I used to have a job analyzing stocks for a mutual fund. A couple of us were asked to do a total analysis of the "videogame sector" since everyone else in the office was older and felt they didn't really understand how the market worked. I did the underwriting Nintendo, THQ and Take Two. I pitched Nintendo (NTDOY or NTDOY.PK if you use Yahoo! Finance) as the stock the company should buy. Below is my original front page summary. Some of my points are glossed over because i only had about 3/4 of a page for my write up, so feel free to ask me any questions you have about my theory.
- Nintendo sold the least in terms of consoles during this most recent cycle. Having once dominated the industry, setbacks during the last cycle have set a reasonably low bar for Nintendo to overcome. With MS and SNE increasingly focusing on graphics and processing power prices are going through the roof, for both consumers as well as developers. This will be pushing the PS3 and Xbox 360 away from the casual gamer, which is the mass market, and more towards the hardcore gamer, who are the most vocal but represent only a minority of gamers. The Revolution will have a chance to flourish amongst casual gamers who are put off by the expenses associated with the PS3 and Xbox 360, as well as hardcore ones who are intrigued by Nintendo's unique approach to gaming to this next gen cycle.
- Nintendo and SNE are the only big players in handheld systems, with SNE's PSP closing in on Nintendo DS's early lead. Here the DS has been helped by backwards compatibility, as GBA (gameboy advance) games have been compatible with the DS. Game quality has been good, but the DS has suffered from poor visual appeal and a lackluster advertising campaign. On the other hand the PSP has done well due to a high quality of games, looks, and marketing, not to mention being a more powerful system. Nintendo, learning from the shortcomings of the DS is releasing the DS Lite; besides it's iPod like looks and upcoming marketing campaign Nintendo improved several technical features that their customers had wanted. This has been a prime example on how Nintendo will compete on content rather than processing power.
- Escalating prices of systems and development cost for games has forced developers to pump out sequels of hits rather than face the possibility of a flop; and not just third party developers but SNE's and MS's in-house ones as well since the systems are sold at a loss. There are new titles coming out, but sequels to hits were the cash cow during the last cycle and are already set to be so again well into the next one. Sequels are important, but new titles/ideas bring more diversity to a system as well as bring the opportunity for another hit. Lower development costs for the Revolution will invite developers to take more chances on game titles which will bring more diversity to Nintendo's offering (AVTI, ERTS, & Ubisoft have all confirmed releases for Rev).
IV. Backward Compatibility
- Nintendo will be re-releasing all of its past games on an iTunes style set up that allow Revolution owners to download old games directly (Game Cube games will require the discs). Gamers, with a $100 hard drive and the ability to solder it to their Xbox have already been able to do this and it has become quite popular among more devoted gamers. This new offering will bring nostalgic games into the main stream and give consumers a legal means of obtaining their old favorites without searching eBay for decades old systems.
- Unlike its competitors Nintendo does not sell it's consoles at a loss. Nintendo has been able to turn a profit every year since they became public in 1994. Even when Nintendo was losing ground to MS they remained profitable and tried to innovate rather than begin a market share war.
Consensus is spread pretty evenly across the board with slightly more sell and buy ratings than neutral ratings (3,2,2), leaving a balanced risk in terms of sell side rating changes. Most expect Nintendo to do only slightly better than the last cycle, but this has more to do with MS and SNE starting off slow rather than Nintendo getting the transition right.
By focusing on the quality, diversity, and price Nintendo is going to attract the underserved casual gamers who will be turned off by paying hundreds of dollars extra for what they see as only a visual upgrade. These gamers represent the masses, but are not generally the ones who are the most vocal about their games.
This month shares have started to trend upwards as investors look towards the next console transition. It will take evidence that Nintendo is regaining market share lost during the last console cycle to significantly move the stock further.
Nintendo trades at a discount to pure developers due to the fact that it bears the burden if the Revolution is a flop. As more third party developers make games for Nintendo more of their revenue stream will be dependent upon the Revolution's installed base. This could lead to Nintendo trading more inline with developers, although probably still at a discount.
I. Discount to Private Market Value: The only recent takeout activity in the public gaming industry has been valued at 19x EBITDA, but that was for a company with $80M in revenues and expecting to grow at 50%. Other activity has been the purchasing of small privately owned developers, and financial data has been unavailable. A recent 20% move in the stock has arguably weakened this pillar.
II. Important Strategic Position: Nintendo is the only company that focuses purely on games and gaming systems. This will allow them to capitalize tremendously on an improved installed base of their console which will lead to further third party support.
III. Growth Potential: At the beginning of each cycle there tends to be explosive growth for 2-3 years, followed by a dramatic slowdown once Nintendo has an installed base. The final year have seen negative growth in each of the last three cycles.
IV. Favorable Industry Cycle: Every five years the industry is forced to reinvent itself with new consoles. With different technology in each console hitting the market, this cycle could prove vastly different than the ones before it.
V. Quality Management: Miyamoto is considered the best in the business by his competitors for "his incredible vision of what gaming should be" (Gates), as well as his ability to keep Nintendo highly profitable during the last turbulent cycle.
VI. Other: Interesting play on Japan's economic recovery. Should hit peak earnings in this cycle in three years
The 20% move i mentioned was the fact that the stock price jumped from $14 to $17 in about one week, which unfortunately happened to be the week the i pitched the stock to my boss. Unfortunately i found out from the questions after the presentation that my boss had been hoping to hear that we should buy Sony because he knew of the playstation brand and had been hearing about Blu-Ray. I told him i thought it was too early for a format play and so the meeting ended with him telling me "you missed it" (in regards to the 20% Nintendo move). This annoyed me and what eventually made me open up my job search, i was currently looking, to other industries. I now take comfort in the fact that the stock price is now $55.75, a modest 225% growth rate. I was also forbidden from owning any stock, besides our company's, because they didn't want to have any possible insider information litigation. So, unfortunately no one made any money off of the work i did.
Feel free to ask me anything about my write up if you make it this far.
One more thing, i mad this pitch in Feb of 2006. read