As you well know because you’ve seen my handy earnings calendar for this season, Microsoft reported its 2024 second quarter results earlier this week.

Only executives and literally everyone, including when I wrote about this very topic last quarter and predicted the revenue amount, expected the software tech conglomerate to post record gaming sales almost entirely becasue Activision Blizzard numbers are now included since closing the deal in mid-October 2023.

That’s precisely what happened.

Still, as I’ll illustrate shortly, I’d argue massive growth isn’t the whole story. I’m more interested in isolating Xbox’s organic performance, comparing post-acquisition to the sum of both entities before it happened and trying to determine how annual numbers will shake out. In addition, I’ll review the acquisition’s notable hit to profitability for the time being due to its cost and integration.

Essentially: headlines, even mine, never tell the whole story!

There’s also a divide happening right now with Microsoft. Just as the company closed above $3 trillion in market value for the first time, it announced big layoffs in its gaming division. Around 1,900 people across Xbox, Activision Blizzard and Bethesda, or 8% of the gaming workforce, were let go. I know there’s various factors behind this, including macro ones like inflation and interest rates. Plus, stock market valuations are determined by a collective set of investors rather than a company’s management.

Still, the optics and timing are tricky. The fact that job loss after the deal due to redundant roles and function overlap was inevitable doesn’t make it any less painful for the people involved. Especially as the broader company reaches record valuations and reports gaudy numbers.

Moving into those numbers, Xbox revenue totaled over $7 billion in the quarter ending December 2023. That’s up 49%. Within that, Activision Blizzard was responsible for contributing $2 billion. This makes Gaming the third biggest contributor to all of Microsoft’s sales at 11% of the total compared to 9% last year, right now behind only Server and Office.

It’s pretty clear what’s underlying this: Buying a massive third party publisher and integrating it within content and services figures. Even so, there was some organic Xbox growth in Q2. Under 6% to be semi-exact. I was also impressed that hardware was able to deliver solid performance during the holiday season, even if boosted by discounting.

“With our acquisition, we’ve added hundreds of millions of gamers to our ecosystem, as we execute on our ambition to reach more gamers on more platforms,” said Chief Executive Officer (CEO) Satya Nadella. “Great content is key to our growth, and across our portfolio, I’ve never been more excited about our lineup of upcoming games.”

Pretty standard corporate speak from Nadella, and I’d argue Xbox’s line-up this entire generation has been anything but exciting. In fact, management quotes around gaming on the earnings call were generally tame. The team did offer select insights that I’ll cover later, namely on cloud streaming and engagement across platforms including mobile, the latter of which hit record highs after the integration of Activision Blizzard players.

Read on to learn what the numbers truly look like, some estimates from me around a combined historical comparison, my guesses for hardware unit sales and then predictions going forward into 2024.

First thing to note when checking the above slides is Xbox, Bethesda and now Activision Blizzard are all accounted for within Microsoft’s broader More Personal Computing (MPC) segment.

Quarterly gaming revenue rose 49% in the three months ending December, up to an all-time high of $7.11 billion. This was exactly within the firm’s guidance.

What drove it? Well I’ll break that into two categories: Activision Blizzard and pre-acquisition Xbox. Here is where we talk the deal’s impact, which actually cost upwards of $75 billion based on the latest filing. During the second quarter, it contributed $2.1 billion to gaming division sales.

Essentially, Activision Blizzard was responsible for 30% of Microsoft’s second quarter gaming business at the top-line. Still, as I’ll get to in a second, its inclusion put major downward pressure on profit.

Separating that out, the $5 billion “organic” Xbox sales implied a growth rate of 5.7%. Much less than the headline suggests, right. Still, it’s certainly noteworthy for the important holiday time frame, notably while facing what executives called a “tough console market.”

Moving to the latest year, which happens to cover the 2023 calendar months, gaming revenue expanded 17% to rise above $18 billion for the first time ever. This particular figure, mapped out over time in one of the below charts, will only grow over time as more quarters take the acquisition into account.

I’ve also provided a new chart measuring Estimated Combined Gaming Revenue that, full disclosure, pulls in a few different assumptions to form a rough estimate of how annual figures compare when adding in Activision Blizzard’s historical revenue. I’ve summed up the two pre-deal entities going back for a few fiscal years then subtracted $2 billion per year in assumed overlapped sales.

What results is where I think Microsoft gaming sales could be when a year of Activision is considered: almost $22 billion, up a bit from the $21.6 billion a year back. That’s an upward trajectory of 1% as opposed to the 17% I just referenced. Good, yet nowhere near as wild as the headlines indicate.

While Microsoft is the first of the bigger gaming companies to report, I like to gather up a comparison to peers and update throughout the season in my articles. Sony’s latest annual PlayStations sales tracked towards a whopping $28 billion, with notable impact from the yen’s depreciation. Tencent was around $26 billion. This is where the current combined Xbox and Activision Blizzard slots, at $18.13 billion. Nintendo’s latest hit $13 billion. My usual caveat is that Nintendo is operating at higher profitability than at least PlayStation, and likely Xbox as well.

Speaking of profit, Microsoft gave us a bit more than usual this quarter! Partially because it had to illustrate the impact from Activision Blizzard, but I’ll take it. For the MPC group, operating profit jumped up 29% to $4.29 billion. Half of the “gross margin dollars” profit metric, a figure that moved up 34% in Q2, was contributed by Activision Blizzard as it helped up operating expenses at a higher rate of 38%. Focusing strictly on Activision Blizzard, its net impact was $437 million in operating income because of those higher costs. There’s also some accounting nitty gritty that I won’t include, for the sake of brevity.

What does this all mean? Well, record sales were mostly due to Activision Blizzard no longer being a 3rd party partner and becoming first party, however there was single-digit organic Xbox growth during the holiday season. Profit for the segment that includes gaming will take a short-term profit hit while integrating costs and following through with the deal’s financial accounting.

Here’s a quick dive into the two Xbox sub-areas, called Xbox Content & Services (i.e. software and subscriptions) and Xbox Hardware.

For October to December, the vastly larger Content & Services jumped up nearly 70% when measured by revenue. The first figure was above guidance, while the second technically under-performed at least based on what I calculated because Microsoft rarely, if ever, issues formal hardware forecasts.

The reason I say “nearly 70%” is because how Microsoft reported its numbers actually indicates that Content & Services moved up 68% to $5.69 billion, another best ever number, rather than the 61% in its announcement. From what other analysts and I can tell, Microsoft seems to have excluded Activision Blizzard’s eSports sales, for whatever reason.

This leads to my estimate of $16.5 billion for Content & Services over the last 12 month. That itself is above the $15.56 billion for all of Xbox in 2022 Q2. Separately, Hardware generated $3.27 billion in the latest annual period, slightly below the last couple years.

When hearing this numbers and looking at these charts, I’ve assumed all Activision Blizzard revenue is caught in the Content & Services pipeline because it doesn’t have anything to do with console manufacturing.

Underlying the best-ever figures for the software side was another all-time high, this time for engagement. Nadella noted that, now that Activision Blizzard players are included, Microsoft’s gaming division boasts 200 million Monthly Active Users (MAUs) on mobile devices. Prior to this, Xbox’s figure overall was 120 million. Activision had 92 million in September, while Blizzard was 26 million and King totaled 238 million.

Nadella also alluded to a double-digit jump in cloud gaming hours streamed, moving up 44% in the quarter. We don’t have specifics on the actual number of hours played by its active users, only the growth rate. Plus, unfortunately, there’s still no word on Xbox Game Pass subscribers. The last update was 25 million a couple years back, and I estimated recently that it’s likely approaching 30 million though has not eclipsed it. I hope Microsoft offers a new figure this year. Yet I’m not holding my breath.

Xbox’s Hardware segment had a solid holiday, even if the result ended up below my expectations.

Console dollar sales moved up 3% in Q2, to above $1.4 billion. This was spurred on by holiday discounting for the Xbox Series X|S family, and the appeal of something like Bethesda’s Starfield. In terms of number of consoles shipped to market, I believe it slightly increased although those units sold at a lower average selling price.

“In our consumer business, the PC and advertising markets were generally in line with our expectations,” said Chief Financial Officer (CFO) Amy Hood. “PC market volumes continued to stabilize at pre-pandemic levels. The gaming console market was a bit smaller.”

It’s a curious statement. Just because it was challenging doesn’t mean it wasn’t good. Any growth right now for Xbox console revenue, even in the lower single digits, is a positive sign. Echoing my past sentiment, and it’s something gamers need to get accustomed to, is that Xbox’s strategy has officially shifted away from consoles and towards offering services on various devices.

During the last year, Hardware reached $3.27 billion. That’s down 9% from the same time in 2022, though above pre-pandemic figures. Again, this tracks with the general theme.

Since Microsoft doesn’t provide global unit sales like peers do, I have no choice but to guesstimate where they stand. For the holiday quarter alone, I backed into 3.5 million to 4 million shipments for Xbox Series X|S. This would be in-line with last year, albeit below the roughly 4.5 to 5 million that its Xbox One predecessor was doing during its prime.

I put Xbox Series X|S lifetime at 25.5 million or so prior to this latest three month report. Which was below the 26 million of Xbox One. Adding on my estimated holiday shipments for the family, I believe Xbox Series X|S stands currently at 29 million to 29.5 million units lifetime since November 2020. Thus, it remains tracking below Xbox One by upwards of a couple million.

For comparison, Sony’s PlayStation 5 was the best-selling console in key regions during 2023, including the United States as I covered recently. The console reached 50 million units sold to consumers in December 2023, and the shipment figure will be even higher when Sony reports in a couple weeks.

Overall at Microsoft during Q2, revenue jumped 18% to $62 billion. Operating profit rose 33% to $27 billion. Microsoft Cloud grew 24% to 33.7 billion. Executives provided some color around how the Activision Blizzard deal affected the full firm’s financials.

“At a company level, Activision Blizzard contributed approximately 4 points to revenue growth, was a 2 point drag on adjusted operating income growth, and a negative 5 cent impact to earnings per share. This impact includes $1.1 billion from purchase accounting adjustments, integration, and transaction-related costs such as severance-related charges related to last week’s announcement.”

That’s referencing last week’s Xbox group layoff announcement, which came after a year of more than ten thousand people losing their jobs at the broader company.

To wrap up the latest quarter, it’s important to look behind the absurd 49% growth and big figures due to integrating Activision Blizzard. There has to be consideration for what numbers look like when combining the two historically, plus the notable downside profit effect for the time being. Not to mention the painful layoffs that happened mostly because of the deal taking place.

In terms of dynamics and future of the Xbox division, these don’t necessarily change with the latest new acquisition. The numbers are bigger, and the portfolio certainly has more brands especially on the mobile side with the unsung King division, while various challenges remain especially on the hardware front plus with industry-wide service stagnation and general costs rising.

I’m also lamenting the lack of details into Activision Blizzard’s underlying financials. We’ll never see them ever again. Pour one out, fellow business nerds and data transparency advocates.

Here I’ll take the chance to look ahead to the third quarter, and make some predictions on the immediate future of Xbox.

Management expects Xbox division sales growth “in the low 40s,” so between 40% and 44%. Out of that, management signaled 45 points would be due to Activision Blizzard. Yes, this means that Microsoft is saying its non-Activision Blizzard Xbox sales will likely decline in this current quarter.

Assuming say 42% growth, that puts Xbox sales at $5.12 billion in the three months ending March 2024. Which, you guessed it, would be a Q3 record. I believe this will be met, though on the lower end.

For Xbox Content & Services, Hood said to anticipate growth “in the low to mid-50s” i.e. around 50% to 57%. Most, if not all of that, will be Activision Blizzard causing a net impact of 50 points or 50%.

Let’s say it gets to 54%, that would elevate Content & Services to $4.77 billion in Q3. Again, I expect that to be achieved, and I think there’s a good chance it hits the upper end.

Finally, management actually provided Hardware guidance! Well, somewhat. They think it will decline. That will certainly be the case if the other numbers hold. As in, console sales could be down by as much as 30%. Based on how they presented numbers this time, I’m guessing around a 5% to 10% decline for console in Q2 which would equate to around $450 million to $480 million.

The early year release slate for Xbox is a tad light, so I’m thinking evergreen titles and the Call of Duty effect being first party will drive the business to hitting these forecasts. In terms of new games, Sega’s Like a Dragon: Infinite Wealth hit a million units yesterday. Warner Bros’ Suicide Squad Kill the Justice League formally launches today, and I’m skeptical on its commercial upside, just like I am for Ubisoft’s Skull & Bones this month. There’s titles like Tekken 8 from Bandai Namco, which I’m quite upbeat on, and Capcom’s Dragon’s Dogma 2 in March that should attract a cult following.

Will these be the biggest software contributors of the quarter? Nope. It’s Palworld, the surprise console exclusive that’s garnering a lot of attention from consumers and pundits alike. It’s much more than the “Pokémon with Guns” moniker, and has been a near unprecedented sales success. So far, Pocket Pair’s latest reached more than 19 million players, 7 million of those on Xbox alone. It’s the largest third party launch in Game Pass history, beating out 2022’s High on Life, and instantly shot to the top of the service’s most-played chart. I’m on record saying it will end the year as one of the platform’s biggest titles. Frankly, it’s absurd and I love it.

That ends the first massive recap of the latest season. Follow me on social for coverage in between articles, and check back soon for more here at the site. Be well!

Note: Comparisons are year-over-year unless otherwise noted.

Sources: Circana, Company Investor Relations Websites, Pocket Pair, Sega.

-Dom