Why the Xbox 360 Is a Loser

My colleague Nate Parmelee recently discussed the good-but-not-great results of Microsoft's (Nasdaq: MSFT  ) last quarter. But there's an interesting bit of extra information that I think interested investors (or haters, whichever) ought to put on their to-do list.

Troy Wolverton at TheStreet.com slices and dices Xbox numbers. He points out that Microsoft sold 50% more Xbox 360 consoles than some researchers had predicted. (This makes me wonder whether my semi-silly prediction of pre-holiday sandbagging by Mr. Softy wasn't somewhat true.)

However, the conclusion to Wolverton's article contains a small bit of nonsense that's important for any Microsoft investor to consider -- whether that investor is hot for the Xbox or not.

It points out that the home-and-entertainment segment lost $293 million on $1.57 billion in sales and says: "That's got to hurt."

My question: "Why?" Or maybe, "Who expected anything different?"

The only people who should be surprised by losses in the home-and-entertainment segment are those who don't understand what the Xbox 360 is about. (Which is why I wonder whether that odd line wasn't thrown into Wolverton's article by a naive editor somewhere upstream.)

Make no mistake: For now, and for the foreseeable future, the Xbox 360 is going to cost Microsoft money. The consoles are sold at a loss, and the costs of launching the new system will continue to grow. The more popular the Xbox 360 becomes, the bigger the losses will be.

Why is that?

Well, Microsoft is trying to outmaneuver Sony (NYSE: SNE  ) , whose next-generation PlayStation is reportedly held up by chip-manufacturing problems. Microsoft is also trying to integrate the Xbox into the rapidly approaching but as-yet-undefined world of home media PCs. That means trying to find ways to play nice with Apple's (Nasdaq: AAPL  ) iPod. It also means accommodating media-center PC functionality from machines by Dell (Nasdaq: DELL  ) and Hewlett-Packard (NYSE: HPQ  ) , as well as anticipating the changes of the upcoming Vista.

All that adds up to R&D. And marketing. And reaching out to game makers like Electronic Arts (Nasdaq: ERTS  ) or Activision (Nasdaq: ATVI  ) , and hoping they don't pull an Ubisoft.

The Xbox, and Microsoft's home-and-entertainment division, is in a marathon, not a sprint. Microsoft is building toward a future where recurring revenues from small gaming and entertainment purchases, along with license fees, Internet advertising, and revenue streams yet unimagined, will congregate in Microsoft-developed living-room products.

Investors are smart to wonder whether or not this effort will work, or whether it's worthwhile, but they shouldn't dupe themselves into thinking that current and upcoming unprofitablity is proof of failure. It's part of the plan.

Microsoft is a recommendation from The Motley Fool's premium bargain-stock service, Inside Value . A free trial will get you the logic behind the pick, as well as spirited discussion on Microsoft's chances to finish this race.

Seth Jayson figures he can hold out exactly one more week before cracking and grabbing a new Xbox. At the time of publication, he had shares of Microsoft but no position in any other firm mentioned. View his stock holdings and Fool profile here. Microsoft is an Inside Value recommendation. Electronic Arts and Activision are Stock Advisor recommendations. Fool rules are here.