NTDOY - Nintendo's Future Is Bright As A Global Gaming Console Company

2023-03-17 04:15:53 ET

Summary

• Nintendo has had numerous successful product launches from their innovative product designs.
• The company is in a strong financial position to continue to grow and invest more into research and development.
• With the rise of new technologies such as blockchain and virtual reality, Nintendo has some big opportunities that it can capitalize on to grow even bigger and even faster.

Investment Thesis

Nintendo Co. Ltd. ( NTDOY ) has built a strong reputation and brand name throughout the world as a provider of unique video gaming consoles. The company’s strong innovative console designs along with their low production costs gives the company a good position to continue to grow in the video game and consumer electronics industry.

Business Overview

Nintendo is a consumer electronics and software company that develops, produces, and sells electric home entertainment products. The company’s major products include its video game platforms and consoles, karuta, a type of Japanese card game, and other playing cards. It also develops the hardware and software for their home console video game systems as well as the games that are played on the console. The company’s most popular gaming consoles include the Nintendo Switch and the Nintendo 64 and some of its most notable video games include Mario, The Legend of Zelda, and Pokemon. The company has three main subsidiaries: development, manufacture, and sales, but they are not considered separate segments as Nintendo operates as a single business segment.

Industry Analysis

Consumer Electronics Industry

The consumer electronics industry is currently valued at $1,103 billion USD and the market is expected to grow at a compound annual growth rate of 2.17% for the next 5 years . This market has seen some serious growth in the past 5 years, especially during the COVID-19 pandemic. Due to worldwide lockdowns, most people were forced to stay at home, and this actually increased the time spent on electronic goods, whether that be phones, computers, or gaming consoles. Between 2020 and 2021, the entire industry had its biggest revenue jump in the past decade, increasing by $77 billion US from $1035,27 billion USD to $1112.02 billion USD.

Video Game Industry

The global video game industry was valued at $195.65 billion USD in 2021 and it is expected to grow at a compound annual growth rate of 12.9% from 2022 to 2030. The main driver of this growth is the constant new developments and technologies in this market. With big companies in the space such as Microsoft, Sony, and Nintendo developing new gaming systems as well as video games to enhance the gaming experience of the user, there is constant demand for these new products. In addition, with the rising prevalence of 5G and virtual and augmented reality, there will be a further increase in the demand of the gaming market especially for the VR platforms and mobile games.

The increasing popularity of esports and video game tournaments has also been a growth driver for the industry. By 2024, there is expected to be 577.8 million esports viewers , with half of them being esports enthusiasts.

Asia has become the largest market shareholder in the gaming industry with huge growth potential from China, Japan, and South Korea. The rapid growth in new technologies such as new apps and gaming applications as well as the formation of new esports teams has had significant effects on the market in Asia. Japan is one of the most notable and prominent players in the gaming market with leading gaming companies such as Sony and Nintendo.

Competitive Advantage

The competition in the video game industry is pretty tough with big players such as Sony ( SONY ), Microsoft ( MSFT ), and Sega. However, there are two things that help to separate Nintendo from its competitors: its low manufacturing costs and its innovative product design. Nintendo is able to manufacture the entire Switch console which includes the tablet, the dock, and the joysticks for $257 through their fabless production model by outsourcing the production to Southeast Asia. The company sells the Nintendo Switch for $300 so they make around $40 per unit sold. Now if we take a look at competitors such as the Xbox and PS5, there is a big difference in the production costs. With Microsoft, the older models cost about $399 product while the newer model costs $599-699 per unit to produce. As a result, the Xboxes are barely breaking even and even losing money with each unit sold. The PlayStation consoles also have similar production cost problems with the PlayStation 5 costing up to $470 to make, which gives the company small profits on the gaming console, as the retail price of a PS5 is $499.

In addition, Nintendo was very strategic with its product design and innovations. When the company released their first gaming consoles, the Nintendo Entertainment System and Famicom series, their gaming consoles were easy to use with high quality games and promoted family entertainment. It opened up a larger audience base to not just the company but to the video game industry as a whole. Then in 2004, the Nintendo DS introduced touch screens on gaming devices to make the experience more engaging, and this was done before Apple even launched its iPod and iPhones. In 2008, the launch of the Wii consoles was a huge hit for the company as they put sensors into the Wii consoles to make the games more realistic and active. And finally, the Nintendo Switch which is a modern, easy to use portable console that has grown very popular, especially with the rise of mobile gaming. Nintendo has always been changing up its gaming console devices to constantly add different new features to make their gaming experience more engaging and personalized.

Growth Opportunities

Incorporation of Blockchain and Digital Currency

With the rise in popularity of blockchain technology and cryptocurrencies and its decentralization benefits, Nintendo can capitalize on these opportunities to incorporate these new innovations into their games and their overall systems. With a current valuation of $7.4 billion and a compound annual growth rate of 66.2% for the next five years, the blockchain market is expected to hit $94 billion by 2027. There is huge potential in this space and Nintendo can start to allocate research and development funds into this industry to integrate these new technologies into their existing platforms.

Mobile Games

In addition to game consoles, Nintendo has great potential to expand into creating mobile games. With about 3.9 billion people around the world who play mobile games, there are very lucrative opportunities in this industry that the company could capitalize on.

Adoption of Virtual Reality

Nintendo has always been coming up with new ways to make their games more interactive and engaging, and a great opportunity to do so would be with VR. The company would relaunch some of their older classic games but incorporating VR into these games to make them more realistic and to give gamers a whole different experience. This would help to increase the customer base of Nintendo and increase the popularity of the brand.

Financials

Nintendo’s revenues and operating income seem pretty stable over the past few years and have been generally increasing except between 2021 and 2022. This decrease can be mainly attributed to research and development costs as well as advertising expenses. If Nintendo were to capitalize on one of their growth opportunities, we would expect that the operating income to drop for the following several years. When taking a look at their balance sheet, the current ratio of the company is good and it shows that the company has enough working capital purchase expenses such as raw materials, advertising, research and development, and dividend payments. Overall, the company is in a good financial position to continue growing and developing new product offerings.

Valuation

I have performed a discounted cash flow model below. For the growth rate, I have used the compound annual growth rate of the company in the past 5 years. For the perpetual growth rate, I used 2.5% to match the economy growth and for the discount rate, I have used the company’s weighted average cost of capital.

Risks

Too Much Dependence on the Nintendo Switch

Currently the Nintendo Switch revenues make up about 85% of the company’s total revenue. If the popularity of the Nintendo Switch were to drop, that would be a serious hit to the company’s financials and the company brand.. This makes it even more important for Nintendo to start diversifying more of its product offerings to expand its revenue streams.

Unpredictability of International Exchange Rates

As Nintendo is a global distributor of gaming devices and systems, 70% of the company’s total sales are from overseas sales, and most of the time, these sales are conducted in local currencies. In addition to overseas sales, the company also holds a lot of assets in foreign currencies. Fluctuations in international exchange rates, therefore have a big impact on how these financial transactions are reported. As a result, Nintendo’s operating results and cash flows may be adversely affected.

Tough Competition

Despite Nintendo’s strong competitive advantages in production costs and product innovations, the video game industry and just technology in general is constantly changing. The big players in the space include PlayStation, Xbox, Google ( GOOG ) (GOOGL), Amazon ( AMZN ), SEGA, and LG Electronics. But on top of these big competitors, there is also the emergence of newer competitors resulting from technological innovation that could pose a threat to Nintendo and its business. This puts a lot of pressure on the company’s research and development costs as well as their marketing investments. If Nintendo is not able to keep up with the rapid changes of its industry, it will not be able to stay at the top for very long.

Conclusion

Overall, I would rate Nintendo a buy with a price target of $12.23 USD. Although there is tough competition in the video game space, there are still plenty of growth opportunities for the company to capitalize on given the constantly changing nature of technology. Nintendo is in a pretty strong financial position to continue investing into research and development to keep up with the changes in technology and start to develop new revenue streams. Looking at the long term, I believe that Nintendo will continue to be one of the big players in the video game industry and will also continue to expand their reach to new emerging markets as well.

For further details see: