Microsoft Looks to “Kinect” with Gamers

Microsoft (MSFT) wants to “Kinect” a broad-based audience of gamers and entertainment enthusiasts with its Xbox One video game console that debuts today in 13 markets including the U.S., Canada, and the UK.

For the uninitiated, Kinect is the name of the game system’s hands-free technology.  It allows users to control the gaming and media system through voice commands and gestures, and it now features facial recognition sign-in.

The technology is a big part of Microsoft’s marketing strategy as the Kinect device comes bundled with the Xbox One (it was formerly sold as an add-on).  The device features a 1080p, HD camera and a noise-isolation microphone, both of which are much improved over the prior version.  It can also track your heart rate for workout games.

“With its improved ability to navigate from games to TV to streaming videos to Skype, Xbox One makes a strong case to be the all-in-one machine for the living room,” said Darren C. Pollock, principal and portfolio manager at Cheviot Value Management. Pollock says Microsoft is a core holding in the firm’s $275 million under management and adds, “These functions may even attract casual gamers over to Xbox One.”

Those casual gamers are crucial to the long-term success for any game system.   Microsoft has gone all in on Kinect and it is one of the primary differences between Xbox One and Sony’s (SNE) new PlayStation 4 (which debuted for $399 last Friday).  It’s also the main reason for Xbox’s price premium (the PS4 offers an optional camera with some similar features as an add-on).

The stakes are high in the $20 billion dollar video game industry.  It’s the first time two major consoles are launching in the same year, much less the same week.  Rival Sony scored a record high by selling one million consoles in North America alone during its first 24 hours.  That made it the fastest-selling video game system launch ever.

Analysts say the hype and “managed production” of consoles to keep demand high and supply artificially low may make it hard to find either system before January.

“The excitement over the new console systems is intense and core gamers are buying more than ever before,” said DFC Intelligence analyst David Cole.  “PS4 sold out right away last week upon launch.  We expect the Xbox One to do the same.”

A Microsoft spokesman wouldn’t divulge exact figures but told FOX Business that preorders for Xbox One are twice as brisk as they were for Xbox 360.  He added, “Based on early demand projections, we are already anticipating that Xbox One will be sold out this holiday, so consumers should shop early.”

Even if Microsoft matches Sony’s record numbers, they will still pale in comparison to Apple (AAPL) selling nine million iPhones in a weekend earlier this fall.  Still bullish analysts say the robust PS4 debut augers well for the industry in a sluggish economic environment.
“Even in the tightest economy, the consumer thirst for entertainment will continue and video games offer the best value-per-dollar spent over any other form of premium entertainment,” contends Jesse Divnich, an analyst with video game consulting firm EEDAR.  He reckons a gamer will pay about $2 per hour for most video games, compared to about $10 an hour for cinema visits or about $2.50 per hour when renting videos at home.

BMO Capital Markets analyst Edward Williams says the back-to-back game console launches will power up the entire industry.  In a note to clients, he wrote, “the interactive entertainment industry is on the cusp of a new period of sustained growth as the next generation of console game machines helps renew consumer enthusiasm for the category.”

Williams predicts Sony and Microsoft will sell a combined five to six million units by year’s end and another 12 million total consoles in 2014.  The analyst expects game publishers Activision Blizzard (ATVI), Electronic Arts (EA), and Ubisoft to prosper with interest in new franchises and updates of older titles for the new consoles (neither Xbox One nor PS4 will play games from prior generations).

Williams also points out the more powerful new systems will allow consumers to download more of their games, which means higher publisher profit margins than for their packaged game discs sold in the store. The BMO analyst has an “outperform” rating on each of the three stocks.

Michael Pachter, an analyst with Wedbush Securities, estimates the two console launches will ring up some $600 million in consumer spending around the holidays.  In his holiday preview note, Pachter wrote that GameStop will see the biggest boost among retailers, while he forecasts and Best Buy will not have as much inventory so they will not see material sales gains from the video game holiday crush.

Looking out to 2014 when Microsoft and Sony are expected to churn out more consoles, BMO’s Williams also sees videogame retailer GameStop (GME) as a winner.  He recently raised his profit forecast for the company’s next fiscal year thanks to expected demand for the consoles and game titles.

Skeptics have been predicting the console video game industry’s decline, if not its outright demise, since Angry Birds first flew onto the screen three years ago.  That’s because sales of the theatrical $60 main course console offerings slid as casual gamers opted instead to snack on free-to-play and inexpensive (99 cent) apps on their mobile devices and tablets, or just stopped buying games for the old consoles due to a tough economy or while waiting for these new gaming systems.

Tony Ursillo, an analyst with mutual fund manager Loomis Sayles, expects the trend toward less expensive apps will resume after an initial buying spree this holiday season by core gamers and early adopters.  Ursillo said, “I think that gaming, and entertainment in general, has moved away from consoles toward mobile and social networking, except for hardcore games.”

Fund manager Pat Becker, Jr. disagrees and his firm is betting some of its $2.8 billion under management on Microsoft.  Becker Capital Management currently owns 1.6 million shares in the tech company.

Becker, the portfolio manager, has come full-circle on the tech giant’s Xbox strategy.

“I was not excited about their foray into this space but the heavy lifting is done,” explains Becker.  “(Microsoft) carved out meaningful market share and one could argue Sony is now chasing them.  I do think its core to their plans.”

Becker sees the Xbox Live Gold memberships expanding Microsoft’s consumer base.  The $60 annual membership is needed to access most of the Xbox One’s content and features, connecting players to the web and each other.  The service is also a good way to expand the number of credit cards the tech giant has on file from customers who can then easily buy more video, audio, or gaming content from Microsoft via download.

“The installed base of (48 million) users that they have signed up for Live is real.  Those users spend a lot of time and money (on Xbox).  I think this is undervalued in the Microsoft story and is just as important as iTunes is to Apple and pictures and posting is to Facebook. “

Will the new Xbox finally get Microsoft its long-desired beachhead in the living room as the One device to bind them all (gamers and their content) in the living room and on the go?  Becker is cautiously optimistic, saying he’s “not sure they can do it, but I can see a roadmap developing.”


The securities discussed in the posted article are current holdings of Cheviot’s clients. The viewer should not assume that investments in the securities identified and discussed were or will be profitable and it should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list. All information is provided for informational purposes only and should not be deemed as a recommendation to buy the securities mentioned. Cheviot closely monitors its positions and may make changes to the portfolio’s investment strategy when warranted by changing market conditions. If a security’s underlying fundamentals or valuation measures change, Cheviot will reevaluate its position and may sell part or all of its position. There can be no assurance that Cheviot’s clients will continue to hold the same position in companies described herein, and their portfolio positions may change at any time. If you would like a complete list of securities purchased or sold during the past twelve months as a block group in client accounts, please contact Cheviot via our contact page or by phone. Thank you.
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