Why China Lifting Its 14-Year Ban on Consoles Isn’t Exciting

On Jan 7, China's State Council temporarily lifted its 14-year ban on foreign gaming consoles, paving the way for Sony (NYSE: SNE  ) , Microsoft (NASDAQ: MSFT  )  and Nintendo (NASDAQOTH: NTDOY  )  to expand into a potentially lucrative multi-billion-dollar video game market. At first glance, this seems like it can be only good news, but when examined more closely, there might not be much of an opportunity in the short term.

Shanghai's free rade zone
With the lifting of the ban also comes new regulation. In a statement released by the State Council, only consoles manufactured in the Shanghai Free Trade Zone, or FTZ, may be sold within China. Plus, before a system can reach the shelves of retailers, it will require inspection by various cultural departments.

Within the FTZ, goods can be imported, processed, and reexamined without the intervention of customs authorities in hopes of opening the world's second-largest economy to international investors. The new zone within Shanghai covers an already-crowded 29 square kilometers (11 square miles), which may prove difficult in finding space to build a new factory, let alone three separate ones.

Fortunately, there is a good chance that there won't be a war over the limited real estate, since each company has outsourced the manufacturing of their consoles to the same company, Foxconn, which has been making video game consoles within China for years. If there is a company with every incentive to expand into the FTZ, it's Foxconn.

China's grey market
Even with the ban, finding a foreign gaming console in China doesn't require knowledge of a store that is hidden behind a door found in the back of an alley. Everything from PlayStation 3 to Xbox 360, and even the PlayStation 4 and Xbox One, can easily be bought from nearly every shopping mall in China. This is in large part due to authorities looking the other way when it comes to regulating sales of not only consoles, but a laundry list of items the State Council has "banned." Although readily available, you might be surprised how large the market is for consoles.

The Chinese market is vastly different
The Chinese gaming market is unlike any other, with an estimated value of $13.75 billion in 2013, up 38% year-over-year. The bulk of the market share belongs to client-based PC games, which accounted for 64.5% ($8.87 billion) of the revenue. The second-largest market belongs to browser-based games, which accounted for 13.5% ($1.86 billion). Social games brought in $890 million and, surprisingly, console games only managed to make an absurdly low $15 million in revenue.

While consoles are estimated to have only generated $15 million last year, there is still a massive opportunity. A large part of the low revenue is due to the lack of an official presence from key players in the console market. Plus, the majority of consoles sold in the grey market are heavily modified to run pirated titles that cost only a few dollars each. It doesn't help that console prices are heavily inflated due to suppliers acquiring them through illegal means.

Did inventors overreact?
After the announcement, Nintendo's stock reached a two-year high, with shares climbing more than 11% in Tokyo. Sony climbed to similar heights in New York, with shares up more than 5%, though part of that could have been driven by Sony's keynote address at CES 2014. Given the facts, could investors have overreacted?

Possibly. The Chinese have already shown that they're willing to spend money on PC titles and, if marketed correctly, consoles can take a slice of the pie (especially since China's gaming market has seen year-over-year growth of nearly 30% for the past few years). To put China's $13.75 billion video game market in perspective, the estimated size of the U.S. market was $14.8 billion, down from its high of $16.9 billion in 2010. Even though it's expected that, with the release of the next-gen consoles, the market in the states will reach new highs, it'll soon be eclipsed by the Chinese market. Entering the Chinese market is still a no-brainer, but it'll take time. 

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