NTDOF - Buy Nintendo: It Has A Lot Going For It

2023-08-18 11:12:58 ET

Summary

• The video game industry is undergoing a major transformation, with consolidation and M&A deals becoming more prevalent.
• Microsoft's attempted acquisition of Activision Blizzard highlights the shift towards content being the future of gaming.
• Nintendo's strong IP library and focus on casual gamers position it well for continued success in the industry.

The video game industry is undergoing a colossal transformation. With the consolidation of the industry already underway, we are at the precipice of a new era for video games. Seb Joseph of DigiDay wrote an article back in January 2022 entitled: ' In Graphic Detail: The great gaming consolidation ' in which he stated:

Gaming is in the midst of an M&A arms race. The protracted pandemic has made sure of that. Companies from all sides of the market, Microsoft, Take Two, Sony to name a few, are cutting deals to secure content. The volume and scale of those deals point to where gaming is heading - the precipice of major shake-ups across its core commercial and distribution models. Microsoft's eye bulging $69 billion deal for Activision is a testament to that shift. Costly as the deal is, it's arguably a small price to pay to secure some of the biggest franchises in gaming: Call of Duty, Warcraft, Candy Crush and Overwatch. Even more so, considering those titles span a community of 400 million active monthly players. In other words, the deal is the boldest sign yet that content is the future of gaming, not consoles.

- In Graphic Detail: The great gaming consolidation by Seb Joseph (January 20, 2022), DigiDay.com

Microsoft's (MSFT) attempted acquisition of Activision Blizzard (ATVI) substantiates Joseph's argument. In fact, video game M&A has escalated recently, reaching a record investment and M&A activity of $74.5B in 2021 (before decreasing to $51.5B last year). Astonishingly, 9 of the top 15 (60%) largest deals of all time have been completed within the last three years according to research published on Statista :

Looking at the list of the largest video game industry acquisitions we see Microsoft on this list three times (as the acquirer), showing their penchant for blockbuster acquisitions. This list is dominated by content acquisitions, rather than those aimed to acquire hardware technology (i.e. Facebook's acquisition of Oculus). Additionally, there is a strong skew towards mobile. Of the 15 largest video game acquisitions, the majority are mobile-focused companies (Zynga, Supercell, King.com, Playtika, Fanduel, Moonton, SpinX Games, Glu Mobile), with most of the other companies also offering mobile products (i.e. Mojang, the developer behind Minecraft , also offers a mobile app version of the game).

Activision has made the list before, having acquired King in 2015 , "a leading interactive entertainment company for the mobile world, with people all around the world playing one or more of our games... We have 250 million monthly active users as of Q1 2022 across web, social and mobile platforms." This surely was a factor in Microsoft's interest in the company.

While Microsoft's purchase of Activision would be the largest video game industry acquisition ever, the deal has not (yet) been completed. It has been a "roller coaster" ride to say the least ( "Microsoft's Activision Roller Coaster" as Stephen Totilo put it in Axios Gaming's July 13th, 2023 newsletter ). Now, over a year and a half (you read that right) since Microsoft's January 18th (2022) offer to acquire Activision, both the companies and their investors desperately want closure. The July 18th deadline for a deal has passed, with Microsoft and Activision amending the terms of their agreement. As the (amended) agreement stands now, if the deal fails to receive regulatory approval (at this point, primarily pending approval from the U.K.) Activision is set to receive a break-up (termination) fee from Microsoft of $3.5B (renegotiated from $3B after the July 18 deadline passed while extending the deal deadline until October 18) . This is equivalent to ~5% of Activision's current market capitalization and would increase to $4.5B if a deal is not completed by September 15.

There are various potential outcomes, though I believe that the deal will ultimately receive regulatory approval in the U.K., as it has with every other regulatory body reviewing the deal (all 38 of them -- the 37 mentioned in GameSpot's May 22nd article plus the U.S.). While keeping in mind that the deal is not yet set in stone, I will share my thoughts on the industry, its future, and where I am investing my money. But first, I think that it is important to examine how we got here and look back into the past in order to help us better understand the present and future.

A Brief History

The video game industry has an extremely rich history, undergoing extensive change in a relatively short period of time. Since their development, video games have experienced a meteoric rise in adoption and popularity. "[T]he first computer game" is often attributed to MIT's 1962 Spacewar! which "ran on a PDP-1 computer the size of a large car," though precursors to this game were developed as early as the 1950s .

Thanks to rapid hardware and software improvements, video games soon began being developed outside of laboratories. Atari's ( Euronext Paris : ALATA) Pong became one of the first commercially successful video games and is even (incorrectly) considered by some to be the first video game. Its 1972 release, less than two decades after the development of the first video games (in laboratories) , "helped launch the video game industry" and has been said to be responsible for the existence of arcade gaming . The Guardian's Keith Stuart declares that it was the 15th greatest video game of the 70s , despite the fact that:

[i]t wasn't the first video game; it wasn't even the first ping-pong game - Table Tennis on the Magnavox Odyssey [a home console] got there earlier [ which led to a successful lawsuit against Atari with the first ever video game patent ]. Pong was, however, the game that kickstarted the video arcade and home console industries, [with] the profitability of its hardware and the simplicity of the gameplay - just two bats, a ball and a scoring system - ensuring its huge success and iconic afterlife ."

- The 15 greatest video games of the 70s - ranked! by Keith Stuart (May 13, 2021), The Guardian

While Atari's Pong was not the first video game, it was Atari's after being incorporated in 1972 by Ted Dabney, who invented Spot Motion Circuit technology, and Nolan Bushnell , considered by many the father of electronic gaming. The first commercially available arcade game was Computer Space, released a year before Pong in 1971 by Nutting Associates. What is often omitted, according to Leslie Berlin of Wired (definitely worth a read), is the fact that Nolan Bushnell was an employee at Nutting Associates and partnered with Ted Dabney on the side to develop video games. Together, they created Computer Space ("...based on an iconic game called Spacewar! ") at their start-up engineering firm ' Syzygy' , which "refers to the alignment of three celestial bodies" which was later renamed Atari. Controlling costs by rewiring the logic circuits within a television instead of using a computer, they were able to profitably manufacture the game and licensed it to Nutting Associates. Bushnell and Dabney were instrumental in laying the foundation for today's video game industry.

Atari's Pong , released a year later in 1972, was an " instant success ... consistently earn[ing] four times more revenue than other coin-operated machines , which resulted in an increase in the number of orders Atari received." Bushnell is quoted as saying that Atari was selling 100 Pong machines a day -- which was not entirely accurate. "Some 7000 Pong games were sold in six months," resulting in approximately 38 Pong machines a day -- still an extremely impressive number. There was intense demand among a variety of businesses to host a Pong machine which was "prized for its relative quiet, novelty, and cutting-edge feel." The machines were everywhere from bars and arcades to "airports, hotels, and high-end department stores that never would have considered a pool table or pinball machine..." Pong broke barriers and helped introduce the general public to video games.

Atari, however, did not have a patent for Pong until after the game was released which opened the door for numerous imitations. Bushnell and Dabney's company -- less than a year old at the time of Pong's release -- had limited resources. In fact, the company initially limited the production of their Pong Cabinets to just 12,000 machines due to financial constraints. With numerous Pong knockoffs hitting the market, Bushnell and Dabney decided to focus on developing new games rather than "spend[ing] the time and money battling for the legal rights of a game that was being imitated across the country."

After a reorganization of ownership (a falling out between Bushnell and Dabney), Atari continued to push forward and innovate :

In 1974 [ other sources specify that the idea came about in 1973, while the development began in 1974], Atari engineer Harold Lee proposed a home version of Pong that would connect to a television. The system began development under the codename Darlene, named after an attractive female employee at Atari."

- The Centre for Computing History, Cambridge ( ComputingHistory.org )

This new console would come to be known as Home Pong . Despite their innovative and superior system, "[ i]n 1975, Atari was rejected by toys and electronics manufacturers and most other PONG systems didn't sell much ." Atari needed a distributor, but there was a lack of interest in Atari's Home Pong console, largely because Magnavox's Odyssey was becoming obsolete.

Even in its infancy, the video game industry was highly competitive and progressed rapidly - but Atari thrived thanks not only to its superior technology (i.e. a single dedicated chip in their consoles ) but also its partnerships. Atari's Home Pong's partnership with Sears was a key component of its success. After the system was developed, "[o]ne of Atari's directors decided to contact Tom Quinn , who worked at Sears/Roebuck... Sears ordered 150,000 PONG systems for Christmas [that year, in 1975]. " Although these systems were manufactured by Atari, they were "sold under the Sears Tele-Games label" (a co-manufacturing model). While not the first table tennis game, thanks to its ingenuity and strategic partnerships, " Home Pong will be a huge [ and instant ] success, and will be the cause of multiple imitations and several lawsuits [as with the original Pong Arcade Machines ]... its popularity did not fall until more advanced systems came on the market." When Home Pong was first released it "became Sears' most successful product at the time , which earned Atari a Sears Quality Excellence Award ." It far outsold Magnavox Odyssey (200,000 units over three years), selling 150,000 units in its first year (1975).

Just a year after Home P ong was released, Bushnell "was [also] ready to cash out and go back to creating things instead of managing them. He sold his remaining Atari stock and ownership to Warner Communications ( T ) in 1976 for $28M. Many, including Stephen Schuyler of Grunge.com , ponder: "[w]hy did Bushnell sell a company that he only founded four years earlier?" Schuyler theorizes that the industry was becoming increasingly competitive, and Bushnell needed both Warner's capital and ecosystem to promote and distribute Atari's products : "Warner was a large conglomerate and had the capital heft Atari needed. As part of the deal, Bushnell remained head of the company, but he was ultimately working at Warner's pleasure."

This was a major moment not just for Atari but also for the entire video game industry. After acquiring Atari in 1976, Warner had tremendous success - perhaps aided by the fact that Nolan Bushnell was still employed as president of the company. Within just a few years, "[b]y 1980, sales of Atari home video systems [i.e. Home Pong, Atari VCS ] had reached $415 million." Simultaneously, in 1978, Atari released its first personal computer . While known for its impact on gaming, "Atari held on to a niche of dedicated fans [of its computers] for years until finally shutting down its PC division in 1993."

Atari had not only demonstrated the potential value of video games but essentially helped to create a market for them. According to Damien McFerran of Time Extension , Atari's role in founding the industry cannot be overstated :

Then there's Atari - the company that arguably did the vital pathfinding in the realm of home video games that allowed companies like Nintendo and Sega to flourish. Atari created the first truly mass-market home gaming system in the shape of the VCS [also known as the 2600 which was " the console that started the video gaming boom in the '80s..."], and also pioneered the concept of [licensing] the software of other companies when it paid Taito for the rights to port Space Invaders to its console. It even inadvertently created the concept of third-party publishing when it treated four of its key staffers - David Crane, Larry Kaplan, Alan Miller and Bob Whitehead - so poorly that they decided to leave and set up Activision, the first video games company of its kind. "

- Flashback: Remember When Atari Turned Down Nintendo and Sega? by Damien McFerran (October 6th 2022), Time Extension

Interestingly, Nintendo signed a distribution agreement with Atari in North America, but due to several factors -- including the 1983 video game market crash -- the deal fell through. One can only imagine how this deal would have reshaped the industry.

What could have been for Atari... within just a few years, " the greatest, most popular games were being made by Activision and the company kept cranking out hit after hit. By 1982 Activision was selling 150 million dollars worth of games a year and had replaced Atari as the fastest growing video game company in the United States." Concurrent with Activision's success, Atari's downfall continued as it made mistake after mistake. "Atari released the home version of Pac-Man, which was highly anticipated by gamers worldwide." Unfortunately, it disappointed customers as "Atari's Pac-Man didn't live up to its hype" and only sold a little more than half (7M) of the 12M gaming cartridges that were manufactured. And even then, many of the sold cartridges "were returned by outraged customers."

That same year Atari committed another, perhaps even more consequential blunder, indicative of the negative effects of the industry's rapid growth and foreshadowing the devastating video game (industry) crash of 1983:

...Atari made a bigger flop with E.T. The Extra-Terrestrial, a game that was rushed out in just 6 weeks, whe[n] it should have taken about 6 months to develop. Atari was adamant about releasing the movie-based game right in time for Christmas, and the company wasn't even sure if consumers would be interested in the game. This resulted in a buggy, unplayable game. According to Ray Kassar, the CEO of Atari at that time, about 3.5 million of the 4 million produced were sent back to the company as unsold inventory and customer returns. Atari ended up dumping nearly 800,000 game cartridges in a New Mexico landfill. "

- Rise and Fall of Atari: How the Gaming Giant Died? by Nafiul Haque, (November 22, 2021 -- updated January 18, 2023) Tech Inspection

Generations: Console Development and Competition

While Atari helped invent and popularize video game consoles, video games have taken on a life of their own and have only continued to evolve. The development of video game consoles is often divided into nine overlapping generations -- though there is debate regarding both how many of and when these generations occurred as illustrated below :

There is a general consensus , however, surrounding the nine generations. Many agree that the first generation spanned from 1972 - early 1980. While there were several consoles released during this period, including the Magnovox Odyssey , Atari's Pong , and Coleco's Telstar , the Nintendo Color TV-Game stands atop the first generation. It sold 3M units just in Japan after launching on "June 1st, 1977 for 9800 yen, which is around $88." The original TV-Game had "six different versions of Pong on it", while the improved second iteration TV-Game 15 "had fifteen different games available for it. Nintendo continued releasing variations on this console until 1983, when they would replace it with the Nintendo Entertainment System [NES]. " According to cbr.com's Sage Ashford , "[t]he numbers on the early first generation consoles are a bit harder to figure out than most cases due to things not being tracked as well as they are now." Still, according to Ashford, the Nintendo Color TV-Game led the first generation of consoles in sales.

The second generation of video game consoles existed between 1976 and 1992. This generation included Coleco's ColecoVision, " the Atari VCS (also known as the Atari 2600), [and] Mattel's Intellivision..." Coleco's 1982 release of its ColecoVision home console was ominous, as it preceded the infamous 1983 video game crash by just a few months. Still, Coleco managed to sell an estimated 6M units of its console at $199 (est. $642 in 2023 using the CPI inflation calculator ), taking the second spot in sales for the generation. The second generation, however, was dominated by Atari's VCS (2600) which sold 25M units after being released in 1977 for $180-190 (est. $935-$988 in 2023). The five-year gap between the two console releases is significant given the rampant inflation at the time. Atari's VCS was almost 50% more expensive in inflation-adjusted terms despite launching for a cheaper price given the high inflation at the time. It is quite stunning how successful these consoles were given their (inflation-adjusted) cost.

The second generation of consoles separated themselves as they:

...featured interchangeable game cartridges that were retailed separately, rather than games that came preloaded in the unit. This advance allowed users to build a library of games [and opened an entirely new revenue stream] ... but, ironically, this surplus proved to be... one of the key reasons that the industry faced a serious crash during the early 1980s."

- Video Game History , Smithsonian

While game cartridges became overproduced and contributed to the video game crash of 1983, there are also many positives that emerged from this new innovation -- for instance, it led to the formation and success of a plethora of companies that develop, publish and distribute games. This wasn't the case in the early days of the industry, however, when games came pre-installed on consoles (these games were usually exclusive to the device, though some games were ported ). This is why Atari was known for both their games (i.e. Asteroids) as well as their devices (initially arcade machines, but also home consoles in the mid to late 1970's). Because they controlled both the devices and games, Atari dominated the early video game market. According to The New Yorker , "[i]n 1982, Atari controlled eighty per cent of the video-game market." How the mighty have fallen.

The 1983 Crash

Andrew Pollack of the New York Times described the troubling situation at Atari in a December 1982 article entitled "The Game Turns Serious At Atari" . Pollack chronicles the issues surrounding the management and culture of:

... the world's largest video game producer... [s]uch rapid-fire dismissals, as well as resignations, have become a trademark... The high turnover was saying something about the management of Atari, but few people were listening. After all, Atari was probably the fastest growing company in the nation, climbing to about $2 billion in sales in a few years as the video game craze swept America.

Now people are taking notice. In the last two weeks, a series of revelations have rocked the video game industry. The most stunning was the sudden announc[ement] 11 days ago that Atari's parent, Warner Communications Inc. ( T ), expected a dramatic slump in fourth quarter per-share earnings - the first such decline in 31 quarters - largely because of disappointing sales of Atari's video game cartridges. The news sent the stock of Warner and other game-related companies reeling and has provoked a major reassessment of a company that has captured as much attention on Wall Street as it has in arcades and family living rooms."

Pollack was documenting the beginning of what would be the infamous 1983 video game crash. Many of the issues outlined by Pollack were not unique to Atari. Perhaps the largest threat to video game console manufacturers was the explosion in the number of competitors, and thus options for consumers, as well as the plethora of available games, many being " of inferior quality " (i.e. E.T.). Much of this stemmed from the industry's rapid growth.

In 1983, just a year after accounting for 80% of video game sales , Atari's "C.E.O. stood accused of insider trading, [and] demand for video games had fallen so much that the company dumped fourteen trucks' worth of merchandise (largely the aforementioned E.T. The Extra-Terrestrial game) in a New Mexico landfill and poured cement over the forsaken games to prevent local children from salvaging them." This dump has become a legend in itself and had been "said to hold more than three million copies (of the five million produced) of the famously awful Atari adaption of Steven Spielberg's E.T.: The Extra-Terrestrial." A dig, documented by The New Yorker , "confirmed that the legend is true, although the archaeologists on hand estimated that the E.T. cartridges numbered in the thousands, not the millions... The E.T. guess was a good one, though, because Atari had produced many more copies of the game than people wanted." The excavating crew found plenty of games, however, many were "more commercially successful titles like Centipede, Space Invaders, and Asteroid." A curious find indeed.

This, in my opinion, is indicative of how bad the crash of 1983 truly was for the video game industry. For some background, "[b]ack in 1983, the course of retail history was changed forever when an industry-wide recession hit the North American video game industry, which was then led by Atari, causing the bankruptcies of some large players and putting the entire future of the budding industry into doubt." While many blame the disastrous E.T. video game for the crash ("There wasn't just one factor -- stop blaming E.T.!" writes svg.com's Helen Lee ), there is more behind the story.

At its peak (back in the 1970's and early 80's), the video game industry was worth a cumulative $11.8B ( an estimated $38.06B in 2023 taking into account inflation). What caused the booming industry to crash? Since the industry was young and:

... still trying to figure out what work[ed] best, execs made some colossal mistakes. For example, the market was glutted with consoles, including multiple Atari products, ColecoVision, Intellivision, Milton Bradley's Vectrex, and the Magnavox Odyssey. Meanwhile, PCs were becoming serious competition. There was even insider trading involved. At the time, plenty of optimism (and hubris) permeated video game business units, and inexperienced, newly formed third-party publishers flooded the market with low-quality games. In fact, 12 million copies of the less-than-perfect Pac-Man were produced for the Atari 2600 console, even though only ten million people owned the system. All this led to a loss of consumer confidence and a crash for the ages.

- The Truth About The Video Game Crash Of 1983 by Helen Lee (January 23, 2023), SVG

The crash changed everything. "Retailers started becoming wary of anything connected with the industry... Atari never recovered... Coleco left the industry to focus on its toy lines. [And] Magnavox, maker of the very first video game console" would only release one more -- in Europe. It was devastating. There were, however, some positives that emerged from the rubble... consumers certainly benefited, as "PC gaming thrived as companies like Activision started to diversify, making games for computers instead. Also, plenty of people could now pick games up at bargain-basement prices, leading to many younger adults discovering gaming." Other results of the crash included "console developers [keeping] a closer rein on what was published for their systems (via safeguards such as Nintendo's lockout chip) and to focus on better development and testing. Additionally, the crash allowed Japan, led by Sega and Nintendo, to take over the dominance of the industry. Basically, it affected the way the industry looks today - for better or worse."

How did Atari in particular fall so far from its former glory? In its early days, Atari had a laid-back and "licentious" culture that bred creativity and success. This "freewheeling and hedonistic" environment did not gel with and, after their 1976 acquisition, was mangled by "Warner's stuffy corporate culture... [hence,] Bushnell came to be increasingly at odds with the new ownership." He disagreed with the changes in Atari's culture and "became antagonistic to Warner." Despite a large financial investment, sales of Atari's new VCS console (released in 1977) lagged behind expectations, which led to a restructuring of Atari and the dismissal of Bushnell in 1978. It seems, through M&A, Atari lost much of what made it successful, including its culture and creative edge.

Concurrent with Atari's 'decline', competition continued to grow. The video game industry was getting crowded and advancing rapidly. The companies that entered the market after witnessing Atari's initial success continued to innovate ("led by two Japanese systems: Sega's SG-100 [in Japan] and Nintendo's Famicom system [1983]"), eventually leaving Atari, one of the industry's founders, behind. The crash helped transform the industry into what we know today.

Arguably, Nintendo's NES "saved an industry." The NES, according to Andrew Cunningham of arsTechnica.com, is responsible for "resuscitating the American video game industry and setting up the third-party game publisher system as we know it." After launching its predecessor, the Famicom ("Family Computer"), on July 15, 1983 in Japan, Nintendo wanted to expand its market to the US. In 1985, after having success with its Famicom console (selling over 2.5M units in Japan less than two years since its release), Nintendo:

... announced plans to release the console in North America as the Advanced Video Entertainment System (AVS) that same year. The American video game media was skeptical that the system would be successful in North America, as it was still recovering from the video game crash of 1983... the March 1985 issue of Electronic Games magazine stated 'the video game market in America has virtually disappeared' and that 'this could be a miscalculation on Nintendo's part.' Boy were they wrong!"

- How Was the NES Successful (October 11, 2021), About The 80s

Andrew Cunningham reiterates this point, explaining that despite "[t]he system [being] impressive... the still-terrible market for video games made such a complex (and expensive) system a tough sell... and after a lukewarm reception, Nintendo went back to the drawing board to work on what would become the Nintendo Entertainment System we still know and love today." Nintendo released the console in the US in October 1985. As Cunningham explains:

[It] wasn't just a console redesigned for a new territory, but a comprehensive re-branding strategy meant to convince Westerners that the NES wasn't like those old video game consoles that had burned them a few years before. This new Famicom was billed as an 'entertainment system' that required you to insert 'game paks' into a 'control deck,' not some pedestrian video game console that took cartridges. The console's hardware followed suit-it was still marketed to kids, but the gray, boxy Nintendo Entertainment System looked much more mature than the bright, toy-like Famicom. At the same time, accessories like R.O.B. the robot [ 'Robotic Operating Buddy' ] assured parents that this wasn't just for 'video games'-still dirty words to many consumers."

Despite the poor expectations, it was reported in 1989 by Compute! that Nintendo had:

sold seven million NES systems in just 1988, almost as many as the Commodore 64s sold within its first five years. The magazine claimed, 'Computer game makers [are] scared stiff,' stating that Nintendo's popularity caused the majority of competitors to drop during the previous Christmas. Some even experienced serious financial problems.

In June 1989, the VP [of] Marketing of Nintendo of America, Peter Main, said the Famicom was present in 37% of Japanese households. By 1990, 30% of American homes owned the NES, compared to just 23% for all personal computers. Also in 1990, the NES outsold all previously released consoles worldwide. The brand's new slogan became 'It can't be beaten'. The only region that didn't sell the console was the Soviet Union."

- How Was the NES Successful (October 11, 2021), About The 80s

The NES not only saved the video game industry but also helped expand it to a much larger audience.

Best Selling Consoles

Today's big two consoles are Microsoft's Xbox and Sony's PlayStation -- but it hasn't always been that way. Analyzing The Best-Selling Video Game Console Of Each Console Generation , Nintendo dominated the first four generations, earning the award for three of them (with the Nintendo Color-TV, NES, and Super Nintendo). Atari took the 2nd Generation with its 1977 release of the Atari 2600, also branded as the Atari VCS, which sold 30M units. Sony has taken the title every generation since (except for Gen-7, when Nintendo's "radically different" Wii stole the show ) with the launch of its original PlayStation in 1994 (Gen-5), which sold over 102M units -- the first console to surpass the 100M mark at the time. Quite surprisingly, Microsoft's extremely popular and profitable Xbox has not topped the list in any generation.

I've listed just the top 25 consoles below in terms of hardware sales (in millions of units). You can see the 80+ ranked devices on the VGChartz website here . Of note, Nintendo holds half of the top ten spots with its DS, Switch, Game Boy, Wii, and Game Boy Advance devices:

But total sales include more than just hardware. These are the total software sales (in millions) by console:

Looking at the other piece of the puzzle, software unit sales, we notice a similar trend. Shockingly, the first four PlayStation home consoles all made the top six spots in terms of associated software sales , with the PlayStation Portable and PlayStation Vita (both handheld consoles) also cracking the top 25. Nintendo is certainly no slouch itself, however, leading the list by taking eleven spots in the top 25 . It is important to note the significance of the top echelon of these rankings, however... there is a steep decline within this list, from 1.5B software units for the top-ranked PlayStation 2 to just 20M software units for the Sega Advanced Pico Beena ranked just two dozen spots lower at #25. Thus, it is especially impressive that Sony and Nintendo take the first 14 spots between them except for one (#4 Xbox 360), though Sony's performance is truly spectacular.

The Tie Ratio: Games per Console

VGChartz.com created the table below illustrating the number of hardware and software units sold for each relevant console, as well as its "Tie-Ratio" , which " ...tells us how many games were sold for every console purchased. Put another way, the hardware to software tie ratio shows how many games a system owner buys on average."

As of May 2023, IGN reports that Sony has sold 102.4M Original PlayStation consoles (released in 1994 in Japan/1995 in the US) . To go along with these consoles, 960M software units have been sold - a tie ratio of 9.375, or to say it another way: an average of 9.375 games owned per console. This is similar to the PlayStation 2, which sold a still-standing record of 159M consoles (estimated through 2013) with 1.5B associated software units - averaging a 9.43 tie ratio. These calculations used IGN's data, which is extremely similar to, and thus validates, the data presented below from VGChartz.com.

While there is some room for debate in deciding the top console manufacturer, it usually comes down to Sony and Microsoft who capture the top 5 spots on the tie-ratio list. From an investment perspective, however, my money is on Nintendo. While it may not have the top-selling console, it is, in my opinion, the best pure-play bet on video games having manufactured several of the all-time best-selling consoles, as well as owning some of the most well-known (and played) franchises in video game history. This is illustrated by the fact they have the most consoles in the top-25 Tie Ratio list, with 11. This is particularly important as there has been a fairly recent eruption in M&A within the industry as companies try to acquire IP in the form of valuable video game franchises as illustrated in S&P Global's graph below (please note this is just software mergers & acquisitions):

And perhaps even more shockingly, 2022's total shown is only through June 30, 2022 -- M&A increased by over 500% year/year in just the first six months of the calendar year (in fact, ~95% of Home Entertainment Software M&A for the year through June 30, 2022 was announced in January). The majority (nearly 80%) of this total, however, is comprised of Micro soft's planned acquisition of Activision Blizzard:

What is interesting, however, is that the majority of acquisitions in the space are primarily comprised of software-centric companies (the list above focuses on just software M&A), which is becoming the primary asset and differentiator in the industry instead of hardware. Companies including Microsoft, Sony, and even Apple ( AAPL ) -- through its Apple Arcade service -- are loading up on IP themselves, often via M&A, as the industry continues to become even more competitive through consolidation. Content--in particular exclusive content--is key. It attracts gamers to a platform; and whether it is a mobile phone app or a console, it creates buy-in . Companies can also acquire users through M&A, which certainly picked up in 2022 as it (software M&A) surpassed $100B in transaction volume just within the video gaming industry .

2022 did more than just set a deal value and volume record - it changed the landscape of gaming. "... 2022 saw three of the biggest mobile gaming acquisitions of all time" :

- Activision Blizzard (acquired by Microsoft for $68.7B pending regulatory approval)

- Zynga (acquired by TakeTwo for $12.7B)

- Bungie (acquired by Sony for $3.6B)

This extremely competitive environment is often good for consumers, which has certainly been the case with a plethora of new console and game releases within the past several years. This competition also creates a natural selection of sorts, and there is one company that truly separates itself from the others: Nintendo.

Present Day

Gaming is a much larger industry than many realize as it stretches far beyond just video game consoles. "In fact, [ according to Andrew Beattie of Investopedia, ] it is larger than the movie and music industries combined, and it is only growing. Though it doesn't get the same attention that the movie and music industry does, there are over two billion gamers [as of October 2021] across the world. That is 26% of the world's population." In recent years, gaming -- undoubtedly aided by the Pandemic and led by mobile (along with new technologies such as Virtual and Augmented Reality) -- has become more popular than ever with an estimated 3.09B players worldwide and 216M in the US alone . The uptick in players and valuations has only increased the consolidation within the industry as it continues to grow and evolve.

Though today's video game market is almost unrecognizable from that of its infancy, numerous current companies have direct roots back to the industry's formation in the early 1970s. For instance, Magnavox is now part of Philips ( PHG ), Atari -- or at least what was left of it ("...Atari home computer games and the intellectual property rights and license agreements associated with such games") -- was bought by Hasbro ( HAS ) in February 1998 for $5M, less than 20% of what Warner had paid for the company two decades prior. Hasbro Interactive was then bought out by Infogrames Entertainment, which renamed itself Atari and sold off numerous Atari assets but struggled to remain afloat, filing for bankruptcy in January 2013. Through the bankruptcy proceedings, Atari assets were sold off to a plethora of companies including Glu Mobile ( EA ), Nordic Games (now part of the Embracer Group ), Appeal Studios ( Embracer Group ), Rebellion Developments, Devolver Digital ( went public on the LSX ), Epic Gear, Tommo, Wargaming, Stardock, Bigben Interactive (renamed Nacon and is publicly traded in Paris), Piko Interactive, THQ Nordic ( Embracer Group ), Ziggurat Interactive among others... and what's truly spectacular is that every single company listed is still in business in one form or another... Atari's IP has truly taken on a life of its own.

The 1983 crash slimmed down the competition, but it has intensified again, some forty years later. The space has seen a tremendous transformation over the years with numerous bankruptcies, acquisitions, and mergers, yet there has been one constant: the video game industry continues to play an integral role in society.

Current Landscape

The video game industry's landscape has only continued to develop and evolve. Konvoy Ventures (a video game focussed VC firm) illustrates the complexity of today's video game industry in the graphic below :

While the graphic was created pre-pandemic in January 2019, it highlights several important and still relevant trends within the industry. Video games have evolved far past just console manufacturers and game developers. Konvoy Ventures divided the sector into six over-arching categories (each with multiple sub-categories): Professional Scene, Community, Technology, Gambling & Fantasy, Game Development, and Sponsorship & Advertising .

Some companies appear in multiple categories. Of note, developers and publishers -- both under the 'Game Development' category -- seem to have the most overlap with 60% of the listed developers (6 of 10) also appearing in the publisher category, which is an understandable union. Others including Twitch (owned by Amazon ( AMZN )) appear in multiple categories demonstrating both the breadth of offerings in the space as well as the overlap between them. That being said, the industry has become extremely specialized with most companies only focussing on one specific offering. This is a significant change from the early days when console manufacturers would also be responsible for pre-downloading games onto the device (either through development or porting from other manufacturers/developers ).

The largest shift, however, has been where and how consumers play:

Arcades, having dominated sales as recently as the 1990s, have all but disappeared, with Consumer video games constituting almost all U.S. Video Game Market Revenues. But this graph lacks an essential split - there is more than one type of Consumer video game revenue stream today as the Visual Capitalist's graph illustrates (to be able to read the small text please visit the article here ):

Today's video game market is far more complex than console vs. arcade. Though consoles play a large role with revenues at $33B (20%) of the industry's $165B (as of 2020), mobile games actually dominate with a 51.5% share ($85B). This is an additional reason I like an investment in Nintendo... not only is their Switch console portable which fits better with most peoples' lifestyles and gaming preferences ( "on-the-go gaming" ) but using their IP, Nintendo has been able to develop some of the most downloaded and top-grossing mobile apps. Nintendo is already implementing a 'mobile strategy.'

Covid Influence

The industry has continued to grow in the long run while undergoing seemingly constant change and evolution (both technological and other). It was even undeterred by the Pandemic, as it instead became "'one of the biggest boons for gaming in the last several years'... In a normal year, [one] would expect video game sales growth to match inflation, so about 2% or 3%. This year [2020], it's up 20% over 2019 figures." COVID caused this unexpected uptick due to efforts to contain the virus, which had people "looking for new ways to entertain themselves and socialize. While experts predict this increase will eventually plateau and then decline, they also think a number of trends will last beyond the pandemic."

Gains were made both on a financial and engagement level during the pandemic:

At least at a financial level, the giants of the video game industry - including Microsoft, Nintendo, Twitch [ owned by Amazon ] and Activision - have thrived in the conditions created by the pandemic. In April, Microsoft disclosed that the number of subscribers to its Game Pass service (think Netflix-for-gaming) cracked 10 million... Last week, Nintendo announced sales of its Switch console were up 24 percent year-over-year, while its new game, 'Animal Crossing: New Horizons,' had sold 13.5 million copies since its release in late March.

The same is true of engagement numbers. Twitch, the most popular video game streaming platform, saw 1.49 billion gaming hours watched in April - a 50% increase since March ... Epic Games's Fortnite has also grown to new heights: An in-game Travis Scott concert saw over 12 million concurrent views from players, and in April alone, players racked up a combined 3.2 billion hours in-game."

- The giants of the video game industry have thrived in the pandemic. can the success continue? Noah Smith, May 12, 2020

COVID's influence on gaming was astonishing. " More than half of players (55%) said they played more games during the pandemic, and most players (90%) said they will continue playing after the country opens up, according to a survey of 4,000 U.S. adults conducted by market research firm Ipsos in February [2021]..." Not only did more people participate in gaming, but they also spent more time doing so according to a 2020 study by RentCafe .

In June 2020, towards the beginning of the COVID pandemic, Neilsen was already starting to see a change in trends stating: "... there's no denying the impact of video games and esports on media consumption as consumers sheltered-in-place during much of [COVID]. In fact, new research from Nielsen found that 82% of global consumers played video games and watched video game content during the height of the COVID-19 pandemic lockdowns." This is a staggering figure and " is even more impressive when you consider the wealth of media options available today..." Nielson also declared that "Video Gaming [was] at an All-Time High During COVID-19."

To further illustrate this uptick , Twitch's viewership ("a barometer for video game content engagement") -- calculated as daily hours watched across the top 50 games -- more than doubled from 13M to 31M hours watched in just a matter of months (between January 3 and March 28, 2020).

The popularity of video games likely also surged during the Pandemic as there are proven therapeutic and educational benefits from (certain types of) gaming. The same study found that "... during the pandemic, video games were a source of stress relief (55%) and distraction (48%)... [they] also served as an escape and a break for children, 71% of parents surveyed said. More than half of parents (59%) said their children played educational games and two-thirds of parents (66%) said video games made the transition to distance learning easier for their children." More Americans than ever -- a total of 227 million -- stated that they played video games , up by more than 13M people (5%) from 2020 and even more from pre-pandemic levels. According to Ipsos' research, casual games were the most popular genre, played by 63% of players (followed by action games [39%] and shooter games [39%]).

While these trends are certainly a positive for the industry, there is one major question in the minds of everyone associated with gaming: will it hold onto its COVID-era gains following a return to normal ? Though there is a debate surrounding this issue, Noah Smith mentions in his article : "[i]n conversations with The Post, those inside the gaming world and those who monitor it professionally expressed confidence that the gains would continue in the years to come." This would be a significant boon for video game companies across the board , though COVID certainly helped boost specific areas of gaming more than others.

By the end of 2022, when many of the COVID-era restrictions and limitations had been lifted, the number of gamers in the US dipped "slightly" to 216M according to the NPD Group . This is still an increase from early 2020's 214M figure, which means that people "are still enjoying games." The future landscape might very well be determined by the trends that began during the pandemic and the retention of these new gamers.

The Current State of Gaming

According to The NPD Group , total " U.S. consumer spending on video game content, hardware and accessories" amounted to $7.6B for the month of December, 2022 (2% growth y/y), bringing the annual total to $56.6B (down 5% from 2021) . Interestingly, hardware sales remained strong, growing 16% in the last month of the year -- though in absolute terms accounted for only a fraction of total spending. For full-year 2022, spending on video game content fell by 7% to $47.5B, but improved to just a 1% decline in December (to $5.5B).

This was surprising to me. When originally researching the topic, I theorized that the growth of "casual" gamers would result in an increase in content spending over hardware, as they would prefer to put their (limited) budget towards new and interesting content. There were two problems with this thesis. Firstly, it failed to capture the full picture as there was pent-up demand for hardware that was unable to be met during COVID because of " continued supply constraints of console hardware, a relatively light slate of new premium releases, and macroeconomic conditions." While I still believe that content is what attracts gamers, US content spend actually decreased during 2022 as a result of people returning to normal (i.e. work and normal social activities, meaning they have less time and need for games) after experiencing an incredible rise during the pandemic. The question is how much of these gains are likely to be retained?

Secondly, I failed to truly understand what the term "casual" gamer meant. Some argue that the term is antiquated ( Casual vs. Hardcore - Explaining the Outdated Terms ) though it is intended to describe those who don't spend much time or money playing. The industry has used the term Hypercasual in recent years to describe players (or games) that:

...are defined by a few factors: simple gameplay, short duration, [and] social features.

The gameplay is hyper-simple - it can be learned in seconds and doesn't require any tutorials or guides. The games are designed to be played in quick bursts, with most lasting only a few minutes.

The social features are what set these games apart from traditional titles. Most hypercasual games feature leaderboards, challenges, and other ways for players to compete against each other.

Together, these factors create an experience that is perfect for Gen Zers who want something fast and addictive that they can play on their phones whenever they have a free minute."

- What are Hypercasual Games? Mechinations.io

Think Fruit Ninja, Crossy Road and Candy Crush according to Mechinations.io - "[a]ll three of these games were released prior to 2017 but continue to be among the top-grossing apps on the app stores thanks to their simplicity and addictive gameplay."

While hypercasual games have experienced incredible success in recent years, some, including Rachit Moti (the CEO of Layer ), believe that "Hypercasual's reign is ending..." as the market is oversaturated and downloads for the genre dropped by 24% last year. Though overall hypercasual downloads are down, it seems to be the "newer titles that are bearing the brunt of the pain, rather than the genre's major earners such as Candy Crush Saga and Gardenscapes. These legacy hypercasual games continue to enjoy successful partnerships with major IPs ." This makes sense to me. Some games (like those mentioned above) will always remain relevant and have an active audience -- and thus demand from advertisers. Newer, less-established hypercasual games, however, are designed to be played on the go (see the aforementioned on-the-go gaming trend ), at any time, and in short durations.

Some apps, like Candy Crush, have gotten around these barriers through partnerships. For instance:

Candy Crush has collaborated with a variety of big names in just the last year, with the pop star Meghan Taynor giving the game timed exclusivity rights on the launch of a new track, while others such as Saweetie and Prada have tapped into the massive reach of the game through partnership campaigns. Prada's in-game activation alone drove an 1800% growth in traffic to their website.

- Hypercasual's reign is ending: Is licensed IP in hybridcasual the path to success? by Rachit Moti (April 13th, 2023) PocketGamer.Biz

While this creative approach has been successful, it does not fit well with the standard advertising campaign. This could be part of the reason why "developers of new hypercasual games are finding the market more challenging than ever." There are also other reasons as well. According to Moti, "the genre's popularity means it heavily relies on in-app advertising to attract new users. This has become a much more expensive task following the introduction of Apple's ATT [ app tracking policy ]." Secondly, user acquisition ((UA)) costs have increased as more privacy restrictions have been implemented. On top of these headwinds, inflation hasn't helped either with gamers now "less likely to part with their hard-earned cash when playing these games." The entire genre of games seems to be at risk:

Developers of hypercasual games are responding to these challenges by introducing additional meta layers and mechanics from mid-core games into their titles to create a new wave of hybridcasual games. In doing so, these developers have successfully widened their appeal by targeting audiences across various genres while adding new moneti[z]ation opportunities in the process."

While this may appear like jargon, it actually makes sense. Oliver Carson of PubNub explains in his article titled The Growing Popularity of Hybrid-Casual Games :

Hybrid-casual games are a new subgenre that combines elements of hyper-casual games and mid-core games to create a unique gaming experience. These games offer simple and accessible gameplay while incorporating more engaging and immersive features typically found in mid-core games. This fusion of genres has led to the evolution of the hyper-casual genre and the emergence of hybrid-casual games as a significant force in the games market."

Moti's argument for hybridcasual games has already come to fruition as downloads in the genre "topped five billion in 2022, generating $1.4 billion in revenue..." Developers are trying to find ways to make their apps stand out... though some, like those with vast libraries of unique and desirable IP, don't face this problem.

Investment Thesis: Nintendo

As mentioned earlier, the majority of the new gamers added during the pandemic are 'casual gamers' in the sense that they see video games as a casual hobby and prefer not to spend $100's on consoles and/or games.

Often thought of as the third player in a market dominated by Microsoft's Xbox and Sony's Playstation, Nintendo is frequently overlooked by investors despite having a lot going for it. Not only did Nintendo play a significant role in shaping the video game industry, but they continue to release popular and innovative products. Their Switch console, which was released in 2017 , may very well be in a generation of its own as it brought a 'mobile' aspect to consoles -- but what truly separates The Switch and all of Nintendo's products is their Intellectual Property. We have seen this before with the Nintendo Entertainment System [NES].

The NES was game-changing. It offered more than just innovative and desirable hardware. According to Neokyo.com , the NES also offered an unmatched library of games :

The NES was then the console of choice for playing the most popular games of the time, such as Super Mario Bros or Legend of Zelda, which have both gone on to be the first titles in highly successful franchises.

The NES is inseparable from Super Mario Bros , which was released at the same time. Developed by Nintendo, the game became one of the most iconic. It alone justifies the purchase of the NES.

...

The NES is home to a huge library of games. The console had a catalog of more than 1200 playable titles..."

Nintendo's IP Differentiator

Did you know that every year Nintendo publishes at least one new IP? It's true, they haven't missed a year since 1983, the year the Famicom launched in Japan. [Editor's note. Except for 2022, it seems. You were on a roll, Nintendo!] In 2020 we had Good Job! , Astral Chain in 2019, Sushi Striker in 2018, and Ever Oasis in 2017 - and that's only naming one each year. Given how only a few of them ever hit a mainstream audience though (like 2019's Ring Fit Adventure ), it's no surprise if they slipped your mind."

- Feature: Remembering The Newest Nintendo IP You'd Forgotten All About by Joshua Goldie (December 23, 2022), NintendoLife

In addition to constantly developing new games, Nintendo owns multiple iconic franchises and characters. These include (many of which are exclusive to Nintendo's devices):

- Mario (with over two dozen sub-franchises including Luigi, Donkey Kong, Yoshi, Wario, Super Mario, Mario Cart, Mario Party, Mario Tennis, Mario Golf, Mario and Luigi, Mario and Sonic at the Olympic Games, Mario Sports Mix, etc.)

- Pokémon (again with multiple sub-franchises and characters) **To note: "the biggest media franchise in the World" is owned by the Pokemon company, of which Nintendo owns 32%**

- Animal Crossing

- Fire Emblem

- Kirby

- Star Fox

- Super Smash Bros.

- The Legend of Zelda

- Wii series of games (Wii Sports, Wii Fit, Wii Karaoke U, Wii Party, etc.)

It is important to note that characters including Luigi, Donkey Kong, and Wario appear in the Mario franchise of games and are not listed separately, but in reality, they have had their own (successful) independent franchises with a variety of games. There is tremendous potential for Nintendo to develop new games based on these characters, and there are quite a few in addition to those listed above. These include (there are also dozens of characters just part of PlayNintendo , this is just a selection listed in the order that they appear on the website):

- Princess Peach

- Toad + Toadette

- Browser

- Daisy

- Waluigi

- Baby Mario + Baby Luigi

- Shy Guy

- King Dedede

- Meta Knight

- Link

- Ganandorf

- Sheik

- Villagers

- The Pikmin characters

- Fox McCloud

- Falco Lombardi

... just to name a few. Nintendo's IP is extraordinary! In addition, Nintendo has also played a role in the development and/or publishing of several other iconic franchises , and while they might not necessarily own the IP themselves:

This means that some part of the content belongs to Nintendo, as [in] the case of music from GB Tetris , or even characters such as Dr. Wright from SimCity . Both of these examples reappear in the Super Smash Bros. series, which means that Nintendo considers this part of [the] content from its creations."

- Nintendo Franchises , Nintendo Wiki (updated June 12, 2023)

Some iconic and valuable titles indeed, which in turn increase the demand for Nintendo's consoles (often the only way to access and play these franchises). Nintendo's IP and software certainly contributes to the success and demand for their consoles. Aboutthe80s.com supports this claim, stating: "[T]he games were a big part of what made the NES successful, including Super Mario Bros., The Legend of Zelda and Metroid , which remain [some] of Nintendo's most successful franchises today." Nintendo's success with its Switch device is no different...

With its portfolio of characters, it is understandable why Nintendo is known as being extremely protective ( if not overprotective in some cases ) of its intellectual property. This stance may have stemmed from its roots when Nintendo was sued by Universal in 1983, who:

... took issue with the fact that Nintendo had an enormously successful game called Donkey Kong. The movie studio felt that an enormous ape climbing a building-esque setting with a damsel in distress was too similar to the one and only King Kong - a character that Universal claimed to own all of the rights to. Universal was so upset, in fact, that they accused Nintendo of copyright infringement and demanded the gaming company not only cease and desist all marketing and distribution of the game but that any and all profits from the title be given to Universal. Nintendo refused, a legal battle ensued, and it completely backfired on Universal."

- How Universal Suing Nintendo Over Donkey Kong Completely Backfired by Cade Davie (December 1, 2022)

Nintendo has benefited tremendously from litigation and continues to use both the threat and use of legal action to its benefit. While this stance has upset and turned away some gamers (and more here , for example), it is an essential move to help the company protect its IP -- its greatest asset, in my opinion -- and avoid the fate of Atari, who failed to take adequate legal action in the face of infringement.

All three major video gaming consoles have their advantages and differences, and hence their own fanbase. For instance, " The Decision identifies a wide body of evidence showing that Nintendo offers a differentiated experience to Xbox and PlayStation because it is focused on family-friendly games that are very different from PEGI [ a European video game rating system ] 18 FPS games like Call of Duty. " Nintendo differentiates itself not only through its differentiated and exclusive content but also through the type of games available on its platform.

Nintendo has also been monetizing its IP in other ways as well which is where I see significant upside. They have released films such as 'The Super Mario Bros. Movie', which performed extremely well at the box office grossing over $1.34B worldwide . "...The Super Mario Bros. Movie... [is] the highest-grossing movie of 2023 as well as the highest-grossing movie based on a video game. Super Mario Bros.' records not only prove its success, but could potentially open the door to more Nintendo movies in the future." Interestingly, Warner Bros. released a Detective Pikachu film in 2019 , leasing the rights (indirectly) from Niantic -- of which Nintendo owns 32% (while also receiving publicity for their games). Other profits are on their way from two Netflix series based on the star character. This strategy has already made Nintendo money in the past, but they now seem likely to take a bigger role in the production and profits of such films.

Ben Holden-Crowther wrote an extremely interesting article on Seeking Alpha last year entitled Nintendo: Wealth in Intellectual Property Can Support Long-Term Capital Appreciation . In his article, Mr. Holden-Crowther explains Nintendo's (not-so) secret formula: "Nintendo's recipe involves remixing decades-old intellectual property like 41-year-old Mario and 36-year-old Zelda with new technology..." He also attributes Nintendo's success "to other competitive advantages such as generous investment in R&D and excellent management, giving the company a wide moat" -- all great points and certainly worth a read.

There are a plethora of potential investments in the sector to bet on a continued surge in video game interest and spending. One's decision should rely on multiple factors including their risk tolerance and time horizon. That being said, I think there are only a handful of companies that allow investors adequate exposure to video games and their potential as many of the leaders of the space are more diversified (see Microsoft and Sony). There are several publicly traded video game publishers (soon to be one less with Microsoft's pending acquisition of Activision), but there is an issue with each of the major companies I reviewed. TakeTwo Interactive ( TTWO ) and Electronic Arts ( EA ) largely rely on licensing. This article actually began with a hypothesis that inflation could benefit companies with pre-set licensing agreements as it is now relatively less expensive with inflation, but there is still tremendous downside to not owning the content -- illustrated by EA's loss of its FIFA rights last year . The question is then who (in the video game sector) owns the best library of IP -- and the unequivocal answer is Nintendo. Its entire strategy is based on its vast library of IP, which is highlighted in a letter to shareholders written by Nintendo's President, Shuntaro FuruKawa. The letter is entitled "A Message From The President" and is showcased on the company's investor relations page. It reads:

As an entertainment company that creates smiles, we aim to offer our unique and original brand of play that anyone and everyone can intuitively enjoy. To enable unique entertainment experiences, we place our dedicated video game platform business - integrating both hardware and software - at the center of everything we do. We understand that all entertainment eventually loses its appeal, so we continually work to provide new and original products and services for people everywhere.

With our dedicated video game platform business, we express the appeal and value of Nintendo Switch - paired with unique game offerings like the Super Mario titles - as an experience that can be enjoyed anytime, anywhere, and with anyone.

To continue growing our core business, our fundamental strategy is to expand the number of people who have access to Nintendo IP. To this end, we seek to broaden the touch points of Nintendo IP with consumers in areas beyond dedicated video game platforms. This includes applications for smart devices, which are ubiquitous throughout the world, as well as visual content, theme parks, and character-based merchandise.

In addition, we work to develop a long-term relationship with each of our consumers, with Nintendo Account as the connection that spans platform generations and unites a variety of entertainment experiences, centered on our integrated hardware-software entertainment.

Based on our belief that the true value of entertainment lies in its uniqueness, Nintendo will strive to increase our corporate value by offering unique entertainment that plays to the company's strengths, continuing to adapt to the times and cherish the spirit of creativity.

We humbly ask you, our shareholders and investors, for your continued support.

- Shuntaro FuruKawa, Representative Director and President"

Both Nintendo's future and its prospects as an investment largely rely on the company's ability to monetize its IP -- be it in the form of video games, movies, theme parks, or any other use-case. While there is certainly potential, it is difficult to determine the stock's present value as much of these new prospects have yet to be announced, let alone released. With that in mind, Nintendo has continued to deliver throughout the company's history. Combined with its strong financial position and IP, I believe that Nintendo is set up to perform well in the future, even though some uncertainty remains.

Financial Analysis:

Nintendo released its quarterly earnings on August 3rd - and, in my opinion, they were better than expected. Nintendo reported net sales of ¥461.34B (approximately $3.22B in USD) for the quarter ending June 30 , up a staggering 50% from ¥307.46B the previous year (2022).

In fact, every major metric reported -- Net sales, Operating profit, Ordinary profit, and Profit attributable to owners of [the] parent -- were up at least 50% compared to the same quarter in 2022. This resulted in Nintendo's profit per share increasing by more than 50% year over year to ¥155.48 ($1.08 USD) from ¥101.85 in 2022's quarter, while simultaneously increasing both the company's assets and shareholder equity from the previous year. NTDOY trades at a PE of 15.86 with $.66 in EPS in the trailing twelve months according to Yahoo! Finance - this is because it is worth only a fraction of a Nintendo share traded in Japan (1/8th of a share - to be discussed later).

In the most recent quarter, Nintendo's average exchange rate was 1 USD = 137.34 yen, up from the previous year when 1 USD = 129.66 yen. This means that the US dollar has strengthened compared to the yen. One would expect a strengthening dollar (and thus a weakening yen) to be a significant negative for a Japanese-based company.

While the Yen's weakness certainly hasn't helped Nintendo, the company actually keeps much of its assets overseas:

One big risk associated with Nintendo is currency risk. Interestingly, when looking at Nintendo's historical and forecasted exchange rate from their recent earnings, we see that the US dollar has been getting significantly stronger in a short period of time, with one USD buying 11.56 more yen (133.00 to 144.56) in just one quarter -- an ~8.7% increase in just three months. Nintendo holds approximately $3.41B USD (with 1 Euro = 1.09 USD) in net foreign currency --nearly 7% of Nintendo's market capitalization-- which helps to mitigate some of these risks.

One thing I found interesting is the fact that Nintendo expects the exchange rate to return to levels seen a year ago in 2024 (1 USD = 130 yen) and even lower for the Euro (1 Euro = 135 yen). Despite the yen being devalued over the past year, Nintendo benefits from the fact that 80% of its sales come from outside Japan. This helped the company actually record "foreign exchange gains of 47.2 billion yen [$320M in USD]," which increased ordinary profits by 22.86% to 253.7B yen (~$1.75B USD) in the quarter. It's a two-edged sword, however, as simultaneous to benefiting when bringing currency back to Japan (the yen), Nintendo's current holdings (in yen) are being devalued.

That being said, Nintendo reported that the "[e]ffect of changes in foreign exchange rates on net sales: +157.8 billion yen" -- that is just over +$1B USD during FY23. To show how significant that is, Nintendo currently has a market cap of ~8.17 trillion yen according to Yahoo! Finance . While this is a shocking number, it converts to approximately $56.2B using the current exchange rate .

Moving to the most recent quarter, ending. June 30, 2023, Nintendo stated:

The end result is that overall sales reached 461.3 billion yen, with sales outside Japan of 369.0 billion yen accounting for 80.0% of that total. Operating profit came to 185.4 billion yen. With the depreciation of the yen in foreign exchange markets, we recorded foreign exchange gains of 47.2 billion yen, with the result that ordinary profit totaled 253.7 billion yen and profit attributable to owners of parent totaled 181.0 billion yen."

The 181 billion yen is equivalent to ~$1.24B in profit attributable to owners of [the] parent - in one quarter. On an annualized basis, that's almost $5B USD in profits, thanks in large part to its forex gains of 47.2B yen ($320M USD) in one quarter. This is in part due to the US Dollar's buying power of the Japanese Yen increasing almost exponentially over the past five years. The chart below exhibits the erosion in the Yen's value (Please note: the x-axis is not evenly spaced). Despite this, Nintendo has been able to perform well operationally and delivered a solid quarter.

Source Link: Japanese Yen - 2023 Data - 1971-2022 Historical - 2024 Forecast - Quote - Chart

Investing in Nintendo

A major hurdle when investing in Nintendo is understanding the Yen-USD conversion as well as the ADR's relationships to Nintendo shares. US-based investors have several options for buying shares in Nintendo. The first is buying Nintendo shares that are listed on the Tokyo Exchange, though this would require converting US Dollars to Japanese Yen in order to execute the purchase (while incurring associated costs). Alternatively, there are two ADRs (American Depository Receipts) available to trade as well: ( NTDOY ) and ( NTDOF ). According to Investopedia , "[a] single ADR may represent one share, a number of shares, or a fraction of a share in a foreign corporation..." This is exactly the case with Nintendo's ADRs. One NTDOY ADR share is equivalent to "one-eighth of a Nintendo share traded in Japan." NTDOF, on the other hand, "equals one ordinary share of Nintendo traded in Japan." All three equities have a market capitalization of $53.28B (¥7.28T) as of Sunday, August 13th.

Additionally, all three tickers traded similarly (excluding dividends) until Japanese Shares (JP:7974) began outperforming their ADR counterparts in late 2021 (NTDOF is the darker blue line in the chart below, while NTDOY is lighter blue and JP:7974 is green):

While NTDOY [green line] and NTDOF [darker blue line], have largely traded hand in hand, just this past week -- approximately two weeks after Nintendo released their quarterly results -- the shares have begun to diverge:

NTDOF has outperformed its ADR counterpart by over 8% -- likely a short-term phenomenon, but interesting nonetheless. Both shares have fixed ratios to Nintendo's Tokyo-listed shares. Baring an arbitrage play between the two ADRs, NTDOF is my preferred investment vehicle -- and it didn't start out that way. Originally I preferred NTDOY, which while worth only a fraction (1/8th) of a Nintendo share traded in Japan, is much more liquid with a daily avg. volume of 1.34M shares compared to just over 5000 for NTDOF. I thought that this liquidity was extremely important. And it is, but over and during a 5-year period both ADRs have traded hand in hand... and personally, given my risk tolerance, the lower volume risk is worth the boosted dividend: $5.44 per share (12.43%) for NTDOF compared to $.33 (3.06%) for NTDOY. Please note that the shares trade for different values, which is why the dividend returns do not match. The choice may come down to your risk tolerance and investment plan, though both should perform well in the long run if Nintendo is able to execute its strategy.

On these strong results, Nintendo increased its shareholder equity to 284,616,000,000 (yes, 284 billion) yen, or approximately $1.94B USD. While it may seem significant, it is less than 5% of (NTOF)'s market cap of $50.85B. That being said, Nintendo records all of its non-current assets (including PP&E as well as other investment and intangible assets) as $542.7B yen ($3.7B USD). Their intellectual property alone is worth much more than this, as illustrated by all of the creative avenues through which they can and have monetized it. These include movies , such as the recent release of 'The Super Mario Bros. Movie' ($1.36B worldwide box office) and 2019's 'Detective Pikachu ($.43B) , their iconic video games (via both hardware and software), amusement parks ( beginning in 2021 ), playing cards, accessories, merchandise, and royalties, among others.

The first question in last quarter's (ending March 2023) Earnings Q&A Summary on May 9th, 2023 was regarding the impact that the success of The Super Mario Bros. Movie "will... have on your [Nintendo's] strategy of expanding the number of people who have access to Nintendo IP? Do you expect nongame revenues to account for a greater percentage of total revenue in the future, or do you see this as one result of the IP expansion initiatives you have implemented to date?"

The President of Nintendo, Shuntaro Furukawa, answered:

There has been a positive reception worldwide to The Super Mario Bros. Movie, and Mr. Miyamoto (Nintendo Representative Director and Fellow), who served as co-producer of the movie also appreciates the response. I have heard that many are going as families, and that some people have already watched the movie multiple times. The movie is an opportunity for people of all ages, from small children to seniors, to come in contact with our IP, and not just those already familiar with Nintendo and Mario. As an example of our strategy of expanding the number of people who have access to Nintendo IP, this has yielded a great result.

In terms of the impact on our business, in the short term, the revenues from the box office and secondary uses of the movie will be reported as sales in the current fiscal year (ending March 2024). But what is more important is that the movie inspires interest in Mario games and has a positive effect on sales of Nintendo Switch hardware and software over the medium to long term. In fact, we are already seeing a variety of positive effects. For example, sales are growing for Mario related merchandise, and there is a slight rise in activity for classic Mario titles that can be played through Nintendo Switch Online. In the long term, we think this will become a powerful touch point, turning people who have never really played games before into fans of Mario and Nintendo, and renewing the interest of people who used to play (on a Nintendo game platform) but are taking a break.

As for the future, we plan to pour our efforts into a variety of visual content, as we did last year with the consolidation of Nintendo Pictures Co., Ltd. as a subsidiary. We are very happy that this movie is a hit, but will remain focused on carefully developing and further expanding each IP while respecting its unique characteristics, just as we have done in the past. Through our strategy of expanding the number of people who have access to Nintendo IP, we want to bring people in contact with our characters and the worlds depicted in our games, with the goal of continually invigorating our core dedicated video game platform business. "

The real value is in Nintendo's ability to monetize its intellectual property -- and thus far, they have done so well. Increasing the number of touchpoints with consumers makes sense, and they have done so in a variety of ways. While I see all of the new channels as positives, I agree with Mr. FuruKawa that these should all be ancillary to their main profit driver:

By doing so, we aim to further grow the overall scope of our business and create an environment where consumers can enjoy our dedicated video game platforms, which comprise the core of our business, over a long period of time."

There are still areas of concern, like management's forecasts for declines in every major financial metric in the fiscal year ending March 31, 2024 (this past report was Q1):

It is hard to succeed in such a competitive industry, but Nintendo has certainly made a (good) name for itself :

Should you invest in Nintendo? The question comes down to whether you are willing to pay about $40B for Nintendo's IP and potential earnings powers. To me, a company that continues to produce in-demand and profitable content is worth that price tag, especially after having generated a net profit ("[p]rofit attributable to owners of parent") of 432.7B yen, or $2.97B in FY2023. That's a P/E of about 13.5 after subtracting out Nintendo's current assets - not a hefty sum given everything Nintendo has going for it. Nintendo's strategy seems to be working, with The Super Mario Bros. Movie not only performing well on its own but also providing a boost to other Nintendo offerings. While there are concerns, there are also plenty of catalysts moving ahead. I am excited to see new Nintendo initiatives including more theatrical releases of their IP and their (positive) effects on the rest of the company's products.

For further details see:

Buy Nintendo: It Has A Lot Going For It