Analyst: PS3 the "light at the end of the tunnel"

Today, Friedman Billings Ramsey analyst Shawn Milne today issued a game industry update to investors, painting a cheerier picture than many of his peers of late by focusing on next year and beyond.

Right off the bat, Milne calls the planned November US launch of the PlayStation 3 the "light at the end of the tunnel" that will bring investors back to game stocks, suggesting that the industry will experience double-digit growth for the next 4-5 years. The continued demand for the Xbox 360 outstripping Microsoft's ability to supply the console, a surging handheld market driven by Nintendo DS and PlayStation Portable sales, and higher price tags for next-gen games are all given as reasons for that growth.

Milne still expects 2006 to show signs of the console transition, with console sales down 3 percent for the year (and another difficult holiday season), but he says 2007 should bounce back in a big way, with "roughly" 18 percent growth in the console sector. Meanwhile, PC gaming will continue to face hard times, Milne suggests, pegging the market to slide 38 percent from its 2005 tally of $879.8 million to $545 million in 2010.

As for what will drive that 18 percent growth on the console side, Milne puts it on the shoulders of the Xbox 360 and the PS3, "less so for the Nintendo Revolution." Projecting console sales through 2010, Milne expects the PS3 to outsell the Xbox 360 each year after 2006, but not enough to overcome Microsoft's year-long head start in the console wars. Through 2010, Milne expects the PS3 to have sold 23.3 million units in the US, with the Xbox 360 claiming a domestic user base of 24.6 million. His projections for the Revolution are less impressive, expecting Nintendo to move 12.5 million units by the end of 2010.

Interestingly enough, Milne expects the PSP to outsell all the next-gen consoles through 2010, with 26.1 million systems in the hands of US gamers. While the DS currently has the edge on the PSP in domestic sales (3.8 million to 3.6 million by 2005 numbers), Milne expects the PSP to overcome that lead this year and never look back. Finally, Milne indicates there's a lot of life left in the Game Boy Advance, expecting it to sell 1.5 million units in 2010, with none of the other current-gen systems selling a significant number of units that year.

Moving from the platforms to the games they play, Milne downplays concerns about rising development costs negatively affecting publishers' profit margins. As he pointed out, "Since the first games of Pong in the mid 1980s, development costs have skyrocketed in the video game market, yet publisher operating margins have expanded significantly."

For example, Milne cites Halo 2 and its exorbitant development cost (he estimates $20 million), and then points out it went on to earn more than $350 million worldwide.

"The bottom line is that game development costs will continue to rise and further change the risk profile of the sector, however, we fully expect big-hit franchises to deliver significant cash flow and drive strong earnings growth from current levels," Milne wrote.