July 7 (Bloomberg) -- Microsoft Corp.’s Xbox Live online video-game service probably broke the $1 billion revenue mark for the first time in the year that just ended, helped by sales of movies, avatar accessories and extra game levels.
Microsoft says about half the service’s 25 million users paid an annual fee to play games online like “Call of Duty: Modern Warfare 2” in the year ended June 30. That would be about $600 million. Sales of products like movie and TV show downloads topped subscription revenue for the first time, Dennis Durkin, Xbox’s chief operating officer, said in an e-mail.
The remarks suggest the business generated more than $1.2 billion in sales last year, exceeding analysts’ estimates. Success in online gaming is crucial for Microsoft because the other products in this unit include the barely profitable Xbox game console and mobile-phone software that’s losing ground to Apple Inc. and Google Inc.
“Xbox Live has helped sell a lot of consoles and created a lot of loyalty,” said Matt Rosoff, an analyst at Directions on Microsoft in Kirkland, Washington. “Everyone has been talking about Microsoft’s inability to innovate, but this is a pretty good example where they have innovated. They timed it just right with this one.”
Durkin declined to give more detailed results for the service, and Redmond, Washington-based Microsoft doesn’t break them out when it reports earnings. Sarah Friar, an analyst at Goldman Sachs Group Inc. in San Francisco, estimates Xbox Live had sales of $1.1 billion in the past fiscal year, up from $800 million a year earlier. Subscriptions for the premium service are $50 a year.
Rival PlayStation Network
Microsoft may have difficulty extending the popularity of Xbox Live to other consumer businesses like television software and portable music and video players, Rosoff said.
Sony Corp.’s rival PlayStation Network is starting a subscription offering, and Xbox Live also competes against Apple’s iTunes for music and TV show downloads. Microsoft said in May that Entertainment and Devices Division President Robbie Bach, who has overseen Xbox for a decade, will retire. J Allard, one of the earliest executives on the Xbox project, also left.
Friar estimates Xbox Live has gross margins, the percentage of sales remaining after deducting production costs, of about 65 percent. That’s buoyed results in the entertainment division, which has reported an annual profit only since 2008.
Microsoft will post operating income of $1.04 billion for the division in the year that ended June 30, projected Friar, who is based in San Francisco and recommends buying the shares. That’s more than six times the income in fiscal 2009. The company is due to report 2010 results July 22.
‘Launch, Sustain, Retain’
Xbox Live is helping Microsoft draw in additional revenue after gamers leave stores with games in hand, Durkin said.
“The old playbook of ‘launch and leave’ is a relic of the past,” Durkin said in an e-mail. “Today with Xbox live, it’s now about ‘launch, sustain, retain’ by continually adding new content that enhances the original experience.”
To boost future revenue, Xbox Live struck content deals with Walt Disney Co.’s ESPN and Activision Blizzard Inc. and introduced a family subscription that gives four memberships for the price of two. Its Kinect device, which lets users play games by movement rather than with a controller, will also fuel sales, Friar said. Microsoft probably can increase Xbox Live sales by a rate of “mid-teens to 20 percent” a year, she said.
Activision says Xbox Live is the only online gaming business -- except for Activision’s own personal-computer based “World of Warcraft” franchise -- that generates substantial money.
“When it comes to online gaming, they’re the only significant alternative to us,” says Activision Chief Executive Officer Bobby Kotick, whose “Call of Duty” titles have 50 million registered online players.
Success may breed increased demands from content providers to share more revenue. Already Activision says it wants a cut of the take from subscriptions, not just the percentage it currently gets from its content sold through the service.
“We’re driving a lot of the subscription interest and certainly hours of game play,” Kotick said.
Microsoft rose 48 cents, or 2 percent, to $24.30 at 4 p.m. New York time in Nasdaq Stock Market trading. The stock has dropped 20 percent this year.
Microsoft’s decision to invest early on in a subscription service for online gaming is paying off, said Michael Pachter, an analyst at Wedbush Securities Inc. in Los Angeles, who covers the video-game industry. Xbox Live began in 2002.
Sony Plays Catch Up
Pachter estimates Microsoft sank about a billion dollars into the effort and didn’t break even until it released its second console in 2005. Still, the early start, combined with exclusive games, means Sony won’t catch up with its PlayStation Network, he said.
“I was skeptical in ‘02 -- I thought it was stupid,” Pachter said of Xbox Live. Now, the service is driving gamers to Microsoft. “If your friends are all playing on Xbox, you get an Xbox. If they’re all on Xbox Live, you get Xbox Live.”
Pachter estimates that Sony is losing money on PlayStation Network, which sells games and other content. Last month, Sony said it will add a premium service and charge $50 a year, matching the Xbox Live fee.
Some of Xbox’s success is due to the popularity of the alien-shooting “Halo” games, which are Xbox exclusives and top-sellers.
The “Halo” franchise “essentially invented” the market for multiplayer online games on consoles, Pachter said. There are 6 million people a month who play the game on Xbox Live, and Sony probably doesn’t have half as many people playing all of its exclusive online games combined, he said.
Microsoft is working to extend Xbox Live’s success to mobile phones. Its overhauled phone software, available later this year, will let customers play Xbox Live games and see users’ avatars, profiles and achievements.
The company needs to expand its success with Xbox Live to its other consumer businesses, Rosoff said.
“They need to take it more broadly,” he said. “It’s taken longer than I expected to do that.”
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