Who's Winning the Console Wars

S&P's Clyde Montevirgen says the Xbox 360 leads in total sales, but Nintendo's Wii showed the strongest launch numbers. His pick in the sector: Activision

Just like gamers, holders of video-game stocks should be prepared for battle and adventurous twists and turns. Last year's wild ride, when the group got crushed in July and then soared in the fall as Sony's (SNE) PlayStation 3 and Nintendo's Wii were released, left the S&P Home Entertainment Software index with a small gain of 3.7%, vs. 13.6% for the S&P 500. So far this year, the group has stayed on a higher path, gaining 2.7% through Jan. 12, vs. a 0.9% rise in the S&P 500 index. One boost came Jan. 11, when key player THQ (THQI) hiked its sales and earnings outlook.

Given lofty valuations after the recent price runup, along with some uncertainty about the timing of launching hit titles, Standard & Poor's Equity Research analyst Clyde Montevirgen has a neutral outlook for home entertainment software stocks (see BusinessWeek.com, 12/21/06, "Part 2: S&P's 2007 Tech Sector Outlook"). He has a buy recommendation on one stock: Activision (ATVI).

BusinessWeek.com's Karyn McCormack spoke with Montevirgen on Jan. 12 about the game-console wars and the companies he believes have an edge. Edited excerpts from their conversation follow.

Note: Clyde Montevirgen is an S&P Equity Research analyst. He has no ownership interest in or affiliation with any of the companies on which he writes research. All of the views expressed here accurately reflect the analyst's personal views regarding any and all of the subject securities or issuers. No part of the analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed.

So far, which company is winning the console war: Sony, Nintendo, or Microsoft (MSFT)?

Right now, the leader in terms of units sold is Microsoft's Xbox 360—it has sold 10.4 million units as of the end of 2006. However, the Xbox 360 was released in November, 2005, so it has had a one-year advantage over the others. It's a solid base, so that's why it's the leader.

But if you look at who won the launch wars by comparing the launch sales, the Xbox 360 sold 607,000 units from November, 2005, to yearend 2005. That comes in third, behind No. 1 Nintendo Wii, which sold 1.1 million units from its release in November, 2006, to yearend 2006, and second place PlayStation 3, which sold 687,000 units from its November, 2006, launch to yearend 2006.

So the leader in units sold and winner of the launch war are two different things. Nintendo Wii won the launch war.

What feature makes that console the leader?

I have five things that I look at that I think will determine the winner in the long run (they aren't listed in order of importance). The first one is graphics. Once developers unlock the potential of the PS3, I think that it will have the lead in graphics compared to the other two consoles.

The second feature is game play. I think the Nintendo Wii will win that because of the interactive gameplay with its motion-sensing controllers. No. 3 is Internet capability. So far, the Xbox 360 has the lead in that, with Xbox Live. No. 4 is game selection for the consoles, or how many games are available. Right now, Xbox 360 has the most titles available.

The last is the price. This is why the Nintendo Wii is the leader, because the price is very attractive. The Wii sells for $250, which is half the price of the PS3.

What are the outlooks for the PS3, Wii, and Xbox 360 for 2007?

Right now, it's wide open—it's hard to tell. I think we could have two winners. In the past, PS2 was dominant. This time, it could be wide open because it's a wider demographic. The hardcore gamers are a little bit older, and now we have the younger audience and more casual gamers that may not pay attention to the hardcore features. So we could have two different winners because the consoles do different things now.