Deep Dive on Nintendo Stock
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This week we relaunched the podcast by interviewing software analyst Tim Beyers. As you may know, before the show stopped we also did “Fundamental Analysis” episodes every Thursday and Sunday where we discussed an individual company. Those have started up again too, but with an added twist.
Every Thursday, Ian Gray (who worked with Ryan at the Motley Fool this summer) will be joining us for a 30-40 minute “Deep Dive” into a specific company. These episodes will, as you might expect, be a more in-depth analysis of a stock. It also will have an accompanying blog post to give listeners further analysis and any follow-up to the episode.
This week Ryan, Ian, and I discussed Nintendo. They are an interactive gaming company with a long history of building hardware (Game Cube, Wii, and currently the Switch) and software (Mario, Zelda, etc.) for customers globally. Unlike others in the industry, Nintendo focuses on building games for their own hardware instead of relying on 3rd-party developers (like Sony does with EA and Activision). Nintendo games also tend towards being built for the 18-and-under crowd vs. the most popular Xbox or Playstation games like Call of Duty or Halo.
Founded in 1889, Nintendo has a long and successful history as a Japanese company. They were originally a trading card company, and it is technically still one of their product lines ($6 million in revenue in 2020!), but they have obviously pivoted since then. In the 1960s Nintendo started creating physical games and toys, and then in 1977, after the crucial highering of Shigeru Miyamoto, the legendary Mario, Zelda, and Donkey Kong franchises were born. Over the last few decades, Nintendo has released multiple consoles and handheld devices, the most recent example being the Switch. As of August 2020, 63 million copies of the Switch have been sold, putting it on pace to be the most popular console ever.
Industry and Competition
The video game industry is huge and growing quickly. The global market is $150 billion when you encompass all hardware and software products, and is estimated (via Statista) to have a CAGR of 9.2%. The console market is an oligopoly with Xbox (Microsoft), Playstation (Sony), and the Switch (Nintendo), dominating. New Xbox and Playstation generations come out this year, while there have been rumors of a new “Switch Pro” being released in the not-so-distant future.
The software-side (i.e. the games themselves) are a lot more fragmented. EA, Activision-Blizzard, Take-Two Interactive, Nintendo, Microsoft, Zynga, Epic Games, Tencent, and more dominate certain niches within the market. Mobile gaming is the biggest, giving a ton of power to the two companies that run the largest app stores, Apple and Google.
Geographically, Asia-Pacific is the largest market, while Latin America is the fastest-growing. North America has a major dollar-share too, with 214 million Americans playing one or more hours a week.
Even though Nintendo has a history spanning three centuries, they’ve only had six (!) different presidents. Up until 2002, this position was held by a descendant of founder Fusajiro Yamauchi. His great-grandson, Hiroshi Yamauchi, was president from 1949 all the way until 2002. The current president is Shuntaro Furukawa. He was awarded the role in 2018, and is only 48 years old. Furukawa has committed to experimentation and being more open with Nintendo’s business model instead of their historical “walled-garden” approach. From 2019:
“Giving our teams the freedom to experiment with new ideas is something I strongly agree with. Expansion can’t happen without the freedom to try something new, and the courage to step into unfamiliar territory.”
Valuation, Earnings, and Balance Sheet
Since Nintendo is an international company, it is hard to get all the valuation metrics you want unless you have one of the expensive Bloomberg-type services to do it for you. Typically, with non-U.S. companies, these need to be calculated. Here are some of the most important ones we came up with.
Market cap $68 billion
P/S 5.6, P/OI of 20.8 (based on year-ending this Spring)
P/S of 4.6, P/GP of 8.5, P/OI of 12.4 (if you annualize the latest quarter)
P/OCF correlates strongly with P/OI
Dividend yield 1.3%
Earnings (latest quarter):
$3.4 billion in sales, up 108% YoY
Gross margin expanded almost 10% to 59%
Operating income of $1.4 billion, up over 400%
5.86 million Switch units sold
56% of games sold were digital
Over $8 billion in Cash and Equivalents
No significant liabilities
A current ratio of 4 (should they buy back more shares?)
The Evolution of the Switch Console
The original Nintendo Switch console was launched in 2017. This console provided Nintendo with the perfect blend of mobile and console. With the Switch, you’re able to play as you go or link with any screen and play it just like any other console.
Powered by Nvidia’s Tegra X1 chip, Nintendo is getting just enough out of this lower-priced chip to be able to perform the necessary functions to run on mobile devices. While it isn’t the highest quality chip Nvidia has made, it makes the Switch far less expensive to build, which in turn gets passed through to the consumer.
Only this time around games are stored in the cloud. The installed base never restarts. Much like the iPhone, the users stay the same but the hardware changes. This was made obvious by Nintendo’s release of the Switch Lite in September 2019, which sold roughly 2 million units within the first 10 days of being on the shelves.
All in all, the Switch platform has sold ~63 million units within the first 3 years of existence. For reference, the best-selling console of all time, the PS2, has sold 155 million units since 2000. But, if a single new iteration doesn’t give you confidence that this is more like the iPhone and less like the Wii, gamerant.com released an article this week announcing various leaks of the much anticipated Switch Pro.
Milking IP and Other Ownership Stakes
One of Nintendo’s long-term growth opportunities is milking their gold-mine of intellectual property (IP) and bringing it outside the walled-garden. We discussed on the show how Mario, Zelda, and Donkey Kong are to Nintendo what Marvel, Star Wars, and Mickey Mouse are to Disney. These brands are undisruptable if managed correctly and can be monetized through merchandise, TV and film, theme parks, and other high-margin licensing deals.
We can’t forget Nintendo’s outside investment interests, the two most important being Pokemon and Niantic. Nintendo owns around 33% of Pokemon, which, if you didn’t know, is the highest-grossing media franchise of all-time. It is unknown what the market value is of the Pokemon Company, but conservative estimates think Nintendo’s stake is worth at least $10 billion, if not more. Make sure to factor that in when calculating enterprise value. Niantic ownership is estimated to be 20%, but it is hard to pinpoint anything exact because they are a fairly secretive start-up. Niantic is the maker of Pokemon Go and is revered as being on the cutting edge of AR gaming, so you could see Nintendo’s stake being a call option on the AR market. From our view, it isn’t the main reason someone should choose to invest in Nintendo, but a sort of cherry on top of the cash flow sundae.
What We Like About Nintendo
All three of us concluded that Nintendo has a strong competitive advantage in gaming content that isn’t R-rated or sports-related. They’ve invested decades worth of time and money to build up the Mario universe, similar to what Disney has with animation characters. Another competitor (like, say, Google or Microsoft) cannot replicate this overnight, no matter how much money they spend. If they can get the console right (which we believe they have already done), Nintendo will have a strong runway to dominate childhood console gaming. Don’t forget that they are just starting to take mobile gaming seriously too.
The valuation feels reasonable. If you back out about $15 billion for outside ownership stakes plus the cash, (this could be as low as $10 billion or a lot higher, outsiders don’t know for certain), that gives them an enterprise value of only $45 billion. Remember, they brought in $1.4 billion in operating profit last quarter.
Lastly, we all think it is positive that Nintendo is starting to produce content and build products for 3rd-parties, either digitally or physically (by physically, we mainly mean a theme park). Yes, keeping the walled-garden can mean higher margins, but it can also make the business more cyclical. Becoming more like EA and less like Sony would not only smooth out the earnings cycle but likely force the market to value Nintendo stock at a higher multiple.
What We Don’t Like About Nintendo
This section is going to be short for Nintendo. If you can’t tell, we like the company a lot (still, do your own research, this is in no way investment advice).
However, one concern we kept coming back to was management being too conservative with cash. A current ratio of 4 is quite high, and we think buying back more stock could be accretive to shareholders without ruining the long-term opportunities that lie ahead. Everyone would rather have a 6-bagger than a 4-bagger over a decade, and that’s what buybacks can do.
As well, a console from Nintendo has never sustained market share for very long (reference the chart for specifics). The market is pricing the Switch like it could fall out of favor, even with the investments Nintendo is making to counteract that. If the market is wrong, and Nintendo can sustain this profitability over the next decade, investors will likely be rewarded in kind.
Links to Further Reading/Learning
Disclosure: Authors are not financial advisors. Anything written on Chit Chat Money is not formal advice or a recommendation.