NTDOF - Nintendo: The Apple Of The Gaming Industry?

2023-06-22 13:18:47 ET

Summary

• Nintendo's Apple-like approach to gaming sees it control both console and game development.
• This control has led to better efficiency and positioned Nintendo as a leading contender in the gaming space.
• Nintendo's proven track record makes it an attractive long-term investment option.

Nintendo (NTDOF) stock has come a good 30% down from its all-time high of $16 in 2021, the year the Switch made record sales. The release of the Switch in 2017 kicked off a four-year growth spurt for Nintendo that had traded at just $6 a share.

At current levels, it may be a good time to start accumulating shares before a new console is released in 2024 (a credible conjecture), in anticipation of a new revenue platform being built by Nintendo.

Naturally, there is a risk of failure with every major launch. To determine the chances of Nintendo delivering, this article looks at its past record of servicing product platforms and its ability to generate shareholder value from them.

Business model

Nintendo started as a humble producer of playing cards. After multiple changes in business models, it released its first gaming console more than half a century into business, in the 1970s.

Although a pioneer of video gaming, it went through its fair share of struggles, losing along the way to competitors like Sega and Sony. At the low point in the early 2000s, Nintendo's saving grace was the popularity of its handheld console Game Boy. Then came the Wii, which re-established Nintendo into the top echelon of the gaming industry.

But what has always been interesting about Nintendo's business model is that it is both a console manufacturer and a game developer. So essentially, it controls both software and hardware sides of business. This is similar to Apple's approach to new product and service development, and the advantages of it are evident.

Although hardware, software and distribution are separate divisions, revenue recognition occurs on a platform, or console, basis. Just like Apple uses the iPhone platform to magnify sales via an entire ecosystem of related services and products, Nintendo views consoles as differentiators to capitalize on and build moats around.

Nintendo's dominion is in handheld and motion gaming, a niche area. The Wii has become the world's most successful interactive gaming unit, which neither PlayStation nor Xbox were able to eclipse, even with more sophisticated hardware. The Switch, Nintendo's current flagship, was the most popular gaming console across handheld and console categories in the past decade.

Unlike the competitors, Nintendo caters to a different segment of gamers. PlayStation and Xbox focus on cutting-edge tech required for serious gamers, people in their late teens to early thirties. Nintendo, on the other hand, targets a casual gamer, everyone from kids to adults.

Peer analysis

Since Nintendo makes both hardware and software, it enjoys certain competitive efficiencies. It starts with effective console sales. Consoles are priced using a razor-and-blade model, either at breakeven or even a loss, with the idea being that subsequent sales of games and subscription services will more than compensate.

Between 2017 and 2022, console sales were topped by Nintendo by a large margin for four out of six years. In fact, Nintendo has dominated for much longer, with the Switch being the most sold console over the past ten years (although newer releases by rivals would invariably steal the limelight and reduce the turnover).

This comparison excludes Xbox due to the unavailability of sales data.

Source: Various compiled by author

What is more important is that - and perhaps this is where the integration of hardware and software plays a role - the Switch sales are profitable. In contrast, Xbox sells at a loss, and PlayStation barely breaks during the release year.

Source: Various compiled by author

One reason is that Nintendo's hardware is less graphic intensive and thus less costly to develop than that of big competitors. While Xbox and PlayStation strive to meet the needs of all kinds of game developers, Nintendo - playing both the hardware designer and game developer - does not need to accommodate as much. Plus, most Nintendo machines include gimmicks, such as motion or hand-held gaming, which draw the attention away from graphics.

In the game

The market leader in game sales is PS4 , with close to 1.6 billion titles sold; the Switch has been in second place for the past two decades, with roughly 1.04 billion titles. But the developer benefits are reversed.

While Sony earns on average 30% from every game sold, Nintendo takes a full 100% cut. Among the top ten games played on the Switch, Nintendo accounts for almost 80% of unit sales. Overall, close to 40% of all games sold on the Switch can be safely assumed to be Nintendo's. The best part is that it still gets 30% from third-party games.

Source: Fandom , Nintendo

A question of efficiency

Does combining hardware and software capabilities incur a higher overhead cost in Nintendo's case? First, versus other console developers - Sony and Microsoft (though the latter reports only revenue for its gaming division). Sony brings in the highest revenue but Nintendo's control over its own ecosystem results in greater profitability. Again, it is Apple-like operating efficiency.

Source: Nintendo, Sony, Microsoft

Compared to the big names in the gaming industry, Nintendo generates both higher collective revenue and profit than most. Profitability, in particular, has paralleled the growing uptake of the Switch.

This goes to show that Nintendo is not only a proven hardware producer but also a capable game developer that uses its platform advantages to sell both hardware and software at wider margins than peers.

Risk

The introduction of a new console in 2024 is an obvious risk. Nintendo has had a number of high-profile flops including the Wii U , GameCube and Nintendo 64, which sold less than 50 million units each. Only when Nintendo managed to position itself as a pioneer of sorts - whether it be in motion gaming with Wii, handheld gaming with DS, or a combination of handheld and motion gaming with the Switch - did its consoles sell well.

Valuation

Currently, Nintendo has the lowest P/E among peers of 15.77; Sony has the second lowest P/E at 17.08. The discount to game developers' valuation is even more pronounced. Given the expectation of a new console in the works, the share price can be reasonably expected to go up from here. For perspective, the stock rose almost 3 times after the release of the Wii and again with the Switch.

Conclusion

Nintendo is the only console manufacturer at the moment due for an upgrade. With a proven track record having sold close to half a billion consoles over the past two decades, Nintendo can be trusted to do well for itself. Like Apple of the gaming space, it has showcased an ability to leverage its economic moats to keep users within the Nintendo ecosystem. An efficient profit maker, Nintendo is undervalued at current levels and makes sense as a long-term hold.

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