This is a follow-up to two of my earlier Instablog video-game related articles.
Nintendo stock just fell almost 20% on bad Wii U (their current home console) sales numbers - which was to be expected. This may a good time to update my outlook in early 2014:
I discussed in my earlier articles that Nintendo (OTCPK:NTDOY) will be squeezed from two sides in the future:
New entrants in the console space (especially hard-hitting for Nintendo is the mobile side where they enjoyed a virtual monopoly since the Gameboy and earlier Game&Watch devices in the 80s) and new distribution models (less packaged games distributed and more digital distribution coupled with cheaper or even "free to play"-games).
Comparing the video game maker from Kyoto to Sony (NYSE:SNE) amazes me: Even 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 just a small portion of the entire Sony corporation.*
My simple scenario for choosing $SNE over $NTDOY (both at a market cap around $20 billion at the moment) is three-fold:
1. Sony becomes the number one company in video games again in terms of units sold. Sony looks like the winner in the current home console generation with the Playstation 4 (with XBoxOne likely second and Nintendo a distant third in terms of units sold) and a new streaming video offering called "Playstation Now" starting later in 2014:
Sony creates custom PS3 hardware for PlayStation Now
Dedicated servers house eight PS3s, built from the ground up for cloud gameplay.
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. Here's 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 HW units when including the mobile console space, it still is the clear overall leader today. But I think this business will shrink considerably over the next 5 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 gaming devices like the Nintendo 3DS will be shrinking according to most analysts and the sales statistics since about 2012.
2. Sony manages to complete its electronics turnaround. Sony for years tried to stop the bleeding in electronics (TVs, point-and-click cameras, batteries...). It may soon be there. This segment should at least be profit-neutral by 2015. One of the biggest troubled areas with the deepest losses, TV "Bravia" hardware, may catch a break thanks to 4K resolution TVs with better margins - or at least smaller losses for a few years:
Sony has been an enthusiastic standard-bearer of 4K video, and Hirai made clear the company had both feet planted squarely in the 4K camp. He emphasized that 4K TVs already make up a double-digit percentage of the company's overall TV revenue.
But he's also conscious of the fact that those 4K profits won't last forever -- one reason the company's ongoing restructuring efforts need to result in a Sony that's drawing from a more diverse revenue stream. "If commoditization of 4K TVs come along -- and someday it will -- we need to be able to withstand the wave of price reductions we'll see. We need to be strong as a company to withstand the turbulence."
3. Sony finds new growth areas in its core business units. A possible turn-around may be linked to fewer key focus areas like smartphones (Xperia Andrid phones), wearables and the audio/video entertainment** - in this scenario, Sony further streamlines its "core" (especially electronics) so that this segment again contribute to the bottom line, even if only modestly in terms of operating margins.
A weaker JPY already helped the electronics "core" since late 2012, 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 - foreign activist investors proposing this idea were turned down by Sony management in the past.
Turning over to NTDOY, I see a much more cloudy future, the only things going for them are their
- Lots of cash, marketable positions (still about half their market cap)
- Gaming and character IP popular with generations of gamers (NTDOY made videogames almost 15 years longer than SNE and has a much stronger first-party sales percentage on their consoles)
Both strengths are also dangerous because it could slow NTDOY down before making the necessary, hard adjustments or cuts soon enough. The strength of their first-party IP and cheaper, but weaker hardware specs on their recent consoles is both a blessing and a disguise: Few and fewer third-party developers make "big" games for Nintendo consoles.
Unless Nintendo can pull another rabbit out its hat, I am skeptical on its 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 a Mario and associated characters, Zelda, Pokemon...). Their IP has a 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 tablets and smartphones.***
- 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 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. I just think a company like DIS could be more suited for Nintendo than other rumored names (NASDAQ:AAPL) often discussed in the past.
Summary: Given the willingness and speed to adapt to challenges and hidden value drivers at both companies, I would prefer Sony shares over Nintendo at the moment given equal market caps and more predictable turn-around scenarios for Sony.
Nintendo's valuation seems to hinge more on past success, including the discussed huge cash mattress - this is dangerous for companies in the technology sector - maybe Nintendo should reinvent itself further in the entertainment sector outside of video games (new business areas such as theme parks...).
* $SNE made most of its profits outside of electronics. Many people may be surprised SNE actually made most of its profits in life insurance/financial services in recent years:
** Moves by foreign activist investors to spin off the Sony entertainment (movies and TV productions) have so far been unsuccessful.
*** I discussed new entrants in the video game industry in an earlier Instablog entry:
Disclosure: I am long SNE.