Analyst: Current gen will last a while

Wedbush Morgan's Michael Pachter issues state-of-the-industry report, says PS3 will take this round of console wars but everyone can come out a winner.

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Wedbush Morgan Securities analyst Michael Pachter issued his annual industry report today, and he used it to warn investors of what he expects to be a changing console generation model. While he addressed everything from the mobile-gaming market to the profit potential of downloadable content in the 207-page report, Pachter's main point was that the current generation of consoles will stretch on longer than the five-year cycle established by previous generations.

Pachter titled the report "Curb Your Enthusiasm," warning investors that customers are buying into the new systems at a slower rate than expected. But on the positive side, longer console life cycles give companies more of a chance to turn a substantial profit from their systems before turning around and pouring money into making their successors.

"In our view, the economics of game development and the tremendous capital required to produce the consoles will virtually compel all constituents to milk the next generation for all that it's worth," Pachter wrote.

Pachter singled out Sony as one player looking to take advantage of a longer console cycle. The electronics giant has already said it wants a 10-year lifespan for its systems, and Pachter noted the delayed introduction of the PlayStation 3 and the company's willingness to include a Blu-ray drive in the machine. Pachter noted that Blu-ray might not be a compelling value-adding feature until (and unless) it beats Toshiba's HD DVD format as the next-gen successor to DVDs.

"We expect the dominant console at the end of the next cycle to be the PS3, primarily due to our assessment that Sony will win the high-definition DVD format war," Pachter said.

However, Pachter doesn't expect that "dominance" to be especially convincing. Through 2011, he projects that the PS3 will have sold 73.7 million units worldwide, edging out the Wii's 72.4 million systems. Pachter has the Xbox 360 finishing third among the consoles with 54 million sold worldwide. But in this round of console wars, there may not be a loser.

"We believe that this is essentially a dead heat," Pachter said, "and each manufacturer will have sufficient market share to generate significant profits."

According to Pachter's projections, the PS3 will sell 32.2 million units in the US through 2011, followed by the Wii with 29.9 million and the Xbox 360 with 26.8 million. That represents the first six years in which the PS3 and Wii were sold (seven years in the Xbox 360's case). For comparison's sake, Pachter's figures show that over the first six years during which the PS2 was sold, Sony moved 32.1 million systems in the US.

As for Nintendo's hit holiday launch of the Wii, Pachter appears unconvinced of the system's long-term prospects.

"We believe that the Wii will outsell its competitors by a large margin for at least two years, but have difficulty predicting whether Wii demand will remain strong or will fade thereafter," Pachter said. "We think that Nintendo is likely to tinker with its hardware some time in the foreseeable future, perhaps offering high definition graphics and a Blu-ray drive in a future version of the console. Should it fail to do so, we think that the other two consoles will become far more competitive as prices come down."

On the Xbox 360's upside, Pachter noted that a misstep by the competition could help, but isn't necessary for, Microsoft to emerge from this generation better off than it was going in. If the HD DVD format (which Microsoft has embraced with an external drive for the 360) manages to best Blu-ray, Pachter said it would be a "complete disaster" for Sony, and completely negate the value proposition of the PS3's Blu-ray drive.

"Microsoft can position itself to thrive in either case, and has in large part secured a more dominant position this time around through its decision to launch the Xbox 360 a full year ahead of the PS3 launch," Pachter said.

Moving to the portable console wars, Pachter noted that media coverage of the PlayStation Portable and Nintendo DS is "fixated" on the sales battle between the two to the point that people have a distorted view of each machine's success.

"The phenomenal performance of the DS has made the PSP's performance appear poor, when in fact, the PSP is actually performing quite well," Pachter wrote. "By the end of its third full year, we expect the PSP's installed base to be approximately 25 million units, on par with the installed base of the Game Boy Advance at the end of its second year. Given that the PSP started from scratch, while the GBA sold into an installed base of over 100 million Game Boy owners, we think that the PSP's performance is respectable."

Of the DS, Pachter said, "We consider the DS one of the primary reasons to expect the next generation console cycle to be the biggest ever."

The analyst expects Nintendo's dual-screen handheld to sell a whopping 97.9 million systems worldwide through 2011. According to Pachter's projections, 6 million of those will be sold in the US in 2007, helping the year's domestic hardware sales total more than $7.5 billion. However, Pachter expects that number--slightly less than the US hardware sales tally of 2005 and 2006 combined--to be driven more by the larger price tags on the latest systems.

"We are impressed that the console manufacturers, video game publishers and retailers seem to have learned in some small way from the same mistakes that they made in the past," Pachter concluded. "Even if they don't make the same mistakes as in the past, there will be ample opportunity to make new ones: the first mistake of the current cycle was Microsoft's decision to launch a console in 2005 without adequate supply; the second was Sony's decision to include a costly Blu-ray drive in the PS3, driving the cost of the console beyond the reach of many consumers and limiting supply at launch; the third, surprisingly, was Nintendo's failure to anticipate demand for the Wii (we all missed this one), a problem that persists as of the time of this writing."

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