Sony Struggles as Nintendo Soars

Sony's money-losing video game business was a drag on first-half earnings, while Nintendo's profits in the period nearly tripled from the previous year

Day by day, Sony's (SNE) core electronics business is looking less like a white elephant. On Oct. 25, the Japanese company swung to a profit in the latest quarter, vs. the year-earlier period, thanks to brisk flat-panel TV and digital camera sales. It also raised its annual profit and sales forecasts from July. In the fiscal year ending March, 2008, Sony now expects overall operating profits to rise fivefold, to more than $3.9 billion, on a modest 8% gain in sales, to $78.8 billion. Both these numbers are 2% higher than earlier estimates.

The improving outlook underscores how more than two years of Chairman and CEO Howard Stringer's tough-love reforms have helped restore the vitality of Sony's key electronics division (, 10/11/07).

But Stringer's record is hardly flawless. The biggest blemish: the money-losing video game business. The July-September quarter offered further evidence that problems plaguing the company's games division aren't going away soon. Had games been less of a drag, the company's overall results might have been more impressive. The games division's quarterly operating losses swelled to $848 million—double the figure from last year—and first-half losses reached $1.1 billion.

Sony's PS3 Models Cost More Than Those of Rivals

That's considerably more than what many analysts had predicted. Goldman Sachs (GS) had estimated the division's first-half losses at less than $620 million. Sony still sells every PlayStation 3 for several hundred dollars less than what it costs to make it. With its decision in early October to cut the price per machine of some models by $100, the gaming division will continue to weigh down Sony for some time. There's the added concern that the U.S. subprime loan mess and rising energy prices could make consumers think twice about spending between $399 and $599 for one of three PS3 models when they can buy rivals' machines for less.

Sony's numbers look even more dreadful compared to Nintendo's (NTDOY). The Kyoto gaming company has been unstoppable in recent months. Almost a year after it began selling the Wii, the console, which has a motion-sensing remote controller that gamers swing like a tennis racket or point and shoot like a gun, continues to sell out at many stores in Japan, the U.S., and Europe. And its DS, which has lured nongamers with a user-friendly touchpad, is the top-selling portable console.

On Oct. 25, Nintendo said first-half profits nearly tripled from the previous year. The company also revised its full-year forecast upward, saying that it now expects operating profit to reach $3.7 billion, 86% higher than last year's. As expected, Nintendo raised its global shipment forecast for the Wii by 1 million units, to 17.5 million, this year, after shipping 7.3 million in the first half. And Wii software shipments, which account for the bulk of profit, are expected to top 97 million units this year. It shipped nearly 37 million in the first six months.

Holiday Selling Season Is Crucial

Nintendo's stock is on tear, as well. Though the shares shed 3.5% following the earnings announcement, they're still up more than 170% in the past 12 months, and Nintendo's market value, at $8.25 billion, is second in Japan only to Toyota Motor's (TM). By comparison, Sony's shares, which fell 1.3% by the close of Tokyo trading, are up 60%, and the company's market capitalization is a little more than half Nintendo's.

Nintendo could widen the gap during the crucial yearend holiday season when game sales typically peak. Many analysts are betting that the Wii Fit, a fitness game played on a pressure-sensitive pad that lets users do yoga or head soccer balls, will be a hit with casual gamers.

"Everything is pointing to Nintendo having another record-breaking Christmas," says KBC Securities analyst Hiroshi Kamide. "It's starting to sound like a scratched record."

The fact that Sony's games division isn't profitable at this stage is no big shock to investors or analysts. Launched last November, the PS3 was expected to lose money in its first two years on the market. That's been the strategy since Sony first entered the business in the mid-1990s: attract buyers by selling the machines at prices below cost, and recoup the losses a year or two later when production costs drop and royalties from game software and sales of games developed in-house start pouring in.

Sony Putting on a Brave Face

But the PS3's sales have badly trailed the Wii's, and analysts think Sony should be worried. Japanese game developer Capcom's surprise announcement this month that its Monster Hunter 3 would debut on the Wii shows how influential game developers previously allied with Sony are defecting to Nintendo's camp (, 10/10/07).

In the first six months, Sony delivered just over 2 million PS3s to stores worldwide—less than a third of the Wii's tally. Sony hopes to have 11 million PS3s in stores this fiscal year. "This sounds very ambitious, indeed," Ovum analyst Carl Gressum wrote on Oct. 25. Getting more than diehards to buy PS3 titles (, 10/5/07) such as Gran Tourismo 5 Prologue and Guitar Hero III: Legends of Rock will be key. For now, Sony executives are putting on a brave face. "We have no intention of changing the PS3 sales forecast," Chief Financial Officer Nobuyuki Oneda told reporters in Tokyo. The next few months will tell whether Oneda is right.

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