows phone and Skype lose about $2.5 billion per year, and we estimate that the Xbox platform may account for roughly $2 billion of this," Sherlund said.

That staggering loss, he added, "is concealed by the hugely profitable Android royalties" that come out of licensing deals Microsoft has with makers of Android devices, which were forced by Google's infringement on various Microsoft patents during the development of the Android OS. Xbox is a "cool" product and successful consumer franchise, Sherlund said, "but it also loses a lot of money and we think is a distraction to the more enterprise strengths of Microsoft."

Sherlund isn't alone in this view: In sell off the division [http://www.escapistmagazine.com/news/view/121610-Forbes-Analyst-Calls-Game-Over-For-Microsoft] if he gets the job.

Source: GamesIndustry International [http://www.gamesindustry.biz/articles/2013-11-07-huge-xbox-losses-hidden-by-patent-royalties-says-analyst]


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[FalloutJack]

I could have told you this years ago. Well, probably they lost less per unit then, but the same effect. X-Box is not a lucrative item.

 

[Dragonbums]

It's been known for awhile now that since inception the Xbox brand has bled money for Microsoft rather than turned them any profit.

The original Xbox beat the Gamecube by 2 million units, and despite that Nintendo still posted a profit on the console while Microsoft posted some huge losses.

They only now just started to see profits with the Xbox 360. I think I saw a graph somewhere that stated that the Xbox line has only gained Microsoft 2 billion in profit, and in light of the fact that they lost 5 billion dollars on the system.
That's a lot of wasted money. Especially when Microsoft is struggling in other places, it wouldn't surprise me if this gen doesn't see the X1 posting big profits, the Xbox brand will be one of many ventures that Microsoft will trim the fat off of completely.

 

[fix-the-spade]

"Sell Off" The division?

Oh right, because investors line up down the street to buy a business losing $2billion per year. If that statement is even remotely true, Xbox is going to die and die soon, we're over a decade into it now and it's still bleeding cash, although it's clearly not as bad as the Zune was.

Then again, this could be stuff and bluster.

 

[medv4380]

No one notice because of Android Licencing?

HAHAHAHHAHAHHAHA

No, XBox fan boys have been unable to understand MS annual reporting magic for the last decade.
Not a single reputable analyst would have said the XBox was ever profitable. They know that MS has a Magic "loss" line that they can use to hide a divisions failures.

The android number is just another line that MS has been able to use to mask its failures. Most people assumed, for good reason, that it was mostly Windows and Office, but with Windows and Office teetering the Android revenue has become more obvious.

 

[Pebkio]

That bad? I mean... are they still making Xbox 360s?

I mean, because the 360 is being sold for far less than it costs to make. All consoles are, really, but game sales are supposed to make up for this. It's the system, we all know this, but I'm really questioning this analyst's fancy guess that most of the company's loss is on the Xbox.

I'd love to see Elop get the job and then try to sell off Xbox, though. That would make for interesting news for the week he'd keep his position...

 

[RandV80]

It's important to note that during this time, Microsoft has undoubtedly been doing R&D on the XBox One. In GAAP, R&D expenses cannot be capitalized until a viable product is available. So all the money MS has spent on designing the XB1 has been booked as straight expense, which certainly cuts into the bottom line.

Company-wide R&D expenses for Microsoft in 2013 were $10.4 billion, or 13% of their revenue.

Good analysis, but if you're going to be in the console business then unless this is your very last console R&D costs for the next gen are always going to be a constant expense. Now yes there should be a steep decline/rise as people stop buying the old console a year in advance of the new console which will bring a huge spike in sales, but overtime that should all average out into a consistent gain/loss direction.

 

[MCerberus]

I'd like to see how Microsoft accounts the indirect costs of the xbox brand; also how they account fixed costs to the division. The claim that they can make a profit from hardware sales alone for the x1 is rather odd, it may be that they are moving costs around and eating them in other places. Then there are events like the rrod or graphics card overheat errors from the 360's first... several runs.

Considering the high failure rate, this has got to be hurting the brand's bottom line, but again, you can account it away by having the response be independent 'initiatives' or 'projects'

 

[Eldritch Warlord]

That bad? I mean... are they still making Xbox 360s?

I mean, because the 360 is being sold for far less than it costs to make. All consoles are, really, but game sales are supposed to make up for this. It's the system, we all know this, but I'm really questioning this analyst's fancy guess that most of the company's loss is on the Xbox.

Xbox 360s are sold at a profit now and have been for years. Consoles are generally sold at a loss early on yes, but manufacturing costs go down over time. Plus I believe Wii and Wii U were never sold for net loss, but Nintendo is kind of a special case.

Anyway, I doubt this analyst. I'd refer you to MinionJoe's posts.

 

[Riff Moonraker]

Rick Sherlund has been campaigning against Microsoft's X-Box division for quite some time now.

http://www.escapistmagazine.com/news/view/124559-Analyst-Recommends-Sale-of-Microsofts-Xbox-Division

Soon as I get my weekly report out, I'll do my own analysis of Microsoft's financial statements. Screw work, this is business!

OK, from MS's FY13Q4 10K statement (as of June 30, 2013):

Entertainment and Devices Division (?EDD?) develops and markets products and services designed to entertain and connect people. The Xbox entertainment platform, including Kinect, is designed to provide a unique variety of entertainment choices through the use of our devices, peripherals, content, and online services. Skype is designed to connect friends, family, clients, and colleagues through a variety of devices. Windows Phone is designed to bring users closer to the people, applications, and content they need, while providing unique capabilities such as Microsoft Office and Xbox LIVE. Through a strategic alliance, Windows Phone and Nokia are jointly creating new mobile products and services and extending established product and services to new markets. EDD revenue also includes revenue from licensing mobile-related patents.
Principal Products and Services: Xbox 360 gaming and entertainment console, Kinect for Xbox 360, Xbox 360 video games, Xbox 360 accessories; Xbox LIVE; Skype; and Windows Phone.

This is the statement from which Mr. Sherlund says EDD is reporting Microsoft's Android licensing revenue.

Entertainment and Devices Division
(In millions)
2013 2012 2011
Revenue $10,165 9,599 8,915
Operating income $848 380 1,261

So, in 2013, MS brought in over $10 billion in EDD. After expenses et al, they had a profit of $848 million. Mr. Sherlund is stating that the X-Box brand, the core of EDD, lost $2 billion while Skype, Windows Phones, and Android licensing (incl patents) would have to bring in over $13 billion in order to achieve the profit reported.

It's important to note that during this time, Microsoft has undoubtedly been doing R&D on the XBox One. In GAAP, R&D expenses cannot be capitalized until a viable product is available. So all the money MS has spent on designing the XB1 has been booked as straight expense, which certainly cuts into the bottom line.

Company-wide R&D expenses for Microsoft in 2013 were $10.4 billion, or 13% of their revenue.

Chances are Mr. Sherlund is attempting to include XB1 R&D expenses with the EDD operating income. There's certainly some cross-over between these two numbers (they're reported in different sections of the financials), but to say a brand has "lost" $2 billion based on R&D expenses is just poor analysis.

I'm still looking, but I can't denote any expenses that could be related to X-Box specifically that would make up the $2+ billion that Mr. Sherlund has provided. There's really only four types of expenses that could denote a "loss" though:

Cost of Revenue: the costs associated with the manufacture and distribution of a product. MS did report selling nearly $1 billion less in 360's than last year, but selling less does not imply a loss.

Research and Design: as discussed above, MS spend over $10.4 billion in R&D, which includes R&D payroll, programming costs, localization expenses, etc. The XB1 development is definitely reported in this expense category.

Sales and Marketing: It may be possible that Mr. Sherlund is counting the costs of the XB1 marketing campaigns. Of course, advertising a product that is not ready for sale will incur losses. This does not mean the product will lose that money "per year".

General and Administrative: CEO payroll, benefits, etc. Not directly tied to any one MS product.

IMO, Mr. Sherlund is attempting to say that the expenses MS has incurred during development and marketing of the X-Box One is reason for MS to sell the X-Box brand even before the new console goes on sale.

Honestly, I'm not following this "analyst's" reasoning here.

(Interestingly, MS reported a loss of $1.28 billion in their Online Services Division. Maybe they should sell their Bing, online advertising, and other Cloud services instead, hey Mr. Sherlund?)

Thank you for your research. This goes alot further than my original intention of just saying I think this analyst is full of bull. Well done, sir!

 

[BloodSquirrel]

Linked article doesn't contain any source to his numbers, or anything else to substantiate what looks a lot a claim straight out of his ass.

Frankly, it looks to me like he's just trying to come up with an excuse for his "sell off Xbox!" warcry.

+1 for the Sony fanboys who, for some reason, can not sleep at night unless they think that the Xbox is operating at a loss.

 

[BloodSquirrel]

Richard Sherlund is an Ex-Goldman Sachs partner who has been Wall Street's top-ranked software industry analyst for nearly two decades...Vs...some guy on a video gaming forum fighting his corner in the console wars...

Nice appeal to authority, but I've got a much, much better one: Microsoft's actual, official numbers which show the division being profitable.

Sherlund is making a claim for which he should be providing evidence, but he isn't. That's pretty much the beginning and end of any logical argument to be made here.