Sony’s PS3 in Danger Zone

In the Gaming segment, Sony’s (SNE - Analyst Report) PlayStation 3 (PS3), the number 3 console in the United States, is losing ground to Nintendo's (NTDOY) Wii, and Microsoft's (MSFT - Snapshot Report) Xbox 360.

Although Sony lowered the price of its top-tier PS3 console from $599 to $399 to withstand competition, the current price is still above Nintendo's Wii the most popular console in the U.S., which is priced at $250 and Microsoft's Xbox, whose lowest priced model is sold for $200. With delays in the launch and volume production of its latest PlayStation game console, Sony severely lags behind competition, which could lead to loss of market share.

According to research group NPD, game industry sales declined by 30% and went below $1 billion in the month of May – the largest drop in sales for the first time in 9 months. In May, approximately 289,500 units of Wii were sold in the United States compared with 175,000 units of the Xbox and 131,000 of the PS3.

Activision Blizzard’s (ATVI - Snapshot Report) Chief Executive Officer Bobby Kotick said in a recently published report that the company could discontinue making video games for Sony's PS3 due to soaring costs and weak sales of the product. As a result of weak momentum of PS3 consoles against its rivals and the high price point of $399, the game publisher has threatened Sony that they might stop supporting the console platform.

“It's expensive to develop for the console, and the Wii and the Xbox are just selling better and Activision might want to consider if we support the console and the PSP too,” said Kotick. “We believe Activision might take this drastic step if Sony does not cut the price of its flagship console,” he added.

Sony lowered its price to boost sales of PS3 and PSP software to remain competitive in the first half of 2008. Currently, the lowest priced PS3 hardware is the 80GB model, which was introduced during the 3Q of 2008. The company plans to further lower hardware cost and launch an enhanced line-up of software titles. Sony maintained its target sale of nearly 10 million units for its slow-starting PS3 console in fiscal 2008 and expects to achieve a target sale of 13 million units in fiscal 2009.

We believe Sony may not be able to achieve this target, given the growing competition and pricing pressure from its competitors. To weather competition and boost sales, Sony plans to unveil the slim 120 GB PS3 this fall and reduce the price point of its PS3, according to recent reports and sources. There were no specific details on the cost of the consoles as well as specific timing for the price cut, but the reports did mention that Sony will limit the supply of its 80 GB model. The source noted that most retailers have about a 60-day stock supply of the 80 GB model. Sony declined to comment on its new PS3. The new PS3 model if launched can be a huge positive for the company.

To respond to the price cut by Sony, Microsoft is widely expected to launch the mid-level $299 Xbox 360 Pro in July or August 2009 and introduce a number of attractive software bundles to help boost growth. Also, the company may reduce the price of its top-tier system to $299 by replacing the 60 GB Pro with the 120GB Elite model in early September.

We don’t expect a turnaround soon for Sony and believe it will continue to struggle due to lack of new product introductions and intense competition. The company recorded its first net loss in 14 years with much lower operating income in 2008. The outlook for fiscal 2009 was another year of declining revenue and losses. Thus, we maintain our Sell recommendation on Sony’s shares.