Will PlayStation 3's cutting edge cost Sony dear?

published 6 December 2006

Could history be about to repeat itself for Sony? Back in the 1980s, the electronics giant backed a loser in the great VHS versus Betamax video battle. Although the latter system was technically superior in many respects, it didn't win the consumer vote, dooming it to a slow death and eventual obsolescence. Two decades on, the group's expensive and much-delayed PlayStation 3 games console could similarly have its thunder stolen by Nintendo's recently launched competitor, the Wii. A previous clash between the two giants saw Sony come out on top; the PlayStation 2 outsold Nintendo's GameCube, launched in 2001, by a margin of more than five to one. But this time around, the omens are less propitious.

The PlayStation 3 is the most eagerly awaited gadget of recent years, says Tim Webb in the Independent on Sunday, and is "already selling by the planeload" in the US and Japan. The trouble is, while the "sleek $500 black machines" are a hit with retailers and consumers, manufacturing problems have limited supplies in the US and Asia. In Europe, the PS3 will miss out on this year's Christmas market after Sony delayed the launch until next Spring, leaving the field open for the Wii and Microsoft's Xbox 360. Not only has Nintendo ensured plentiful supplies of the Wii and a retail price of just under $250 half the price of the PS3's cheapest version it is also beefing up its global advertising budget by 10bn ($85m) to steal an early march on its rival, says the FT.

The move is the latest salvo in what promises to be "the most expensive console war ever fought". Nintendo says a fattened marketing budget reflects the wider range of customers that the Wii is aiming for. Having previously pitched its product at young gamers, the new console is more of a family affair, with games that "tend to be non-violent, more intuitive to play and original", says Robert Cyran on Breakingviews. The Wii controller, which is shaped like a wand or TV remote control, allows players to carry out realistic movements within games, from teeing off on a golf course to a backhand volley on the tennis court.

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The group says it wants to "break the wall separating players from non-players", although, as Cyran observes, it is merely making a virtue of necessity. The more advanced offerings of its bigger competitors, both "more supercomputer than toy", are costly to design and build and Nintendo simply can't afford the same focus on "technical one-upmanship" as its bigger rivals. But shareholders can't complain; the group hasn't lost money in a decade and the stock has doubled in the past year, surpassing both Microsoft and Sony.

By contrast, Microsoft has never turned a profit from Xboxes, and selling games to go with the console hasn't been enough to recoup its losses. Sony loses as much as $300 on every PS3, and analysts warn of a cumulative loss of more than $3bn over the next two years, although the weaker yen could help to reduce this figure sharply. The delayed launch is down to its expensive and troublesome Blu-Ray technology, which allows the console to double as a player of high-definition DVDs. Paul Jackson of Forrester Research, quoted in the Independent on Sunday, says Sony is "pushing the envelope of innovation" by incorporating Blu-Ray. But will frustrated consumers feel that the delay and expense are worthwhile? Only time will tell. Meanwhile, here are three stocks that may benefit from the latest console wars.

Computer gaming stocks: three potential winners in a fickle sector

Although the computer games sector is volatile, analysts expect Nintendo (NTO, e169), unhampered by shortages, to sell around four million Wii consoles by the end of this year, and this figure could double over the first quarter of 2007. But the shares are at their highest since 2000 and on a forward p/e of 30 not cheap so investors might do better ignoring console makers in favour of games publishers.

In this sector, California's Electronic Arts (EA) is the leader, but Ubisoft (UEN, e47.40) aims to be number two in the next five years. Two years ago, Electronic Arts took a 20% stake in the French firm. It pledged not to raise its holding without Ubisoft's approval, but didn't rule out a full takeover. Current sales are ahead of estimates, but shares aren't cheap, on a forward p/e of 30.

A better bet could be the UK's SCi Entertainment Group (SEG, 476.5p - click here to order this company's annual report for free), which last year swallowed up Eidos, creator of Tomb Raider heroine Lara Croft. The delayed release of PS3 has hit its share price, but SCI insists it's not over-dependent on the launch. The group is releasing 19 titles this year, against nine in 2005. It doesn't pay a dividend, but with £37m cash can afford to and is seen as a potential target for a larger rival, such as Electronic Arts. It currently trades on a forward p/e of around 14, falling to 12 for 2008.

Graham has spent the past three years as a cash management editor at Deutsche Bank. Graham started off as a Risk Management Professional editor at Perspective Publishing for two years, then became a writer at The Treasurer for 5 years and then an editor at gtnews.com for 5 years. He then freelanced for 5 years where he reported on corporate treasury issues, risk management, insurance/reinsurance and pensions. Graham has a degree in English Literature from the University of Bristol and he has contributed to MoneyWeek’s share tips.