If you were to bet on a single winner in the next video game-console cycle, forget Microsoft ( MSFT), Sony and Nintendo. Put your chips where those console makers did -- on IBM ( IBM). All three companies chose IBM to help design and manufacture the gaming chips that are powering their next-generation video-game consoles, a first for the video-game industry that puts Big Blue in a powerful position. "It's an incredible opportunity for IBM, because whoever wins this market ... IBM is involved," says Chris Crotty, a senior analyst who covers consumer electronics for electronics market research firm iSuppli. "It gives them a very strong starting presence in consumer electronics." That position in consumer electronics marks an important shift for IBM, which is best known for its tech prowess in the business market. "If you think about where all the innovation is in technology these days, it's really around the consumer experience," says Pacific Crest analyst Richard Petersen. "So IBM is positioning themselves pretty well to benefit from that growth trend." By contrast, "innovation in the enterprise has slowed down a lot," Petersen adds. "We're much less excited about the opportunity there," said the analyst, who has a sector perform rating on IBM and whose firm hasn't done any investment banking with the company. And if any of the video-game consoles eventually evolves into a
device that controls all home entertainment -- as envisioned by the console makers -- then IBM also stands to benefit, Crotty points out. IBM and analysts cite everything from the company's Power PC chip technology and design expertise to flexibility and cost as factors that helped IBM win the chip business in all three consoles, beating out such formidable rivals as Intel ( INTC). However, because IBM is such a behemoth, with projected annual sales of $92 billion, its video-game chip business doesn't have a huge impact on the company's financials. It's part of the company's microelectronics division, whose sales are estimated to account for less than 5% of IBM's total sales.
"It doesn't make or break the story at IBM," says Bill Gorman, a vice president who covers technology at PNC Advisors, which holds IBM shares. But IBM's microelectronics swinging back into the black after a tough patch has been an important factor in improving earnings overall, he says. IBM does not specifically disclose revenue and earnings for its microelectronics division. But the company did say that microelectronics sales grew 14% in the third quarter -- more than four times as high as the 3% growth posted by global services, its largest division. The division's operating margin is higher than that of global services, though lower than the company's overall operating margin. IBM already has begun receiving sales from the custom processor it designed for Microsoft's Xbox 360, which has sold out at numerous retail stores since last week's
North American launch . And next year IBM will start receiving revenue from the Cell processor specially designed in a joint venture with Sony and Toshiba for Sony's PlayStation 3 console, set for sale in at least one region this spring. Similarly, IBM's technology will be powering Nintendo's Revolution game console also due out next year.
A Cool BillionSanford Bernstein analyst Toni Sacconaghi estimates that IBM will ship 2 million to 3.5 million gaming processors in 2005, translating into $240 million to $400 million in revenue at $120 per chip. But that forecast may be high, as iSuppli has estimated that the Xbox 360 gaming processor costs $106. And IBM may get even less -- say 50% to 75% of that amount -- for chips it farms out to be manufactured by partner Chartered Semiconductor Manufacturing ( CHRT), says Len Jelinek, director and principle analyst covering semiconductor manufacturing for iSuppli. Still, suppose IBM gets roughly $100 for each Xbox 360 sold, and Microsoft has estimated that it would sell 4.5 million to 5.5 million consoles by June 30. It's not a leap, then, to forecast that Microsoft would sell 10 million Xbox 360 consoles in 2006. That translates into a cool $1 billion in chip sales for IBM, representing 1% in additional sales for the company.
Sony's Play Station 3 , still widely expected to maintain Sony's No. 1 spot in the video-game console race. PlayStation 3's Cell chip is expected to cost even more than Microsoft's chip. "There's every expectation that PlayStation 3 will sell more than 100 million units , and there's probably $150 of IBM silicon just in PlayStation 3," says Richard Doherty, leading semiconductor analyst of research firm Envisioneering Group. Of course, Sony won't sell 100 million units immediately. But it did sell roughly 10 million consoles in the first year after PS 2's launch. IBM's isn't expected to realize 100% of the game-chip revenue from PlayStation 3 either. Instead, it's more likely to split the revenue with partners Sony and Toshiba, which shared the cost of developing the chip. IBM and Sony will both fabricate the chip. Still, IBM realizing, say, one-third of the chip revenue from PS 3 could mean an additional $500 million in the first year after the console's launch. Though Lisa Su, IBM's vice president of semiconductor research and development, declined to comment on the financial details surrounding any of the gaming chips, she did say that the high volumes in the game-console business are certainly one major attraction for IBM. IBM views its semiconductor business in general as a key differentiator in the enterprise systems market, Su says. But IBM sells fewer servers and mainframes than the number of video-game consoles sold in a year. So moving into the higher-volume gaming business helps spread out IBM's semiconductor manufacturing and research and development, Su says. "We were looking for applications where we could use our leadership technology in a complementary market. Gaming is a perfect example," she says. "It's using the same technology base, but we're able to leverage it into a higher-volume market."
And those volumes, of course, will be higher than ever for IBM because its chips will be in all three consoles. Sony alone has sold 90 million PlayStation 2 consoles. And many experts believe that the video-game market will expand even further in this next-generation console cycle. "There's a good chance by 2010 or 2011 there will be 200 million IBM chips in game consoles sold," says Doherty. "That's an awful lot of chips." And that's why in the next-generation console cycle, IBM's a sure bet.