Topic: Interesting article about Steam Machines and Nintendo's place

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All of a sudden, there is a 900 pound Gorilla in the room.

Sony's (NYSE:SNE) Playstation 4 and Microsoft's (NASDAQ:MSFT) Xbox One have a serious problem on the horizon, and right now, it doesn't look like either of them can do anything about it at all.

The problem I'm talking about are Valve's (a privately held company) new consolized PCs, which are known as "Steam Machines." They're named after Valve's extremely popular instant-demand online games and matchmaking service called Steam. Steam machines use powerful processors and graphics hardware and a custom operating system designed with playing on HDTVs in mind:

This is the perfect time for a new hardware maker to jump in.

Valve is looking to strike while the iron is hot, before the PS4 and Xbox One really have a chance to hit critical mass. Valve is not new to the games industry. Along with Steam, Valve has made several of the world's most popular first-person shooters, the "Half-Life", "Portal," and "Counter-Strike" series, among its more well-known titles, as well as the newer but very popular role-playing game "Dota 2."

While they are, however, relatively new to the hardware industry, they have licensed out the manufacture of the Steam Machines to third-parties that do have experience with assembling computers. All of the Steam Machines are essentially built using off-the-shelf parts that enthusiast gamers have been buying for ages. The hardware that Valve has licensed also is specified to be more compact and heat efficient so as to lower noise levels and shrink the overall footprint of the console.

And because the Steam software can be configured to use standardized parts available to anyone, then any user can assemble their own Steam Machine. Or they can use the computer they already have and switch between Microsoft Windows and the custom Steam OS.

This is not the first time that a third party hardware/first party software arrangement has been attempted. The long-since gone 3DO model was a similar venture between a new start-up created by the founder of Electronic Arts (NASDAQ:EA) and Panasonic (OTCPK:PCRFF). Ultimately, it was overpriced, underpowered and had an unimpressive games library.

Valve has learned from the mistakes of 3DO.

Valve does not have the same weaknesses. As of right now, there are already more than 125 million users registered to the service. For them, it's just a matter of marketing a product to replace the current generation of set-top boxes. Sony and Microsoft should be very concerned about this, because many companies that develop games for the PS4 and Xbox have been releasing the exact same games on PC/Steam.

Sony is in an especially dangerous place right now. One of the things that the designer of the PS4 was most proud of was the fact that it was designed on PC/x86 architecture, so it was familiar and relatively easy to program compared to the PS3. But that strength created an entirely new problem for Sony because it allowed game creators to more or less have a fully functioning version of their games immediately available to publish for PCs.

Things look good now, but the future is suddenly in doubt.

There has been a recent rise in Sony's stock price due to the market's perception that Microsoft is losing the war on this console generation, as the PS4 has now surpassed 20 million units sold, while the Xbox One has sold only about half that many.

However, the reason that both of these companies are in serious trouble right now is that there are very few compelling first party titles. Most of the very high profile games that are out are coming out on third party software and available on multiple platforms. For example, Playstation held a gamers day recently where Capcom (OTC:CCOEF) announced "Street Fighter V" would be a console exclusive to the PS4, but will have a PC version, which really means a Steam version, as Capcom has been publishing there for years now.

And games that are already out on PS4, such as Rockstar/Take Two Interactive's (NASDAQ:TTWO) "Grand Theft Auto V," are getting new life breathed into them from the more powerful PC hardware available. The Steam version will support 4K HDTV resolutions and a new first-person mode.

Nintendo (OTCPK:NTDOY) by contrast is not really facing these same kinds of struggles. The company's first party titles are the primary reason that people buy their hardware, and their quirky, unique gaming hardware is a strength for them as well. Even though the other console makers have copied Nintendo products in the past, they haven't had the software to make those devices compelling.

Additionally, Nintendo is still the No. 1 portable dedicated games hardware maker, as I covered here. Steam will not be a threat to them in the portable market. Nintendo also has not ruled out the possibility that they might start to do development for mobile phones and tablets. But just like Valve, nobody is forcing them to do anything, and they can take their time and do whatever works best for them.

While Sony and Microsoft are in trouble here, Sony has it much worse.

Sony as an electronics business is really struggling right now to make money. They have already exited the computer business, and are looking to exit several other markets where they are losing money, especially HDTVs. Apple (NASDAQ:AAPL) has eaten the Walkman lunch with their iPod, and is overtaking Sony's place in home stereo accessories with Beats by Dr. Dre headphones and other small speakers as well.

If Steam supplants itself as a strong alternative to the Playstation hardware, that will leave Sony with no strong brands. Since Steam gets all of its content through downloads, there won't even be sales of Blu-Ray discs. It could send Sony toward bankruptcy, and that's not just me trying to be dramatic. The company has already seen some very large losses over the last few years:

2014 2013 2012
Sales $75,421,000 $72,158,000 $78,900,000
Net Income (-$1,246,000) $441,000 (-$5,529,000)

The balance sheet is deteriorating as well. Sales and cash levels are stagnant. When a technology becomes obsolete, there's no market for the factories that make it. You're forced to take a hit on the value of that real estate because the machinery in there will have to be completely replaced. That's happening to Sony and is evident here in the Property, Plant and Equipment line:

2014 2013 2012
Cash $10,162,000 $8,775,000 $10,870,000
Property, Plant and Equipment $7,283,000 $9,148,000 $11,313,000
Net Tangible Assets $8,649,000 $9,073,000 $11,525,000

Microsoft has a stronger outlook. Valve has a killer app.

As I stated, while both companies will be affected, Microsoft will not take the same kind of hit as they will still have their home PC and server side operations.

Of note, Microsoft, Sony and Valve as well all have Virtual Reality headsets coming to market. I'm certain that there are a lot of people who also are interested in hearing more news about these devices, but it seems too early in the product cycle to really discuss the pros and cons, but I do want to speculate on something for a moment.

There has been a recent bit of interesting activity on the Steam client for Windows. Valve has been offering discounts on games that currently run on Windows but are specifically optimized to run on SteamOS and consequently Steam Machines. I think that there is a very strong possibility that as soon as SteamOS has a solid base of users, that Valve will announce the much rumored "Half-Life 3" exclusively for SteamOS, and that will really anchor them as a competitor against the other consoles.

I think that's why Valve made it a point to get the news out about their new "Source 2" graphics engine at the Game Developer's Conference this year. I think that they weren't in an extreme hurry to talk about it, but saw Epic Games' new "Unreal" Engine as a possible roadblock to the Steam Machine's success. I believe that making the announcement was an effort to make sure those lanes were all clear.

The new hardware is an attractive upgrade over both systems for only a small difference in cost. Entry-level machines can be purchased for $479.99. It also will hit several years before either of those companies can get new hardware of their own to market. And if Valve can get Half-Life 3 out, or at least news about it out this year, I think they have a very good chance of making this strategy work.

At today's prices, I could see Microsoft drop by 25% or so. I'm giving them a 12-month price target of $30/share. Sony could fall by far more. I'm giving them a target of just $15/share.