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Bought $NTDOY
Nintendo is a 131 year old Japanese company with the express mission ”to put smiles on the faces of everyone we touch”.
One of the reasons that Nintendo is an exceptional company is it’s long, successful track record of innovation in both technology (hardware & software) and creativity (storytelling & intellectual property).
Since 1980, Nintendo has had 14 major console releases. At the same time they released numerous influential franchises, including Mario, Donkey Kong, The Legend of Zelda, Kirby, Metroid, Fire Emblem, Animal Crossing, Splatoon, Star Fox, Super Smash Bros., and Pokémon.
A common criticism of gaming companies that manufacture consoles is the cyclical boom-bust nature of the business. Every new console is viewed as a high risk event where the customer count resets to zero. But there is reason to believe that the Switch is breaking Nintendo free from that narrative and toward an iterative product line similar to the iPhone.
See below for the origins of the Switch from Wikipedia:
“The Nintendo Switch was unveiled on October 20th, 2016. The concept of the Switch came about as Nintendo's reaction to poor sales of its previous console, the Wii U, and market competition from mobile games. Nintendo's then-president Satoru Iwata pushed the company towards mobile gaming & novel hardware. The Nintendo Switch's design is aimed at a wide demographic of video game players through multiple modes of use. Nintendo opted to use more standard electronic components, such as a chipset based on Nvidia's Tegra line, to make development for the console easier for programmers and more compatible with existing game engines. As the Wii U had struggled to gain external support, leaving it with a weak software library, Nintendo preemptively sought the support of many third-party developers and publishers to help build out the Switch's game library alongside Nintendo's first-party titles, including many independent video game studios. While Nintendo initially anticipated around 100 titles for its first year, over 320 titles from first-party, third-party, and independent developers were released by the end of 2017.By the start of 2018, the Switch became the fastest-selling home console in both Japan and the United States. As of September 2020, the Nintendo Switch and Nintendo Switch Lite have sold more than 68 million units worldwide.”
Below is an excerpt from Ryan O’Connor’s 2018 white paper on Nintendo:
“...let’s look at why we think Nintendo may be the single best risk-adjusted setup we’ve encountered in the history of the Fund. Perhaps the biggest reason, outside of valuation, is that Nintendo is changing from a cyclical, “hits-driven” business to a secular growth juggernaut with stable recurring revenues, expanding margins, and declining capital intensity. It’s doing this by getting away from having earnings depend on the success or failure of each new console. Instead, it’s transitioning to an iterative hardware model, where its installed base continuously grows and never resets. That should ensure the Switch benefits not just from the ongoing structural shift to higher-margin digital distribution of software, but also from the ability to sell high-margin software and related services to an ever-larger installed base. Moreover, the Switch’s explosive success has already ignited Nintendo’s long-lost network effects, fueling a sustained ascent of sales and earnings that we think will result in nothing less than a tripling of Nintendo’s share price in the years ahead. But Nintendo’s business model transformation doesn’t end there. Nintendo isn’t just surrounding its own indefinitely-lived hardware platform with a proprietary software-driven digital marketplace, like Apple surrounds its iPhone and iPad with its App Store. It’s also making games for smartphones themselves – vastly expanding its reach by targeting the world’s 2.5 billion smartphone users, and promising to layer on yet another high-multiple stream of stable, recurring, increasingly high-margin revenue.In short, entering the smartphone space dramatically expands Nintendo’s addressable market,
stepping up its recurring revenue base while permanently boosting its baseline profitability. (Its operating margins in mobile, at scale, should be over twice the corporate average.) And while some observers doubt Nintendo’s ability to succeed in smartphone games, we think that view is nonsense– an ironic collapse in confidence at the very moment our 800-ton Godzilla has finally mastered its mobile gaming powers. Later in this report, we’ll make the case that Nintendo is ready to tear into the mobile profit pool with a vengeance.”
A quick search for Nintendo in the App Store seems to support Ryan’s points on the smartphone gaming angle:
Another criticism of Nintendo over the years has been the undermonitization of it’s intellectual property. While this is true, Ryan O’Connor also provided some prescient insights back in 2018.
“Finally, Nintendo is aggressively ramping up monetization of its peerless library of game franchises and classic characters – the most valuable such collection in the videogame industry by far. Television shows, theme parks, movies, stand-alone retail locations, toys, and various licensed products are all in the works. Monetizing its IP is an area in which Nintendo has traditionally lagged, but over the last few years it’s been hard at work making up for lost time. These efforts promise to provide it with yet another pillar of defensive, high-margin, annuity-like revenue and cash flow.”
Since this letter was released, you can see evidence of this thesis coming to life with a theme park, hotel and innovative toys like Mario Kart Live: Home Circuit.
Mario Kart Live: Home Circuit Trailer: https://www.youtube.com/watch?v=01gaiThtflI
While the “Smart devices, IP related income, etc.” category has grown 794% from 2016 to 2020 it still only accounts for 3.9% of total revenue. With a renewed focus on this category and secular tailwind in demand for valuable IP driven by the Streaming Wars, there’s reason to believe this category will become an increasingly larger share of revenue over the coming years.
At a high level, Ryan laid out the four major tailwinds for Nintendo over the coming years:
“de-cyclifying the console business, moving to digital distribution, making smartphone games, and effectively monetizing its IP – should not only transform Nintendo’s business model, but permanently improve its ROE, rapidly expanding the sources and quality of its underlying revenue base and exponentially increasing its earnings power.”
Looking at the fundamentals of the business over the last decade, this is an exceptionally high quality business with a strong 6 year track record of increasing return on invested capital.
On a relative valuation basis, Nintendo appears to be undervalued by EV/Total Assets, EV/Sales and EV/EBITDA.
Most importantly, Nintendo is a company that has been relevant my entire life and I’d wager it will become even more relevant for the rest of my life. Very few companies, especially in the gaming industry, have matched the sustained cultural resonance that Nintendo has achieved globally for decades. This speaks to their deep-seeded culture that is at the heart of their competitive advantage.
A sustainable, resilient and innovative culture with a long track record of success is the single most important quality that I look for in an investment. It gives me the conviction to hold for the long haul. This is true for Amazon, The Trade Desk and Square. Nintendo feels like the missing piece in my portfolio. After doing my due diligence, I decided to initiate a 5% position. Over the next 12 - 18 months, I'll be looking for opportunities to add to this position if a better price point presents itself. Very few companies are worthy of the “never sell” category. I believe that Nintendo might be worthy of this title.
Ryan O'Connor Interview on the Investing City Podcast: https://youtu.be/NnWTzawMffU?t=1307
Ryan O'Connor investor letter on Nintendo from 2018: https://drive.google.com/viewerng/viewer?url=https://gallery.mailchimp.com/f5064af0f6e5340816e525710/files/ce57076f-3ee7-4dc1-82a6-ac476fc9d258/2018_Annual_Letter_Nintendo.pdf&wmode=opaque
drive.google.com
2018_Annual_Letter_Nintendo.pdf
I’ve been thinking a lot on autocatylsis. Nintendo seems to be a company I think has a lot of autocatylsis (franchises).
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