Sega wakes from Dreamcast nightmare

Few people shared the enthusiasm of this Japanese man, the first person to buy a Dreamcast.

TOKYO, Japan -- Japan's Sega Corp has emerged from its abandonment of the Dreamcast games console with a stronger share price and better rating from analysts.

But it has also suffered a downgrade from B2 to B3 by ratings agency Moody's Investor Service -- a result of its eroded financial flexibility after deciding to exit the games hardware market and focus on software.

Shares of the electronic entertainment group soared 17 percent by midday in Tokyo (0300GMT), spurred by brokerage Morgan Stanley Dean Witter's decision to lift its outlook for Sega from "neutral" to "outperform".

Sega on Wednesday announced plans to pull the plug on Dreamcast, which has failed to sell well amid competition from Sony's rival PlayStation. Its future had been dimmed by the looming release of similar consoles by Microsoft and Nintendo.

The news proved to be mixed for Sega's rivals Nintendo and Sony, which have both lost value in line with a declining Tokyo market. Sony shares are down 0.83 percent and Nintendo is down 1 percent at midday.

The decision means Sega will suffer a record loss for the 2001 financial year of ¥58.3 billion ($459 million), due to an extraordinary loss of ¥80 billion ($689 million) stemming directly from the closure of its long-running hardware business.

Shares stronger

Nonetheless, Sega's shares have spiked more than 75 percent since investors caught wind of a possible move out of hardware a fortnight ago.

Analysts described the end of the 128-bit Dreamcast as a crucial step towards profitability for a company facing four straight years of losses, although the size of the abnormal loss outstripped all expectations.

"Ultimately this will be good for the games market and good for consumers," said Zachary Liggett of WestLB in Tokyo.

"I think all of Sega's rivals -- Microsoft, Sony, Nintendo -- would have expected this. It's pretty much a non-event for them because Sega didn't compete very well, but it's good because they will get a commission from the games Sega sells for their platforms."

Launched in 1999, Sega was the first games console to be equipped with Internet capabilities. It has a 56K modem that connects users to games, chatrooms and online tournaments.

Marketing campaign failed

However, it could not match the marketing power of either Nintendo or Sony, which entered the gaming market through its hugely popular PlayStation.

"There was nothing wrong with the hardware or the content, but they failed with the marketing against a great campaign from Sony," says Liggett.

Sega says it will stay in the software business, throwing a lifeline to Sonic the Hedgehog and other characters and games that became synonymous with the world's first Internet-compatible video game machine.

"The hardware business was becoming a heavy burden to the company," said executive vice president Hideki Sato. "By shifting away from it and into the software business, where we are stronger, we will aim to get back in the black in the next year."

The vast majority of Sega's value of ¥315 billion ($2.7 billion) is attributed to its software sales and intangible assets, such as its strong product development team.

In the business year to March 2000, its hardware division earned 23 percent of total sales and contributed to 95 percent of its total operating loss.

Operating losses from the hardware division in 2001 were expected to balloon to ¥43.5 billion in the current business year from ¥38.4 billion a year earlier, the company said, adding that Dreamcast sales fell 44 percent short of an initial goal.

Better outlook for software

"They're sticking to their core competency, and in three or four years' time, present software companies like Konami, Namco and Capcom will find themselves up against a very strong competitor," says Liggett.

Sega said it will now focus on providing game software content and entertainment titles to other video game makers, including Sony, Nintendo and Microsoft Corp, whose new game console system "XBox" will be launched before the end of June. This week Sega also announced an agreement to develop games for Palm Inc's handheld PalmPilots. It will pursue other deals in the wireless and non-games console markets.

Reuters contributed to this report.

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Sega denies rumor of Dreamcast demise

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