OPINION: Sony plays hardball

By Paul Sweeting -- Video Business, 11/30/2007

Whether out of desperation or strategic planning, the company finally seems to be taking bold steps to reclaim some of its lost stature—not to mention market share—in the videogame console business after falling to a humiliating third place against rivals Nintendo and Microsoft.

Since slashing the price of its entry-level console to $399, Sony has seen a surge in sales; in November, PS3 sales in Japan surpassed sales of Nintendo’s Wii console for the first time since the Wii’s introduction.

Sony also recently slashed the price of its PS3 development kit in an effort to spur more support for the platform from third-party game publishers.

Now comes word that Sony will launch a high-definition video download service for the PS3 early next year, an area Microsoft has successfully mined with its Xbox Live service.

The real measure of Sony’s strategic and tactical reinvestment in PS3, however, is found on Sony’s balance sheet, which is undergoing something of an overhaul.

In October, Sony hired an investment bank to help it find a buyer for a 50% interest in Sony Pictures Animation and an even higher percentage of its digital-effects shop, Imageworks.

That followed on the heels of a deal to spin off most of its interest in its Cell chip manufacturing unit, the main processor used in PS3, to Toshiba.

Both moves seemed designed to conserve cash, presumably for use elsewhere. Both the Cell chip and Imageworks represent promising businesses but ones that will require significant investment to reach their potential.

Then last month, Sony made its biggest balance-sheet move yet, selling an undisclosed stake to an investment company owned by the ruler of the Persian Gulf-emirate Dubai, Sheikh Mohammed bin Rashid Al Maktoum.

Although the amount is believed to represent less than 5% of Sony, keeping it under the disclosure threshold for Japanese companies, Sony has a current market-cap of $54 billion, so even a 1% stake would represent a cash infusion of more than $500 million.

WHY WOULD SONY be so anxious to raise and conserve cash? One reason could be that turning around the fortunes of PlayStation 3 is going to take a lot of it.

The division lost $849 million in the second quarter alone, according to Sony’s most recent earnings report. Clearly, PS3 is in no position to fund its own turnaround.

The steps Sony is taking to bolster its game platform, moreover, are likely to make the cash drain worse in the short term. At $399 including a Blu-ray drive, Sony Computer Entertainment is taking an even bigger haircut on its entry-level console than it was before as it tries to buy market share. The company recently pushed back its estimate for when PS3 will reach breakeven until the fiscal year that ends in March 2009, and even that could be optimistic.

Creating more games will also require more investment, either directly or by lowering development costs for third-party publishers. Given the long lead times needed to create a game on the complex Cell architecture, ramping up development means increasing the short-term cash drain.

Will all of its moves ultimately be worth it?

Three years ago, the PlayStation unit generated 70% of Sony’s net profits. If Sony doesn’t get PS3 right, even oil-rich Sheikhs may not be able to help it.

Paul Sweeting is editor of Content Agenda. Get more of Sweeting's analysis here.