Nintendo: A Business Transformation
Earlier, we talked about why Nintendo is an interesting asset. Today we’ll go into more detail.
ABOUT THE COMPANY
Nintendo has been around since 1889! I did not know that before!
Historically, Nintendo has depended on the successful release of gaming consoles. The gaming console business is a “razor + razor blade” business model, where consoles have been sold for low margins, with higher margins on games. However each console faced a “chicken and egg” problem. Game developers always want to develop for consoles with large installed bases while consumers always want to buy consoles that have the best quality games. This unfortunately was the reason Nintendo sales fell over 75% from 2009 to 2015, as the “Wii U” flopped. As a result, Nintendo has primarily been viewed as a cyclical business.
Recently however, the company has been undergoing a transformation. We’ll break these down into the following areas
Improving Console Business
A Focus on Digital Sales and Subscriptions
A Focus on Mobile Games
New IP Initiatives
Improving Console Business
Unlike in the past where each new console caused a reset in the installed base, going forward, Nintendo will follow an “Apple Approach” (think about how Apple benefits from leveraging the iOS platform when consumers upgrade their phones).
This has been a long time coming. But this is huge!
This transition towards a longer lasting platform creates significantly more predictability in the business, and reduces the cyclicality of the past. The new model exhibits a higher level of recurring revenues at higher margins, which makes Nintendo an even higher quality business than it was.
Investors tend to like predictable businesses like this. Hence this expands Nintendo’s potential investor base and likely warrants a higher multiple.
Lastly, this likely leads to less need for so much cash on their balance sheet (~20% of their market cap today) over time. Just like Apple has made incremental improvements to the iPhone over the last decade, Nintendo will be able to do the same. This is less expensive than innovating on a brand new console every 5-6 years. This excess cash can either be returned to shareholders or further invested into the business.
In 2017, Nintendo released the Nintendo Switch console, a home and portable console in one. This has been a big hit so far, and continues to amass a large installed base. In fact, the “Nintendo Switch” was the most searched term on Amazon Prime Day!
Sales of the Switch have increased compared to last year, and this trend is expected to continue.
Nintendo is looking to enter the Chinese market where they are partnering with Tencent, who will help them distribute the Switch. In the future, this may also lead to Tencent porting over its games onto the Switch.
This Fall Nintendo also plans to launch a cheaper portable version of the Switch (Switch Lite), which is targeted at younger more cost-conscious buyers, including former Nintendo 3DS owners.
A Focus on Digital Sales and Subscriptions
Unlike in the past, now digital sales are a huge driver of growth for the company.
And software sales seem to be accelerating, which is promising.
Included in the above digital sales is the “Nintendo Switch Online” subscription, which gives users access to important features like cloud backup, social features like voice chat and community, and of course access to classic Nintendo games.
This feels highly under-priced at only $20/yr (<$2/month). By comparison, the XBOX Gold and the Sony PS4 subscriptions costs $60/yr. The recently announced Apple Arcade will also cost $60/yr. Over time, I expect Nintendo’s subscription price to increase. Any revenue from such price increases will go directly to Nintendo’s bottom line.
A Focus on Mobile Games
“In addition, to facilitate the ability for consumers to be closely and continuously connected with Nintendo IP, Nintendo will also deploy Nintendo IP on games for smart devices.” -Nintendo 2014
Nintendo is finally showing up to the mobile games market. Finally!
In the past, Nintendo tended not to make its games available off of its own consoles. The risks of a failed console were greater than the benefits of making the Nintendo IP widely available. Today, this isn’t the case.
Today, in addition to the improved console businesses, there are >2 billion mobile phone users worldwide, and Nintendo needs to get in front of them. Over the past couple of years, they have released a handful of games. In September, they released Mario Kart, arguably Nintendo’s biggest franchise. Considering the size of the market and the familiarity of the characters, mobile games could become a huge new profitable and fast growth vector for the company. The current Mario Kart for iOS isn’t even multi-player! It will get there.
New IP Initiatives
Disney is probably the world’s most successful company in monetizing its characters. Nintendo has the opportunity to simply follow Disney’s playbook. As I’ve said before, Cloning can be very powerful.
They have already started to do this. They are planning to open “Super Nintendo World”, an attraction at Universal Studios theme parks that will feature rides and experiences based on Nintendo’s characters. The first park is scheduled to open in Osaka, Japan in time for the 2020 Tokyo Olympics.
They are also developing a new Super Mario Bros. animated movie. They are doing this as a joint venture with Illumination, the computer animation film production company behind “Despicable Me”. This provides great optionality. If this movie is successful, one can expect many more in the future.
So, Is Nintendo a Good Investment?
Big returns come from revenue growth, margin expansion, and multiple expansion, ideally all three. Nintendo has the potential to grow revenues (Switch is growing, they are expanding in China, and they are finally focused on Mobile), improve margins (digital sales and subscriptions), and get a higher multiple as the quality of the business improves (higher margin more sticky platform).
So the question becomes, how much is Nintendo worth?
We will discuss this next time:
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