Playing the PlayStation 4

 | Nov 22, 2013 | 3:00 PM EST  | Comments
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The big news about Sony's (SNE) new PlayStation 4, which went on sale on Nov. 14, is that it is actually profitable to manufacture.

That is undoubtedly good news, since the company sold 1 million PS4s during the first weekend they were on sale. But it's not quite as much good news as it seems. (Sorry, Dan Loeb, whose Third Point hedge fund has invested $1 billion in Sony.)

After years of selling PlayStations for a price below the manufacturing cost, the PS4 actually has a bill of materials lower than the retail price. The components in the PS4 cost $372, IHS has calculated. Add in another $9 for manufacturing (or more accurately, assembly) costs and the total comes to $381 for a console that retails for $399.

Of course, this isn't exactly the same as saying that Sony makes money on each PS4 -- it costs money to market the machine, etc. -- but a bill of materials below the retail price is certainly a step in the right direction. And it suggests that the machine will actually generate a profit as volumes build and hardware costs decline with time.

In contrast the PlayStation 3, introduced in 2006, showed a bill of materials, according to a teardown by IHS, that was as much as $100 (depending on the version of the PS3) above the console's retail price.

The big question for Sony, and for investors in Sony hoping for a turnaround in the company, is how many PS4s Sony will sell, which, in turn, will help determine if and when the console starts to generate a reasonable profit. Sony's consumer electronics business, which includes the unprofitable TV business, needs big sales and profits from the PS4 and the new Xperia line of smartphones for there to be any hope that this business will earn back its cost of capital. (Yes, money costs something even in Japan). Making TVs is a very tough business. Even Samsung, the market share leader, makes only a 3% operating margin in its TV business

Even with the 1 million PS4 units sold in the initial weekend, changes in the gaming business make it unlikely that a product with the cost structure of the PS4 can play the role of "The Little Engine that Could." Because the growth of gaming on smartphones has cut into the traditional gaming market on consoles and PCs, Wall Street isn't forecasting significant growth in volumes for the PS4 over that of the PS3. Analysts are projecting sales of 49 million PS4 consoles over the next five years. That works out to 9.8 million units a year, a significant drop from the 80 million units, an annual pace of 11.4 million, the PS3 has sold in seven years.

And I don't think investors can count on the weak yen to fix Sony's profit problem. The consumer electronics unit did show a positive EBITDA (earnings before interest, taxes, depreciation and amortization) over the last 12 months, but even with the weak yen, the EBITDA margin was just 1%.

If you want to trade Sony on the good PS4 sales numbers, be my guest. Just don't look for a turnaround in the fundamentals of the company.

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