Nintendo Revisited 👨🏻🔧🐢
24 months on from my $NTDOY investment
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$NTDOY Metrics (at time of publication)
Market Cap - $61B
Cash = $9.47B
Cash + Securities = $4.48B
EV = $51.53B
EV - Securities = $47.05B
FCF = $3.315
EBIT = $4.44B
Summary Ratios -
EV/EBIT = 11.6
EV(minus securities)/EBIT = 10.6
FCF Yield = 5.4%
Debt/Equity = no debt
Return on Equity = 19.96%
Dividend Yield = 2.6%
5 Year CAGR = 4%
I’m bullish on Nintendo. I first wrote about the company back in 2021 and invested during the same year. My views aren’t original, most of the insights are based on Ryan O’Connor’s article. In this write-up I aim to understand if the investment thesis remains in-tact 2 years on.
Since my first article the Switch has surpassed 132 million total units sold (including the OLED & Lite). This is an uplift of 45% in 24 months and was bolstered by the 2021 launch of the OLED. Cumulative Switch software sales (games) are now over 1.33B.
From mid-2021 highs to the 2022 pull back, the shares have remained mostly flat. The market still considers Nintendo a hit driven, hardware manufacturer, but is that starting to change?
Margin of safety - Vast cash reserves plus other hidden investments.
Shift in business model - A transition from cyclicality and hits driven to recurring and high gross margin. The Switch 2 will create an iOS / App Store style model and accelerate this further.
Some of the best, but under utilised IP, on the planet which is slowly being unlocked. This has been highlighted by the billion dollar success of the Mario movie.
24 Months of Progress
A lot has gone right for Nintendo. The release of the Switch OLED pushed the console to over 132 million units, despite being underpowered in comparison to the next gen PlayStation and Xbox.
The Wii capitulated at 100 million units. The market reasoned that the Switch could not surpass the same milestone.
As Switch sales continue to grow the narrative will follow. The company is shifting from cyclical and hits driven to a secular, digital-first and increasingly high-margin company.
Nintendo Switch Online now boasts 38 million accounts, up by 10 million in 2 years but only 5% since 2022. The company continues to grow the active user base, despite a reduction in game releases. Annual playing users continue to increase, reaching a record high of over 117M gamers.
Zelda, Tears of a Kingdom sold a massive 19.5 million units over the 3 month launch period. Super Mario Bros Wonder was released in October and sold over 4.3 million units in the first 2 weeks - the biggest ever release for a Super Mario title.
Changes In Japan
With over 130 years of history, Nintendo is a champion of Japan and a testament to the country’s ingenuity. Since the crash of the Japanese stock market in 1990, companies have maintained a frugal and risk-averse approach, opting to stock pile cash. This overly cautious approach has meant that Japanese businesses are generally slow to enter and invest in the new fields that are expected to grow.
In January 2023, the Tokyo Stock Exchange (TSE) published the "Summary of Discussions on Measures to Improve the Effectiveness of the Market Restructuring” with the aim of attracting foreign investment.
The TSE points out that companies with a price-to-book ratio (PBR) below 1 need to show improvement. About half of the 1,835 firms listed in the Prime section have price book ratios under 1.
The changes are forcing a cultural shift. It is no longer acceptable to build cash and avoid investment. Some Japanese companies have announced buyback plans to increase price to book ratios.
Cross-shareholding in Japan is common. A company takes a small stake in their suppliers and customers as a gesture of goodwill. The reduction of cross-shareholdings between Japanese corporations should lead to increased liquidity and re-investment.
With incentives to unlock value, investing in Japan should be easier, allowing the country to benefit from foreign investment. It’s not a certainty, but this should lead to positive macro headwinds.
Margin of Safety
As of the most recent earnings, Nintendo had $13.65B of combined cash/securities on the balance sheet, ($9.27B in cash and $4.39B in equities). Historically, the company has held vast amounts of cash to ensure it would survive a ‘console failure.’ Without it, there was a real risk of bankruptcy. The company still bears the scars of the Wii U failure and will likely only re-invest once the Switch successor has proven successful.
Across 2021 & 2022 Nintendo outlined plans to spend up to $900 million buying back shares to 'cancel' them. The business enacted a 10-for-1 stock split in October 2022, to add further liquidity by reducing the stock price. In June of 2023 Nintendo announced they planned to ‘continue to carefully evaluate the feasibility of (stock) reduction,’ meaning further buy-backs could be on the horizon.
Through utilising cash holdings to shrink the float, Nintendo is adding further shareholder value. Outside of the Pokemon Company (discussed below) Nintendo holds shares in BANDAI NAMCO, DeNA Co and The Bank of Kyoto amongst others.
The Pokémon Company
The Pokémon Company generated $11.6 billion in licensed goods during 2022, according to a License Global report. This was an increase of 36.5% compared to $8.5 billion (£6.6 billion) in 2021. During the latest financial year, the Pokémon Company reported: -
Sales: 204 billion yen / US$1.6 billion (up 70.4% from last fiscal)
Operating profit: 59 billion yen / US$460 million (up 115%)
Net profit: 41 billion yen / US$320 million (up 123%)
The Pokémon Company (PC) has reported $10 billion in revenue over past 20 years in licensing fees alone. In 2022 it held the 5th spot on the top 150 global licensors. Pokémon IP is some of the most valuable in the world.
Some reports highlight that the Pokémon Company may have generated as much as $118.5 billion in revenue since the founding in 1996. Conservatively the company can be valued at $6.5B, based on 20x trailing earnings.
Nintendo’s ownership is effectively valued at $0 on the balance sheet, making it one of the largest ‘hidden in plain site’ assets. In the most recent earnings Nintendo reported that *Investments in unconsolidated subsidiaries and associates as of March 31, 2022 and 2023 were as follows: USD 883 million.
Income from the Pokémon Company is not reported by Nintendo. Nintendo gains rest of the world sales of Pokémon games, whilst Japanese revenue goes through the PC. Nintendo regularly discloses 32% of voting rights, but the real stake is much higher as Nintendo owns the rights to the name, logo, every character and all the patents. Upon the launch of the the Switch successor, it’s been predicted that there could be one Pokémon game release per year.
Pokémon remains especially popular in Japan. Pokémon Centres (stores) are located across the country. Customers can purchase merchandise and even dine in. The centres allow hardcore fans to directly engage with their favourite characters or purchase branded merchandise. According to JapanTravel Redditor, reservations open 31 days prior and sell out almost immediately. This is another innovative example of how Pokémon IP is utilised.
The Switch Successor
The Switch successor is not a guaranteed homerun but it is key to the future success Nintendo. History doesn’t repeat, but investors are terrified there are echoes of the Wii U, which sold only 13% in comparison to its predecessor, the Wii. The Wii U release decimated Nintendo’s share price by 85%. ‘This time it’s different’ are famous last words in investing, but this time things really do appear to be different.
The Switch successor is rumoured for release in the second half of 2024, according to a report from VGC. The successor console will likely be a portable hybrid.
To achieve a smooth transition and achieve a ‘iPhone style’ model, it’s essential that accounts and libraries of customer’s digital downloads are instantly portable. Nintendo president Shuntaro Furukawa recently stated:
“As for the transition from Nintendo Switch to the next generation machine, we want to do as much as possible in order to smoothly transition our customers, while utilizing the Nintendo Account.”
The 330 million existing Nintendo Accounts offer an instant audience for the new console. Porting these accounts would elevate Nintendo closer to the coveted Apple-style model, where users purchase new hardware but can sign in to the same digital profile.
It has been reported that the Switch 2 will have two versions, a backwards compatible version and a digital only model. Further rumours are that the company has patented a ‘dual screen device’ that can split in half and operate independently. A potential move to a digital only console will increase gross margins further.
It’s still not clear whether the successor to the Switch 2 will launch in 2024 or even into 2025. Current leaks have suggested that the Switch 2 "looks and runs" like a PS5 game.
With previous consoles, Nintendo was predominantly focused on first party games (Mario, Kirby, Zelda etc). Third party software sales are now around half of all games sold, in comparison to the 25% volumes in the early years of the Switch.
The current Switch is notoriously underpowered, especially in comparison to the PS5 and Xbox X. This has meant it has struggled to host third-party franchises such as Fifa or Call of Duty, titles which drive sales through annual releases. Games which have been ported over, such as Witcher, would not appeal to the top level gamer. Fans described the Witcher 3 on Switch as “a blurry, tolerable compromise."
If Nintendo can retail the largest franchise games, it ensures the Switch 2 takes an additional cut of an untapped market, whilst appealing to a secondary audience normally be drawn to Xbox or PlayStation. Sales of third-party titles could be worth up to $1 billion in annual income.
Competing against the PS5 and Xbox will be no easy task. The largest advantage of the Switch 2 is the portability, the second is that it will include Nintendo games and IP.
To increase the power output of the console, the Swich 2 has been rumoured to employ Nvidia's Ampere architecture, the GA10B (Ampere) for the GPU chip. Nintendo will likely utilize the T239, a custom-made version of the T234 for the CPU.
The difference between the Switch 1 and 2 will be three generations of GPU performance. The device will likely take advantage of Nvidia's DLSS (Deep Learning Super Sampling) upscaling technology to improve frame rates while reducing power requirements. DLSS (deep learning super sampling) is a feature exclusive to Nvidia graphics cards. On PC, it works by using AI to upscale the resolution of games, allowing developers to achieve higher graphical settings and better frame rates on weaker hardware.
Nintendo is rumoured to have demoed the Nintendo Switch successor behind closed doors at Gamescom and already dispatched Switch 2 development kits to key partners.
Other sources claimed that Nintendo showcased Epic’s The Matrix Awakens Unreal Engine 5 tech demo – originally released to highlight the capabilities of PlayStation 5 and Xbox Series X in 2021.
The visuals were reportedly comparable to the Sony and Microsoft current-gen consoles. The Switch 2 will not compete with the raw power of the PS5 or Xbox X, but what it is clear (if the rumours are true), the graphical output will be on par.
Unlock of IP
In the latest financial report Nintendo reported that:
In the mobile and IP-related business, sales totalled 55.0 billion yen, up 133.3% year-on-year, bolstered mainly by the generation of revenue related to The Super Mario Bros. Movie during this term.
The Super Mario Bros. Movie generated over $1.36 billion in global box office revenue, the inverse of 1993’s disastrous Super Mario Bros release.
The success has put Nintendo IP in front of a new generation. In November, Nintendo announced the live action production of Zelda (with Sony reportedly co-financing the movie). Nintendo will be hoping to build on the success of Mario with the Zelda production.
The sequel to the Mario movie has not yet been announced, but (when) it is released will be 2026 or 2027, following Illumination Entertainment's trend of relatively quick turnaround times for sequels.
The success of the Mario movie (plus future projects) generate a fly wheel effect, increasing the engagement of a new audience who in turn purchase the hardware/software.
Super Mario Bros. Wonder was released in October 2023 and became the fastest ever selling Mario title, selling 4.3 million copies in the first 2 weeks. Nintendo believes the "global excitement" from the Super Mario Movie played a part in the "large sales volume" of Wonder.
On the 17th of February, Universal Studios Hollywood opened Super Nintendo World. This followed the 2021 opening in Universal Studios Japan. Universal Studios Japan plans to open a new area themed after Donkey Kong in 2024, expanding the area to 1.7 times its current size.
Work is currently being undertaken at Universal Studios Singapore and Universal Epic Universe (Florida), both of which are scheduled to open in 2025.
The launch of the four theme park segments in relatively quick succession will allow consumers to engage with Nintendo IP and characters, creating fans for life.
Nintendo is on the right track. Since my original article in 2021, the company has gone about quietly defying market expectations, proving to be uncharacteristically resilient.
The company is shifting to a higher gross margin model and a move to software only games. If Nintendo can achieve the ‘Apple style’ model, there is further value to be unlocked.
As an investment the company provides growth opportunities, plus there is considerable downside protection with the cash holdings and understated investments in the Pokemon Company and other equities.
The release of the The Super Mario Bros Movie brought Nintendo IP back into the public consensus. The follow up with a live-action Zelda movie will further strengthen public engagement.
There’s no doubt that Nintendo needs to get the Switch 2 right. Management appears to have learned from history, but success is not guaranteed. Release plans are very cloak and dagger. Early reports suggest that an announcement is on the horizon with promising early user feedback.
Questions remain if the Switch successor is too late to the party or underpowered in comparison to the PS5 and Xbox X. The competitor consoles were released 3 years ago and are more advanced than anything Nintendo will release. The Meta Quest and Apple Vision will add further competition to a marketplace that has been dominated by three players for decades.
By targeting the users of third party games, Nintendo goes head to head with Sony and Microsoft. The Switch 2 will undoubtedly require a higher price point, entering uncharted territory in a current two horse race.
I remain bullish on Nintendo and look forward to the release of the Switch 2. As a benchmark, Activision was recently purchased by Microsoft for $68.7B. Nintendo is valued at only $61B, if the company can truly unlock further success, how much more value can truly be delivered?
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Sources and Further Reading