Comparing Nintendo (OTC: OTCPK:NTDOY), the video game maker from Kyoto, to Sony (SNE) is interesting since both have a similar market cap at the moment and overlapping business segments in video games.
Let's start off with Nintendo:
Nintendo stock recently fell almost 20% on bad Wii U (current Nintendo home console) sales numbers - this was to be expected after weak channel numbers during the holiday quarter. The bad news however is not over. Nintendo's traditional business model will continue to be squeezed from two sides in the future:
- New possible entrants in the home console space such as Amazon (AMZN) or Apple (AAPL) (but especially hard-hitting for Nintendo is the mobile side where they enjoyed a virtual monopoly since the original Gameboy and even earlier Game&Watch devices in the 80s)
- New distribution models (less packaged games in stores such as Gamestop (GME) and more digital distribution coupled with cheaper or so-called "free to play" and "freemium" games).
After the latest NTDOY stock drop, SNE's entire market cap still is just about the same as NTDOY - even though video games (Sony Computer Entertainment division, established in 1993) are of course just a small portion of the entire Sony corporation.
In fact, Sony at the moment makes most of its profits outside of electronics and entertainment. Many people, even including some investors, are still surprised to find out SNE actually generated most of its profits in life insurance/financial services in recent years.
My simple scenario for choosing SNE over NTDOY (both at a market cap around $16-18 billion at the moment) is three-fold:
1. Sony becomes the number one company in video games again in terms of units sold in this console cycle. Sony looks like the winner in the current home console generation with the new Playstation 4 (with XBoxOne likely second and Nintendo a distant third in terms of units sold). In addition to that, a new streaming game service offer called "Playstation Now" will launch later in 2014:
Sony creates custom PS3 hardware for PlayStation Now
Dedicated servers house eight PS3s, built from the ground up for cloud gameplay.
This streaming technology is based on a service called "Gaikai", a company acquired by Sony back in July 2012 for close to $400 million.
Online games and multi-player/free-to-play games that Sony is better positioned for with its "Playstation Now" initiative are becoming more and more important, especially in Asia. Below is a list of popular online/multi-player games and their revenue potential as of early 2014:
Please note about hardware sales and units sold: Nintendo sells most hardware units when including the mobile console space, it remains the overall leader for now. But I think this business will shrink considerably over the next five years given growing competition from general-purpose tablets/smartphones used for "casual" gaming - many kids today receive such devices at an early age. The market for dedicated mobile gaming devices like the Nintendo 2DS and 3DS will be shrinking going forward (it may already be at its peak right now - Sony mostly gave up on this market segment with its slow-selling PS Vita mobile game console).
2. Sony manages to complete its electronics turnaround. Sony for years tried to stop the bleeding in electronics (TVs, point-and-shoot cameras, PCs, OEM parts such as batteries...). It may soon be there. This segment should at least be profit-neutral by 2015. One of the most troubled areas with the deepest losses for almost a decade, "Bravia" TV hardware, may catch a short break thanks to new 4K resolution TVs with better margins - or at least smaller losses for a few years. In addition, SNE will spin-off its PCs ("Vaio" PCs) by the summer of 2014 and just retain 5% of that unit.
3. Sony finds new growth areas in its core business units. A possible turn-around is linked to fewer key focus areas like higher-end smartphones (Xperia Android phones, Sony achieved better results thanks to the Xperia Z and Z1 models), the Playstation 4 mentioned above and audio/video entertainment shows. In this scenario, Sony further streamlines its "core" (especially in electronics) so that all segments again contribute to the bottom line (minus the huge one-time restructuring costs in TVs and PCs in 2014) - even if only modestly in terms of operating margins.
In addition, a weaker JPY already helped the electronics "core" since late 2012 (the start of "Abenomics" in Japan with a weakening JPY), even though Sony now has many (exporting) plants located outside of Japan.
Finally, another driver could be a spin-off of the entertainment division, but I doubt this will happen anytime soon after the core electronics is restructured. Foreign activist investors (like Dan Loeb) proposing this idea were turned down by Sony management in the past.
I think SNE can achieve a turnaround until 2015 provided that
- the divesture / spin-off in Sony's core problem areas in consumer devices (TVs and PCs) can be completed in 2014
- the focus is on fewer products (reduce the product portfolio, e.g. in low-end consumer electronic devices with no differentiation)
- higher margins - this also depends on a weaker JPY, for example at or above USD/JPY@100 levels - continues.
Turning over to NTDOY again, I see a much more cloudy future. The main two advantages remaining on their side are
- Lots of cash and other marketable asset positions (still about half their market cap)
- Gaming and character IP popular with generations of gamers (NTDOY made video games almost 15 years longer than SNE and had and still has a much stronger first-party games sales percentage on their consoles. This of course helps their margins)
But both strengths are also dangerous. Past success probably slows NTDOY down before making the necessary hard adjustments or cuts.
In particular, the strength of their strong first-party gaming IP and heritage mixed with cheaper, but weaker hardware specs on their recent consoles is both a blessing and a curse:
Few and fewer third-party developers make big ("AAA") games for Nintendo home consoles today. Big publishers like Electronic Arts (EA) or Activision (ATVI) didn't even bother porting their main development environments to the new Wii U console; that and the former lack of strong online gaming frameworks on the previous Wii console will result in even fewer third-party games going forward. This especially affects popular multi-player franchises like first-person shooters that "core" gamers have been buying for the same competing platform (Playstation or XBox) over many years - Nintendo has shut itself out of this business since 2007. The major (Western) third-party developer remaining is Ubisoft (UBSFY), but even Ubisoft is scaling back its commitment after the weak Wii U sales numbers throughout 2013.
Unless Nintendo can soon pull another rabbit out of its hat, I am skeptical on its long-term outlook. Two examples for unexpected "rabbits" (that might help NTDOY turn the ship around) and one exit strategy are discussed below:
- Nintendo enters new sectors and escapes the competition. One example could be Nintendo theme parks in Asia, maybe even globally. This could work very well with kids and families. Nintendo could renew itself as a Disney-like entertainment company given their great and rich IP treasure chest created since the early 80s (such as Mario and associated characters, Zelda, Donkey Kong, Wii Fit/Wii Sports and Pokemon...). Their IP has a unique global appeal.
- Nintendo manages to create another smash surprise hit (like the original Wii console and Wii Sports bundle console back in 2006) in their core console business. This however, seems harder than ever to accomplish today given the growing competition in the living room - and on mobile devices with general-purpose tablets and smartphones (most of the popular apps on Android and iOS devices are games). I discussed four possible new entrants in the home video game industry in an earlier Instablog entry in more detail. This could affect Nintendo more than Sony going forward because NTDOY is obviously a pure play in the sector with no other revenue streams.
- Nintendo merges with another company in the technology or entertainment field. This is hard to imagine at the moment given the liquidity position and its conservative leadership coupled with large domestic shareholders. If the inevitable happens, I could see Disney (DIS) as a good partner (to name a specific company, not just because of the theme park idea I discussed above) - however, to repeat, I don't see this happening because of cultural differences. I just think that a company like DIS could be more suited for Nintendo than other rumored US-based names (AAPL was mentioned in unfounded speculation) often discussed in the past.
Summary: Comparing the willingness and management execution speed to adapt to new external challenges and unlock value, I would prefer SNE shares over NTDOY at the moment - given equal market caps and a more predictable turn-around scenario for Sony.
Sony has hidden value going into 2015 provided that its turn-around in the core electronic segments (spin-off of Vaio PCs and Bravia TVs, focus on games, smartphones, entertainment in 2014) is successful.
Nintendo's current valuation on the other hand seems to hinge more on past success, including the discussed huge cash mattress - this is often dangerous for companies in the technology sector since they then display a lack of urgency thanks to their liquidity.
Maybe Nintendo can reinvent itself one day in the entertainment sector outside of video games (new business areas such as theme parks I mentioned above) but it will take a long time before meaningful revenue is generated. Nintendo management recently also hinted at evaluating new markets such as "personal healthcare", but this remains very nebulous with no further specifics given at the moment.
Worst of all for Nintendo, there are strong rumors (see hiring spree in recent months) that AAPL will soon be entering the fitness/health sector with a wearable device. If so, Nintendo could be looking at a strong new competitor in both its core market (an updated Apple TV with support for casual games?) and its newly envisioned "personal health" market (a wearable Apple device with fitness and medical sensor functionality?).
I therefore see SNE as a more attractive investment opportunity at the moment.
Additional disclosure: I am long SNE since late 2012. Foreign investors in SNE should also think about hedging the JPY (a weakening Yen against your local currency is a likely long-term scenario in my opinion).