Dear Microsoft Stock Fans, Mark Your Calendars for June 30

June 30 will mark the end of Microsoft's (MSFT) fiscal year and is normally a routine milestone for investors. This year, however, it will be a tipping point for the company's gaming division.

The core issue is the Xbox profitability crisis. Microsoft has invested in its gaming division for over 25 years. Even if you exclude the $69 billion Activision Blizzard King acquisition, Xbox has spent more than $20 billion on content platforms in just the past five years alone. Annual revenue is still down by nearly $500 million in these past five years, so management has hinted they are about to take some heavy-handed actions.

The culprit behind this decline is a 33% drop in Xbox hardware revenue. Gaming revenue was down 7% to $5.3 billion last quarter, which has turned into a drag for the whole More Personal Computing segment.

Xbox Is Struggling — And It Might Get Even Worse, Thanks to GTA 6

Xbox is struggling to sell consoles, and it is also having trouble building the next one. At the same time, new competitors like Steam have entered, and Sony (SONY) continues to dominate market share. The next PlayStation 6 is expected to come out within the next 24 months. Xbox's sales may come down even more after that.

I would expect a slight sales bump after Grand Theft Auto 6, but a less-than-expected one. Sony released the PlayStation 5 Pro less than two years ago, and it offers the best console experience for GTA 5 thanks to its upgraded GPU. The best Xbox on the market right now is the Series X, and it costs up to $800 for the 2TB version and $650 for the 1TB version. The upgraded PlayStation 5 Pro is $900, up from $700 at launch due to higher component costs and demand.

However, the base PlayStation 5 Slim costs $650 and has near-identical performance to the Series X, with the digital edition costing $600. The standard PlayStation 5 also costs $650. Xbox only outflanks Sony with its Series S at $400 to $450, but customers will likely be playing GTA 6 at 30 frames per second (fps).

The PlayStation 5 is widely considered the better choice for GTA 6. Sony holds exclusive marketing rights, and Rockstar Games specifically utilized the PS5 for their initial in-game trailers.

Costs Are Through the Roof

Xbox CEO Asha Sharma, who is some three months into her tenure, has delivered a blunt internal memo stating that heavy spending with thin profit margins and declining revenue "cannot continue."

Microsoft CEO Satya Nadella also recently had words about the situation with Xbox: "We've invested a lot […] for the last 25 years. We have to turn this into a sustainable business […] The challenge we have is we've not been monetizing that entertainment. In fact, if anything, we've been subsidizing that entertainment."

The sudden reality check is due to rising component costs eating at Xbox's razor-thin margins. Gamers are having trouble building PCs due to high RAM and GPU costs. Console manufacturers have temporarily shielded them from some cost hikes, but sales are coming down now that they too are forced to increase prices. Xbox is now expected to keep seeing both mounting losses and declining sales.

June 30: Layoffs Are Coming for Xbox... Maybe Even a Spinoff

With the decline and further shocks on the horizon, Microsoft is cutting its losses, and it may even cut the cord. Significant layoffs are expected in July. Xbox could shed 1,000 positions across Xbox Game Studios, hardware engineering, marketing, and corporate support functions. This comes after the company already eliminated approximately 9,000 positions earlier in its restructuring cycle.

Some analysts are already sounding the alarm on a full spinoff. I doubt this will be the case, as Microsoft has invested heavily in Xbox. But if trends continue, the segment could turn toxic enough to force a spinoff.

Microsoft is now focusing entirely on AI and computing. It wants to show Wall Street it is a high-growth, high-margin business. Xbox will hurt the overall net margin figure, and whatever profits it does generate won't be enough to offset stock market declines due to a margin miss. AI companies are increasingly turning to the market to raise capital for the AI buildout, so a spinoff might eventually make sense.