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Microsoft’s Xbox Spinoff Scenario Gains Steam

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Scott Raynovich
Scott RaynovichNovember 27, 2013
9:53 am MT

With Microsoft drawing closer to the era of its next CEO, it’s becoming clear that its Xbox division is coming under closer scrutiny as a potential spinoff candidate.

Current CEO Steve Ballmer is stepping down by next June, and leading candidates for the job include former Nokia Stephen Elop and current Ford Motor Company CEO Alan Mulally. The markets have heavily handicapped Elop as the leader, as previously reported, though the Mulally meme appears to be gaining momentum.

 

Since CEO Steve Ballmer announced he is leaving the company by June of next year, Microsoft shares have drifted higher on the belief that the next CEO would provide a catalyst for change at the company, including radical restructuring and spinoffs that would unlock value.

A spinoff of the Xbox division is at the heart of this debate. The story of Xbox is one of promise and disappointment. Microsoft has long invested in the product as a “loss leader,” hoping it would pay off in the long run. Cumulative losses on the Xbox may be as high as $4.1 billion, according to some analysis, though in recent years it has turned into a solid cash generator.

But the question is whether Xbox has paid off on a strategic level — because that has been Microsoft’s story all along. The problem is that while Xbox is a very successful gaming platform, its dominance as a multi-purpose living room device. And even its success as a gaming device is vulnerable. Recent data and analysis incicates that the Xbox One launch may be lagging the Sony PlayStation 4 (PS4) sales, and some predict PS4 will beat out Xbox in the holiday season. This may weigh on the new CEO’s decision about the product line. 

This recently led influential Nomura analyst Rick Sherlund to question the real “strategic” value of the Xbox in the Microsoft franchise.  How strategic is Xbox, exactly? The current indicators are messy, at best. Yes, Xbox is a pretty good multimedia device. By adding communications, streaming, and storage features, Microsoft has pushed Xbox deeper into the consumers’ lives as it searches for control of the living room. In fact, in my household, we use our Xbox to stream Netflix and home movies from a networked computer.

Unfortunately, Microsoft does not enjoy the dominance in the living room that it enjoyed in the business PC market, even though it’s been at this for years now. In the living room, it competes with a raft of other gaming and device companies, inluding Apple, Google, Nintendo, and Sony, among others.

Microsoft’s see-sawing battle with Sony PlayStation, Nintendo, and many others, is indicative of how competitive the market is. Which leads to the question: Isn’t Xbox more valuable as a spinoff? The Xbox division would certainly be very valuable as a separate entity and investors argue that such a move would unlock billions of dollars of value.

Sherlund, who can definitely move Microsoft’s stock price, has been beating the drum on the spinoff, saying the Xbox unit is a good candidate because it’s not living up to the strategic value that Microsoft places on it.

“Our conclusion is that this would be a good candidate to spin-off to shareholders,” wrote Sherlund in a research note this past weekend. “We would advocate for keeping it if we were confident it could counter the effects of disintermediation that tablets and smartphones are having on Microsoft’s consumer business. It is just not enough, in our view, to cement Microsoft’s position in the consumer market when much of the broader video and music content is now already in your iPad or iPhone and available for mobile usage.”

Sherlund’s right. While Xbox is an excellent and successful product, it has not lived up to its expectation that it could be a game-changer for the Microsoft living room strategy. Quite simply, there is too much competition. And the new CEO is going to be pressured to look very carefully at the spinoff scenario.

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Scott Raynovich

About Scott Raynovich

Raynovich is the VP of Research and Analysis at SDxCentral Previously, he was Chief Analyst and Publisher of The Rayno Report (www.raynoreport.com), which was acquired by SDxCentral in October of 2015. Considered an expert on networking and service-provider technology, he has been covering these areas as an editor, analyst, and publisher for 25 years. He was the Editor in Chief and Editorial Director for Light Reading for a decade, where he started the Heavy Reading Insider research service. Prior to joining Light Reading, Raynovich was Investment Editor at Red Herring, where he started the New York Bureau and helped build the original Redherring.com Website. He has won several industry awards, including an Editor & Publisher award for Best Business Blog and a Folio award for Best Website. His analysis has been featured on prominent media outlets including NPR, CNBC, The Wall Street Journal, Bloomberg, and the San Jose Mercury News.

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