Yesterday, Microsoft was the first of the “big three” gaming console manufacturers this season to report its financial results. (Didn’t know it was happening? Hop over to my latest earnings calendar post!)
It’s the first quarter of the brand new 2023 fiscal year for the American cloud and software giant, during which it pointed towards a better-than-expected quarter for the Xbox brand.
As I wrote a few months back, Xbox recently reported its best financial year sales ever. Now, quite resiliently, it’s achieved a new record: the best Q1 sales since reporting began.
Xbox generated $3.61 billion in quarterly sales during the period between July and September, which is up “slightly” since last year, or around half a percentage point of growth. This led to a mostly positive report overall for Microsoft’s gaming division since it either met or exceeded expectations, notably on the hardware side.
Microsoft attributed the gaming revenue gain to growth in Xbox Game Pass subscriptions and a double-digit boost from console sales. Even despite a modest decline in Xbox Content & Services, the business unit was able to grow.
The approach of services like Game Pass and cloud gaming continues to attract first-time or lapsed players, and is seemingly keeping existing buyers around, plus indicators for inventories on the hardware side are slowly improving. In particular, the more affordable Xbox Series S model is spurring growth.
“We’re adding new gamers to our ecosystem, as we execute on our ambition to reach players wherever and whenever they want, on any device,” said Microsoft Chief Executive Officer (CEO) Satya Nadella on its conference call. “We saw usage growth across all platforms, driven by strength off-console.”
How does a record first quarter for revenue look in the context of the broader company? See below for a complete rundown, full analysis and even more perspective on these numbers.
Digging into the above slides from Microsoft’s presentation, the biggest data point is that slight increase in gaming revenue to the record Q1 of $3.61 billion.
This happened in spite of downward pressure from both first and third-party software and lower engagement, mainly on the backs of subscription and hardware proving to be growth catalysts. To me, this indicates there are enough new buyers entering the ecosystem, some of which are buying consoles and others are subscribing to Game Pass on whatever devices they own. It’s enough to outpace a lighter release calendar and existing gamers spending less time playing, accordingly.
Moving to how this latest quarter fits in a broader context, the current annual sales for Xbox total $16.25 billion. My chart shows the trend over time, and the breakout of Xbox Context & Services versus Xbox Hardware contribution.
That dollar amount is actually the third best trailing 12-month result in the history of Xbox, behind only a couple recent quarters. Taking the full year into account shows the sort of revenue durability that better hardware availability and a steady subscription base can produce. Even when first party output is low, like it has been for most of this calendar year.
Now let’s talk these recent figures for Microsoft and Xbox in the scope of the overall industry. I often compare it to three peers: Tencent, Sony and Nintendo. Keep in mind a couple qualifiers. First, currency fluctuations, especially lately with the weakness of Japan’s yen, can drastically impact these kinds of comparisons for global companies. Also, revenue is just one measure of a company’s wellbeing. Microsoft doesn’t share profitability for its Xbox division, unfortunately. I still think this is a worthwhile endeavor, even given these caveats.
In terms of recent annual sales, Tencent remains the largest global gaming company at roughly $24 billion combined from its domestic and international games businesses. Next, Sony’s PlayStation amounted to $21 billion at last count. Which means Microsoft slots in here, at just over $16 billion. Finally, Nintendo’s latest annual result was $13 billion. These ranks have been about the same in recent years, although Nintendo has higher margins than its peers so it makes more in profit.
Speaking of profit, we can at least glean some insight by looking at Microsoft’s More Personal Computing (MPC) segment that houses the Xbox brand. Gross margin dollars declined almost 10%, with a shifting business mix to lower margin sources. Along this, expenses rose 2% which led to MPC’s operating profit moving down 15% to $4.22 billion. Gaming is usually one of the lower margin sub-segments, so I wouldn’t be surprised if Xbox saw weaker profitability in Q1.
Now digging into the category mix for Xbox, made up of Xbox Content & Services and Xbox Hardware.
The larger contributor is Xbox Content & Services, which includes software, subscriptions and related sources. It generated $2.81 billion in sales, a year-on-year drop of 3%. This comprised 78% of overall Xbox sales most recently compared to 80% in Q1 last year. That dynamic makes total sense since its Xbox Hardware counterpart is gaining recently.
During the last 12 month period, Xbox Content & Services reached $12.45 billion in revenue. That’s roughly 77% of the aggregate and the lowest annual figure in around a year, mostly due to a lighter palette of newer software titles.
The most unfortunate part of the whole report is yet another lack of update on Xbox Game Pass subscription numbers. The last official figure from the company is 25 million, and that’s a year old. Executives claim memberships are growing, one of the positive elements of that Xbox Content & Services result, however refuse to share by how much. The only stat focused on PC Game Pass, which saw 159% increase in subscriptions. Because many of these were discounted and promotional, the top-line contribution is lighter than its console offering.
Separate of the earnings report, Microsoft’s Head of Gaming Phil Spencer did offer a slight morsel around revenue contribution and profit dynamics during a Wall Street Journal Live interview. According to The Verge’s Tom Warren, Spencer claims 15% of Xbox Content & Services revenue is currently generated via Xbox Game Pass subscriptions. He expects it to remain between 10% to 15%. If the top end is true, that’s upwards of $420 million for the latest quarter and $1.88 billion over the last year. Additionally, he claimed the service is profitable for Microsoft, though didn’t offer anything in the way of detail or proof.
Back to the report, Microsoft did share an updated engagement figure for its Xbox Cloud Gaming effort, stating 20 million people have now tried game streaming via this service. That’s twice as many as back in March when it was 10 million, thus indicating there’s continued appetite for cloud as a supplement to traditional gaming and a way to attract folks that might not own a console.
How did that more traditional source fare during Q1? Well, Xbox Hardware accounted for $800 million in revenue, up 13% from last year’s quarterly output of $710 million. Add this double-digit increase to the growing list of indicators that the supply chain situation for consumer electronics is stabilizing, as is part availability, which leads to better retail inventories.
During the latest four quarters, Xbox Hardware revenue reached $3.8 billion. That’s an all-time record amount, slightly above the $3.79 billion from two quarters ago. The entry level Xbox Series S in particular has been a boon, as Nadella claimed almost half of Xbox Series S buyers are brand new to the Xbox ecosystem.
The big question, of course, is how many Xbox Series X|S units have sold to date? Starting last generation, Microsoft doesn’t share unit sales for its hardware anymore. So it’s difficult to say for sure. Last quarter, I estimated upwards of 16 million to 16.5 million. Based on better stock and a constant demand curve, I could see 17.5 million or upwards of 18 million lifetime right now for the family of devices. As a quick comparison, Sony’s PlayStation 5 is currently at 21.7 million and will be even higher when the company reports next week.
Here’s a quick look at Microsoft’s overall results. The company achieved over $50 billion in quarterly revenue, moving up 11% year-on-year. Operating profit totaled $21.5 billion, an increase of 6%. Microsoft Cloud revenue rose 24% to $25.7 billion. Results for revenue and earnings-per-share beat out analyst estimates.
I mentioned More Personal Computing (MPC) earlier, which generated the same amount of revenue as it did a year ago: $13.3 billion. Operating profit dipped 15% to $4.22 billion on higher costs.
Shifting back to Xbox, it was a great quarter for gaming given the broader environment and challenges it’s seen on the hardware side. Achieving best-ever first quarter sales is an accomplishment, even if profitability likely took a hit due to heavy investing in Xbox Game Studios development and securing third-party deals for Xbox Game Pass. That’s, quite literally, the price of doing business.
Management provided its general outlook for Microsoft and touched on guidance for the Xbox division. Note that forward-looking guidance does not account for the pending Activision Blizzard deal, which the company still expects to close by June 2023.
“As we look towards the holidays, we offer the best value in gaming, with Game Pass and Xbox Series S,” Nadella said, pushing a bit of marketing speak. Even so, I tend to agree when it comes to both of these entry points into a robust suite of software offerings. It’s quite attractive across the landscape of the industry, especially after many publishers are embracing higher pricing for premium releases.
For the period between October and December, the coveted holiday quarter, Microsoft anticipates gaming revenue will decline in the low-to-mid teens mainly because of just how well it did last year on the strength of big first party launches. Translating that into dollars, assuming a 12% decline would get the holiday quarter to $4.79 billion in sales for Xbox. Essentially, it may regress back to a pre-pandemic level.
The company expects Xbox Content & Services to move downward at the same pace as overall gaming revenue, in the low-to-mid teens. There is upside in the guidance, as management thinks Xbox Game Pass subscriptions will increase yet again. By how much? It’s not clear. Finally, Microsoft didn’t provide guidance for Xbox Hardware. Calculating it based on the prior two, the implication is a potential double-digit decline as well.
Personally, I’m slightly more bullish on Xbox’s holiday prospects, in particular I think hardware can make up for dips in first and third party content. There’s no real flagship Xbox Game Studios output in the coming months to end 2022; no Forza or Halo like last year. The largest software launches are all third party titles, though there’s no doubt deals will be made to feature some major external publisher content on Xbox Game Pass.
Elsewhere, Phil Spencer blatantly teased the rumored Project Keystone cloud streaming device in a social media post. All reporting points to the dedicated streaming device being early in development, so it’s still a ways out. What it does show is Microsoft’s commitment to streaming as a new business avenue.
More immediately, there’s been activity on the Activision Blizzard buyout side as regulators worldwide continue to review the proposed $68.7 billion deal. By now, government agencies of Saudi Arabia and Brazil have issued their approvals. The major holdout is the United Kingdom’s Competition and Markets Authority (CMA) which has moved into a second phase of its inquiry into potential antitrust concerns. the CMA claims there will be impact on competition in various industry verticals, while Microsoft responded saying the concerns are “misplaced.” Most recently, the CMA is requesting feedback from the public. That ought to go well!
I remain a firm believer that the deal will eventually be approved, it’s just a matter of how long it takes as governments notoriously move at a snails pace. American and European regulators will be the key, and we’ve yet to hear from them specifically.
Well, then. That’s the first big results recap of the season. What’s your reaction to Xbox’s big Q1? Do you agree with its forecast for the holiday quarter? Feel free to drop a line here or on social media, I’m happy to chat!
Additionally, I’ll have more reactions to earnings in the coming weeks. Thanks everyone for hanging out. Be safe and spooky!
Note: Comparisons are year-over-year unless otherwise noted.
Sources: Company Investor Relations Websites, ShackNews (Image Credit), Tom Warren.