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Street Hits Pause on PlayStation Portable

Analysts see obstacles to a key contribution from Sony's handheld game device.

Sony'sundefined new PlayStation Portable is getting a lot of buzz, but that won't necessarily translate into a significant impact on the company's financial results.

Sony won't even

launch the device in North America -- the company's most important market after Japan -- until the end of its fiscal year ending in March, at the earliest, meaning that the bulk of sales of the device likely won't show up until next fiscal year.

Even then, given the history of Sony's gaming systems, it may be a while before the PSP starts to contribute to the company's bottom line -- and that's assuming that the device is a success, something that at least some analysts are questioning.


is targeting the same 18-to-34-year-old audience with its new DS handheld that Sony is trying to reach with its PSP, noted Morgan Stanley analyst Masahiro Ono. But Nintendo released its DS earlier than Sony did the PSP, is charging less for it, and has practically owned the handheld gaming sector in recent years.

"I worry about Sony's position and the PSP's potential," said Ono.

Sony introduced the PSP in Japan last month at a price of less than $200. The device essentially offers the capacity to play PlayStation 2 quality games in a handheld format.

But it also plays music and movies, can display digital pictures and has a built-in Wi-Fi radio. Indeed, Sony sees the device as a way to take on not just Nintendo's handheld gaming systems, but



iPod and other handheld devices.

Sony, of course, is a huge company, with the equivalent of $73 billion in sales in its most recent fiscal year. So any one product won't make or break it.

But the PSP offers a lot of potential for Sony, beginning with the possibility of jump-starting sales from the company's slowing games division. Sales in yen from the company's games sector were down 22% in the first two quarters of the company's current fiscal year, after falling 19% year over year in the company's fiscal 2003.

Sales have fallen amid price cuts on the flagship PlayStation 2 system and supply constraints after the company shifted production last summer and fall to a new slimmer version of the PS2.

The company ostensibly would love to see a similar jump in revenue to what it saw after it introduced the PS2 in 2000. In its 2001 fiscal year, revenue from Sony's games division soared 52%, thanks to PS2 sales. That helped the company post an overall revenue gain that year, despite a drop in sales at its giant electronics division.

Sony is seeing similar dynamics today. The company's overall revenue was down in the first six months of its fiscal year, thanks not only to the drop in its games sales but also from declining sales from its electronics and music divisions.

But more than just covering for declining sales in those areas, the PSP actually may help juice sales in other divisions, analysts say. Sony plans to make the device work with its Sony Connect music store and will release films from its studios on the Universal Media Discs that will play in the device. The PSP offers the potential for "synergy" within Sony, tying together its hardware and intellectual property businesses, Ono said.

Already, it looks like the company may have a hit on its hands. Demand for the device in Japan was huge after it was released there last month, with 200,000 shipping at launch and 510,000 by the end of the calendar year. Sony plans to ship 3 million of the devices by the end of its fiscal year in March, and the latest manufacturing data indicate that the company will exceed that target, said Yuji Fujimori, an analyst with Goldman Sachs. (Goldman Sachs has done investment banking business for Sony in the last year.)

Sony likely will provide an update on the PSP's progress when it reports its fiscal third-quarter earnings later this month.

But the PSP will be hard-pressed to be Sony's savior. Ono and other analysts already are questioning how much demand Sony will see for the device, and Nintendo is offering its new DS for $149 in the U.S.

In contrast, Sony has yet to set a price for the PSP in the U.S. Indeed, reports out of Japan indicate that the sub-$200 price point is deceptive; customers are finding that they need to buy an extra battery back and other accessories, pushing the total price closer to $249. (Both Sony's PlayStation console and



Xbox are now selling for about $150 each.)

Even if the PSP proves popular, some analysts also have questioned whether Sony will be able to meet near-term demand. At the company's official launch party in Las Vegas earlier this month, Sony declined to give a definite date for when it will start selling the PSP in North America. Given the shipping problems with the updated PlayStation 2, it wouldn't be a surprise to see something similar with the PSP.

Further, at least in the short term, the company is in a kind of Catch-22. Video game-hardware makers typically offer their devices at a loss, hoping to make up for it with high-margin software sales and royalties on third-party games. In the long term, that can be a profitable strategy. But in the short term, it can lead to big losses. For instance, in fiscal 2000, the year in which Sony debuted its PlayStation 2, Sony's gaming division posted a $51 million loss.

Fujimori estimates that Sony is losing $50 on each of the PSPs it ships. "Unfortunately this year, the larger the sales volume they can get, the loss will be larger," he said.

Ironically, for the device to eventually be profitable for Sony, it needs to sell as many as it can to generate a sufficient number of games, music and movie sales. "In order to make it a success, the penetration must be significant," said Ono.

Regardless of whether the PSP is an immediate hit, investors may be willing to give the company time to sort it out. The PSP and the video game sector in general are good opportunities for Sony because they're big markets and growing bigger all the time, said Hank Hewitt, a portfolio manager of the Light Revolution Fund, which has been a longtime holder of Sony shares.

That said, investors hold Sony because it's a solid, stable company, not because it's a fast-growing one, Hewitt said.

"The downside with a company like Sony is that it's big. It's hard to grow," Hewitt said. But he added, "You don't buy Sony because you're going to make 10 times your money."