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Microsoft's Mission Implausible

The Numbers Game

Microsoft expects to sell as many as 3 million consoles in the first three months after launch and 4.5 million to 5.5 million consoles by the end of its fiscal year on June 30.

Those sales will be key to accelerating the company's top-line growth. In the December-ending quarter alone, Goldman Sachs software analyst Rick Sherlund estimates Xbox hardware and software sales will soar 36% to $1.5 billion from $1.1 billion a year earlier. (Sherlund has an outperform on Microsoft and his firm has done banking with the company.)

Microsoft has forecast its home and entertainment division, including Xbox, will grow 50% or more in fiscal year 2006, helping total annual revenue growth climb to about 11% from 8% a year earlier.

However, that won't immediately translate to the bottom line, because Microsoft loses money -- an estimated $50 to $100 -- on every console sold. The company expects the Xbox business to swing into the black in fiscal 2007.

"Going from unprofitable to profitable is probably a part of the margin story that many investors don't appreciate," says Tony Ursillo, an analyst with Loomis Sayles & Co., which holds Microsoft shares.

Ursillo estimates Microsoft's video-game business will generate an additional $500 million in operating income between this fiscal year and next fiscal year, which translates into an additional 3 cents a share in earnings.

Although that only amounts to a 2% increase in earnings, Ursillo says that's the difference between earnings growth of 10% and 12%.

"I'd say of all of Microsoft's emerging business efforts in the past five years, to me this has clearly been the most successful one -- better than MSN, better than business solutions, better than their mobile device effort," he says.

But that doesn't mean Xbox 360 will be able to unseat Sony, whose Play Station 3 is expected to have even more technical horsepower than Microsoft's when it launches next spring.

For one thing, Sony has a far larger installed base of fans to tap for next-generation sales than Microsoft. Sony has shipped 90 million Play Station 2 systems worldwide as of June, more than three times Microsoft's 21.9 million Xbox consoles. And the Play Station 2 commands nearly 60% of the U.S. market, far higher than Xbox's 23% share.

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