Nintendo deal with IBM a blow to MIPS

Nintendo today announced that it will incorporate PowerPC processors from IBM to serve as the nerve center in the next generation of game consoles to be released in the fall of 2000.

Unfortunately for MIPS, that's not the best news. Although the company is emerging as a leader for processor design in future TV set-top boxes and competing game consoles, Nintendo is still the main source of business for MIPS.

Seventy-five percent of its revenue, and most of its growth, comes from royalties from the chips used inside the current Nintendo 64 game consoles, the company said in a Securities and Exchange Commission filing April 22.

"We understand that the next-generation Nintendo video game system will not incorporate any of our technology," the company said in the filing--adding, in capital letters, that "WE MUST DIVERSIFY OUR SOURCES OF REVENUE TO OFFSET THE EVENTUAL DECLINE IN REVENUE WE DERIVE FROM SALES OF NINTENDO VIDEO GAME PRODUCTS."

Investors, though, don't seem fazed. MIPS's stock rose almost six points to $41.875 today.

The contrast between future opportunities and present realities will likely be the subject of much debate in the chip design world. A number of analysts have pegged MIPS as one of the leaders in interactive TV set-top boxes.

The company's chip designs also lay at the core of the much-touted "Emotion" processor that will go inside the Sony PlayStation 2 coming out next year. MIPS does not manufacture the chips but licenses its intellectual property to companies like NEC, which put out the final product. Toshiba , for instance, will manufacture the Emotion processor.

"Set-top boxes need a simple processor that does several things very well, and a lot are going to be MIPS-based," said Kathleen Maher, an analyst with consultancy Jon Peddie Associates of Tiburon, California.

For now, however, Nintendo is paying the bills. "Contract revenue and royalties from Nintendo and NEC relating to Nintendo 64 video game players and related cartridges accounted for 23 percent, 69 percent, 79 percent, and 75 percent of our total revenue for the fiscal years ended June 30, 1996, 1997, and 1998 and the first six months of fiscal 1999, respectively," the company said in the SEC filing from last month.

MIPS designed the graphics processor and the main microprocessor used inside the Nintendo 64 systems. The company already lost the graphics contract for the next generation game consoles to Artx, formed by former SGI engineers that worked inside MIPS. NEC manufacturers these chips but uses the MIPS design.

Nintendo revenue, however, won't dry up right away. MIPS said it expects to continue receiving royalties on the Nintendo 64 systems.

In addition, MIPS may revive a lawsuit it filed against Artx a year ago. The suit, which alleged that Artx infringed upon its intellectual property, was suspended in May last year under a memorandum of understanding, according to a MIPS spokeswoman.

At that time, Artx had agreed to work with Nintendo to select a microprocessor manufacturer for the future consoles, Artx said then. MIPS was a candidate for that contract.

The decline in revenue as the Nintendo deal fades out could also be relatively slow, and even be positive in disguise, said Seth Dickson, research analyst at Warburg, Dillon, Read.

As part of its original deal with Nintendo, MIPS receives royalties on the software cartridges as well. If the upcoming systems are backward-compatible with existing cartriges, "that could be a big positive," he stated.