- Apple's financial firepower is best utilized creating competitive advantage over Samsung and Android.
- Gaming is one of the defining smartphone features, but gaming-wise Apple's positive differentiation vs. Samsung is currently minimal.
- The Nintendo catalog would provide unparalled differentiation.
To first address the latter, Apple would be moderately insane to buy Tesla. Apple's goal is to disseminate iOS across the entire motor vehicle market. The more car owners see benefit in Apple's CarPlay, the more iPhones they sell and the more powerful the network effect becomes. Great car integration is where one of the next battles for smartphone differentiation is taking place. Owning Tesla would just get in the way of working/negotiating with all the other car companies, rather like the issue Google (NASDAQ:GOOG) faced while owning Motorola. Perhaps there are some battery development synergies to be unlocked between the two companies, but nothing that necessitates an acquisition. Moreover, despite its tremendous future prospects, the price of Tesla makes a buy to acquire growth strategy (even if Apple was open to such an idea, which seems unlikely) dubious at best.
Instead, if Tim Cook is ever to make a truly major acquisition, then I believe a better candidate is Nintendo (OTCPK:NTDOY). The mid- to high-end smartphone market is now essentially a battle between Apple (with iOS) and Samsung (with Android). Any defensible differentiating factor is potentially highly lucrative to either. I believe the Nintendo game back catalog provides such a differentiator. Games have undoubtedly evolved to be one of the key use cases for smartphones, as one can easily infer from the App Store paid sales charts.
However, as gaming fans are all too aware, Nintendo has steadfastly refused to port its iconic games to smartphone platforms. While Sega (OTCPK:SGAMY) long ago realized it could not sustain its hardware business, Nintendo has yet to come to this (likely inevitable) realization. However, that day is seemingly coming. For this hardware generation, their living room box, the Wii U, has been a substantial failure. Moreover, with Apple's own Apple TV box rumored to be adding game functionality, the lower end of the living room console market is only going to get more competitive. At the high end, the PlayStation and Xbox franchises appear largely unassailable by Nintendo, bar some game-changing innovation.
On the handheld side they are doing better. The 3DS has sold moderately well and is largely sustaining the company at this point. However, I have significant doubts that pure-play handheld gaming devices can retain mass market status in the face of the increasing power and sophistication of smartphone gaming platforms. Long term, Nintendo appears to be fighting an impossible battle. They do not appear to entirely disagree with this, which makes their reticence in adopting the SEGA model all the more surprising.
But they have one shining asset: the strongest set of iconic gaming franchises owned by one company. In my view, access to the Nintendo game catalog on iOS would strike a major blow to Samsung. Having Pokemon, Mario, Zelda, and their many friends exclusively tied to iOS would likely provide the most significant point of software differentiation between the two rivals.
Why an acquisition though as opposed to an exclusive deal? Well, I imagine Apple (or Google or Samsung) would certainly be willing to pay a vast sum for exclusive smartphone rights to the Nintendo catalog. The problem is that as long as Nintendo is unwilling to give up on their own hardware business, they will likely refuse to risk cannibalizing their own sales. Maybe management (perhaps activist shareholder driven) will one day consider that software only business model is right for Nintendo, but until then an acquisition may be the only way for Apple to lock down Mario.
As to the price Apple should pay? Nintendo's market cap is currently in the $17B range (and falling). While more than a rounding error, this is little more than one quarter of profit for Apple, or a little over 10% of their cash balance (and some overseas cash would find a home with such a deal). In terms of Nintendo's value to Apple, if we assume a $20B purchase price and a 6% cost of capital, then they would need to see incremental annual profits in the $3B range to break even over a 10-year period. Such incremental profits would accrue from the hardware share shift plus sales of the games themselves. Whether the combination of the two would approach $3B per year is thus the key question of interest. My bet is that they would, and Apple should buy Nintendo.
With tremendous game and development assets, yet a macro gaming environment that is evolving way from their core markets, the resulting question is how to play Nintendo. While a small position in out-of-the-money LEAPs would be a reasonable way to share in the upside should one of the mobile giants decide to pounce, unfortunately there is no option market on the Nintendo ADR. Thus, a speculative long position is the only obvious play for most investors. While this would carry moderate risk, a possible bidding war for Nintendo in the next few years may make that risk palatable.