Sega & the Sonic Boom (Fool Plate Special) August 31, 1999

An Investment Opinion

Sega & the Sonic Boom

By Rick Aristotle Munarriz (TMF Edible)
August 31, 1999

Am I dating myself if I confess to once being impressed by video game pioneer Pong? Sure, it was colorless flat-paddle ping pong, but it took a medium which everyone accepted as a means of entertainment and information and made it interactive overnight. A genre was born.

Next week the cries of "I want it" will crescendo as Sega's Dreamcast gets plugged into a television set near you. Last night Sega announced that toy stores had logged 300,000 pre-orders, three times what Sony (NYSE: SNE) garnered with its 1994 PlayStation debut.

The arrival of a newer, more powerful kid on the block should not alarm video game console historians. The Atari, Colecovision, and Intellivision of the 1970s gave way to the 8-bit wonders of Sega and Nintendo in the 1980s. Both companies, heeding the call for better systems, raced toward 16-bit systems as the 1990s rolled in.

It seemed as if the two Japanese competitors would own the market forever. Then, some pesky upstarts crashed the party. In 1993, 3DO (Nasdaq: THDO) and Atari's attempted revival in its Jaguar system hit the market. While both machines met a quiet demise, they did whet the consumer appetite for the PlayStation release a year later.

Running on CDs that were cheaper to produce than Super Nintendo and Sega Genesis cartridges, and toting a superior spec sheet, Sony began to wrest market share from its lowly 16-bit competitors. It also charged developers lower royalties than its peers -- securing plenty of available titles and at lower price points.

Sega attempted an immediate attack but sputtered. Nintendo took to tarrying while it readied its Nintendo 64 system. The cartridge-based N64 has fared well but still trails the PlayStation in popularity. Still, the console industry is booming. According technology market-watcher Ziff-Davis, 21 million stateside households owned at least one video game system last year. This year -- 43 million. The staggering growth, more than doubling over the course of a single year, can be attributed to falling system and software prices. Sony and Nintendo slashed the console retail prices to just $99 earlier this month -- having gone from $149 to $129 over the past year. Individual game titles are also more attractively priced.

The latest reductions are clearly a preemptive strike at Sega's $199 asking price for the Dreamcast. It might not be enough. Sega has suffered through four holiday seasons, written off by many during that time. But it has been an astute pupil of history. It has seen new machines fail because of high initial prices (the 3DO was launched at $700), lack of software support (the 3DO system hit the shelves with just one available title; Sega has lined up more than a dozen, including the arcade favorite House of the Dead 2), and incomplete distribution channels (every major retailer seems to be stocking the Dreamcast).

The Dreamcast's power is jaw-dropping. Catch a display model running the return of Sega's Sonic the Hedgehog to see what I mean. The Dreamcast also offers something new -- a 56k modem -- with limitless possibilities. While 300,000 early adopters might seem insignificant in light of 43 million game-playing homes, Sega is back -- and there are some investing implications to ponder.

Before Wall Street as a whole figures it out, there seem to be clear winners and losers beyond the console makers. Destined to have a rocky road this holiday shopping season are traditional toymakers like Mattel (NYSE: MAT) and Hasbro (NYSE: HAS). Between the bargain-hunters stockpiling PlayStations and N64s to the mad rush for Dreamcast titles, there won't be much stocking left to stock. Yes, Mattel and Hasbro are alive in the realm of software, but not significantly enough to offset the gamer defections. The big-ticket Dreamcast might spoil the hype for what could have been a great Star Wars selling season for Hasbro in particular. Next year might be more of the same as Sony rolls out its PlayStation 2.

There will be winners, too. Retailers, like leading toy vendor Wal-Mart (NYSE: WMT), and toy-specific players like Toys 'R' Us (NYSE: TOY), might enjoy the inventory advantage of storing smaller game boxes, with whirlwind turnover, over bulkier play fare. Online toy merchants like eToys (Nasdaq: ETYS) and (Nasdaq: AMZN) should flourish given the convenience of specific title requests rather than vague action figure and Barbie wishlist references often best filled in person. Sega is back, and to some, it's a Dreamcast come true.