Nintendo Is Swtiching Into Fifth Gear: It Is About The Games

| About: Nintendo Co., (NTDOY)
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Summary

The analysts are clinically dissecting sales figures, whilst forgetting the old truism - it’s about the games.

The failure of the Wii U (previous console) casts a long shadow on Nintendo’s stock price but the storm has passed. Nintendo still has game.

Lingering doubts about the Switch, however, can now be cast off. Gameindustry.biz reports that Nintendo has sold 1.5 million units of the Switch to consumers.

Nintendo’s launch title Zelda The Breadth of Wild stands at commanding a 97 at Metacritic, placing it in the same echelon as Super Mario 64 and Halo.

Stock Market Response Is Tepid

Source: Google Finance

Nintendo (OTCPK:NTDOY) is one of three key players in the home console (video game) market. Nintendo's stock showed signs of life last year when the market mistakenly believed that Nintendo owned the economic rights to Pokémon Go. The firm's latest effort is on track to outsell the Wii. However, the firm's stock is 63% below the highs of ~¥70,000 it reached during the Wii's heyday (2006-8). If Nintendo can achieve a similar sales number as it did last generation, the stock is primed to sky rocket.

Consoles, unlike PCs, are refreshed every 5 years (the previous generation lasted a decade). Console manufacturers tend to launch new consoles in tandem and each refresh counts as one generation. We are currently in the eighth console generation. The launch of the Switch is an anomaly - it marks the first time a major manufacturer has launched two consoles within one generation.

Sega posted dismal sales numbers when it launched the Dreamcast. After which, Sega bowed out of the console race permanently and began its inexorable march to oblivion. Nintendo, however, chose to double down. After finally retaking the crown from Sony (NYSE:SNE) with the Wii Nintendo ceding ground when it launched the Wii U. The console has only sold ~10% of what its predecessor achieved since its launch in 2012.

However, clinically dissecting sales figures will lead investors astray - it's about the games.

Middling Wii U Sales Figures

Source: Kotaku, Wikipedia, IGN

The failure of the Wii U is largely to be blamed on the market's fixation on top line sales numbers. Nintendo ushered in the current console cycle on November 18th, 2012 with the launch of the Wii U, the successor to the massively successful Wii. The Wii U has floundered since then and has only sold 14 million units to date. The PS4 that launched on November 15th, 2013 has sold 53.4 million units.

Nintendo's second attempt at cornering the current generation, the Switch, launched on March 3rd of 2017 to lukewarm reviews. Its average review score is in the 60-70% range. The middling reviews may deter would-be bulls. However, console reviews do not hold much water.

Both the PS2 and the Wii lagged their counterparts in overall reviews. However, during the 6th console wars, the PS2 handily beat out the Xbox. In fact, the PS2 sold over 155+ million units globally versus her technical superior peer that racked up 24 million in sales. Similarly, the Wii trounced (102 million units) both the PS3 and Xbox, which sold ~84 million units apiece. Like her technically deficient ilk, the Switch is on track to dominate the current cycle.

The Switch Is The Most Successful Launch In The Firm's History

Source: Gameindustry.biz

Your lingering doubts about the Switch can be cast off. Gameindustry.biz reports that Nintendo has sold 1.5 million units of the Switch to consumers making the Switch the fastest selling console in the fabled company's history. In fact, GameStop's (NYSE:GME) (largest pureplay video game retailer) Senior Director of Merchandising Eric Bright believes that the Switch might outsell the Wii, which sold an impressive 101+ million units. The retailer's bullish sentiment should translate into more shelf space for Nintendo. Following the launch, Nintendo doubled its production forecast of the console to 16 million units next fiscal year.

Nintendo might be rewarded for the ramp up. Kotaku reports that Switch sales doubled to 78,441 units during the week of March 20th compared to the week before. For comparison, the Xbox One sold 115 units, the Wii U posted 411 units, and the PS4 posted a more respectable 25,472 units.

Console Exclusives In The 90+ Club

Source: Finder.com.au

The real moneymaker in video games, unsurprisingly, is video games. Nintendo's flagship launch title, Zelda The Breadth of Wild, stands at commanding a 97/100 at Metacritic, placing it in the same echelon as Super Mario 64 (94), The Last of Us (95), and Halo: Combat Evolved (97) - three of the most beloved first party exclusives of all time.

Here's some perspective, Finder.com.au's analysis of 20 years of Metacritic (think Rotten Tomatoes for video games) data found that the number of 90+ console exclusives have been steadily declining since their heyday in 2001. Sony has bucked the trend thanks to homegrown favorites such as the Uncharted franchise and The Last of Us. However Nintendo didn't; it didn't produce any AAA games in 2016. Zelda marks a much-welcomed return to form.

Moreover, Zelda's strong showing alleviates fears about a lack of third party support; an area Nintendo has always scored poorly in. The Xbox franchise would flounder without third party support, but for Nintendo this is par for the course. Zelda which is available on both the Wii U and the Switch sold disproportionately more units on the Switch. If the early adopters cared about the third party support, the sales would have been skewed in the Wii U's favor. Furthermore, the prominence of third party video games has begun to fade.

90+ Third Party Games Dry Up

Source: Finder.com.au

Collectively third party publishers only released 2 more triple A games than Sony in 2016. The drop in quality underscores the importance of triple A exclusives; Microsoft's (NASDAQ:MSFT) Xbox One console has fallen by the wayside due in large part to a lack of AAAs. The few titles that are in the pipeline are either lackluster like Crackdown or have been cancelled such as the heavily hyped exclusive Scale Bound. Moreover, the Xbox One regularly posts numbers that lag the PS3 in Japan, despite enjoying the same third party support as Sony.

Royalty Fees

Source: OnLive

Polygon reported that 54% of US gamers (numbering 155 million) use their consoles to stream movies. Sony monetizes those consumers with their Vue TV service, which hasn't always been the case. For example, when the PS3 launched, it was the cheapest Blu-ray player on the market and consequently consumers saw the device as a gateway Blu-ray player.

Thus, Sony deprived itself of royalty fees. Tie ratios are the number of video games on average that are sold per console. The PS3 had a tie ratio of 0.98 at launch. A console that was sold at a loss didn't have the accompanying royalty revenues to offset Sony's losses. Sony has righted the ship with its latest offering. The PS4 has an attach rate of 7.51 implying that a total of 401 million games have been sold on the platform.

The barebones Nintendo consoles typically have much higher attach rates than the PS3. For example, the Wii's tie ratio was 4.64. Unfortunately, the limited functionality and poor indie offerings also limits Nintendo's ability to reach the same heights as the PS4. However, Nintendo should be able to tie her previous effort.

Royalty fees

Wii U

4.64

Lifetime sales (M)

102

Royalty fee

$7.00

Royalty Revenue

$3,301

Source: LA Times

In which case Nintendo would earn $3.3bn in royalty fees (tie rate x console sold x royalty) of pure profit - not too shabby.

The Chink In The Armor No More

The chink in Nintendo's armor has always been its paltry internet services. Both Microsoft and Sony have been able to charge a subscription fee of $59.99 a year to play online. Nintendo is sticking to the same strategy. But first Nintendo will have to make good on its promise to simplify the process of adding friends (a nightmare on the Wii). Furthermore, through its "robust" online store Nintendo should be able to access $15 retail margin on top of $7 of royalty fee per full game sold. All signs point to success - Zelda (89% attach rate) has not cracked the top five on Nintendo's eShop.

Best-selling Switch eShop Titles

Source: express.co.uk

However, it is not all rainbows and butterflies. Zelda's attach rate is unusually high because of the dearth of AAA launch titles available. Horizon Zero Dawn, a AAA PS4 exclusive, which launched in the same window as Zelda, has sold 2.6 million units making it the most successful new IP launch in Sony's history. Horizon posted those numbers on console that has sold 53.4 million units to date. The concentration risk is real.

The Wii U casts a long shadow on Nintendo' stock price, but the storm has passed. Nintendo still has game and that's what gamers care about.

This article is a part of a series that will cover the video game industry. If you enjoyed reading this article, then please click the follow button so you won't miss out on new material and please visit my author page in case you missed an article in the series. Thanks for reading!

Disclosure: I am/we are long NTDOY.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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