Quick Overview on Nintendo (NTDOY/7974) - A Cyclical Video Game & Hardware Producer with Strong IPs

As a high level overview. I do like this business a lot with the exception of the cyclicality of the business. Nintendo is a 131 year old company that is primarily a hardware producer for consoles, handhelds, mobile/IP related content, etc. 

Some of the consoles they’ve produced: 

• Nintendo Switch 
• Nintendo Wii U 
• Nintendo Wii 
• Nintendo GameCube 
• N64 
• Etc 

Some of the Handhelds:

• Gameboy/Gameboy Color/Gameboy Advance 
• Nintendo 3DS 
• Nintendo 2DS 
• Nintendo Switch Lite 

Some of the IPs they have created over the decades: 

• The Mario Universe (Super Mario Brothers/Super Mario 64/Mario Party/etc etc etc 
• The Legend of Zelda 
• Pokemon 
• Bayonetta 
• Donkey Kong 
• Super Smash Brothers 
• Star Fox 
• Metroid 
• F-Zero 
• Fire Emblem 
• A ton more 

This is a business in the gaming industry which is a bit unusual but they basically develop everything and I mean almost everything. They spend the money developing the consoles, they develop the games, they come up with the IPs which they build on over a long period of time, they mostly do everything from the developing the consoles, the games, the infrastructure and its stops at the launch where they have it manufactured overseas and then sold all over the world by retailers. The exception is that they sometimes have the occasional third party developers and other partners that may assist with development but they own almost all aspects of their IPs. 

This business has a very loyal following and fanbase which contributes to the pricing power they have over the consumers. Nintendo fans will always buy the consoles and the games in most instances outside of a really bad flop they have with the Wii U which didn’t do very well. They have a very protective way of using their IPs and their games are usually very polished and well made. 

I think the whole thesis here relies on if the business can somewhat smooth out the cyclicality of their revenues or earnings. This company is still extremely reliant on console sales. Anywhere from 80-90% of the revenues are coming from the latest console. Why I say this is a medium risk investment is that if for whatever reason they have another Wii U kind of release you are looking at the next couple of years of either 0 organic growth to the company burning cash for a few years due to bad sales. This is a big reason why the management is overly conservative with cash and has been very reluctant to buyback a decent amount of stock, they will hold cash to weather a few bad cyclical years. In the case where this company doesn’t figure out how to smooth out the cyclicality of the business, this investment would be both hard to value and in most cases it would have to be really cheap to consider jumping into. 

Running some calculations you can kind of estimate what price point you should consider buying the stock. During the off-years where they didn't have the growth of the WII or the Switch Console sales the stock was trading around $20-$40. This is probably a really decent range where you can pick up over a 10% earnings yield and the upside would a decent console release that at the bare minimum is better than the Wii U release and it would sustain some growth here. 

I see two ways for Nintendo to combat the cyclicality of their business: 

1. The most recent bull case I've read and many have talked about is where Nintendo is able to leverage their IP and expertise to produce subscription based revenue. I think they can do this depending on how willing the management is. There’s a ton of ideas how they can do this. Maybe a subscription service to play retro Nintendo games similar to a streaming service...maybe? But I won’t speculate too much here. 
2.  Develop various hardware, tap into mobile gaming a bit to bring in other revenue outside of the consoles. I don’t know how they would do this, I don’t know enough of the industry to understand how they could achieve this where it is just not common to have recurring revenue each year from various gaming related hardware. Generally these companies have one piece of hardware that's really popular in year 1 and 2 and then tapers off in years 3, 4 and 5 until the next release. Handhelds somewhat help smooth that out, but not much.  

Why I think this would be highly rewarding is simple. Lets assume they succeed in a product that brings them in subscription revenue each year on retro games for instance. It smooths out the revenues a bit, allows the management to be less tight financially meaning that capital can finally be returned to shareholders. They can buyback a lot more stock and perhaps pay out dividends when necessary as well as organically grow the business very smoothly. I think it will take a while for Nintendo to figure this out consider how incredibly reliant they are on console sales but a lot of upside would be here in that case. 

Lastly regarding the management. There’s aspects that I like from them, and some that I do not, but I kind of understand now knowing a bit more about the business. My view is that they are a bit too conservative for me, they’re too conservative on leveraging their IPs to help grow the business in a less volatile way. Maybe it is the right choice, im not sure completely. Ultimately it is up to them on taking the opportunities that’s available to them. I was very critical on how much they horde their cash but I think it is the right choice to avoid a bad console release and the risk of them taking on debt/diluting shareholders to offset bad years of cash burn. Thanks for reading, I will send out a more through updated analysis of Nintendo when I get time to study the business and the industry a bit more.