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NTDOY AT A GLANCE

 

 

 

 

 

 

Nintendo (OTC:NTDOY) is a Japanese video game company, and the fifth-largest software company in the world^[1]. Released in 2007, its flagship hardware product is the Wii, a seventh-generation console with worldwide consolidated sales of 26.0 million units in FY2009^[2]. While this represents a dramatic increase from the 5.84 million units sold in FY2007, monthly unit sales have been in decline from May 2009, according to research firm NPD Group^[3]. It's second most popular video game in terms of revenue, the Nintendo DS, is an older, dual-screen handheld game console, with yearly unit sales growth of nearly 56% since its release in 2005^[2].

The Game Boy Advance led worldwide hardware and software sales among Nintendo's product lines, with respective sales of $81.1 million and $376.7 million^[4]. The Nintendo DS was a close second showing the importance of the handheld gaming industry to Nintendo's business.^[4]

With its beginnings in GameBoy, Nintendo continues to be the preeminent handheld console manufacturer driven by the success of the Nintendo DS. Both the DS and Wii are products of Nintendo's strategy to expand the video game consumer market. Both products are simple and easy to use so that they may appeal to the casual gamer, female consumer, and 35+ demographic. The strategy has been paying off for Nintendo. The DS is selling faster than any other gaming device and Nintendo reported that 40% of DS users are 35 and older. At the same time, Nintendo can still attract the younger market with its many popular gaming franchises including the Legend of Zelda, Mario, Pokemon, and Donkey Kong.

Nintendo's profitability and sales are influenced by several factors. Video game consumer preferences will be extremely important in determining the success of any of Nintendo's consoles. The Wii is a shift from conventional console strategy and has been accepted by video game consumers resulting in a huge success. Nintendo's internal software production was one the company's earliest strengths, but Nintendo's dependence on it has also made it one its past weaknesses. Nintendo's shift towards third party software developers has been one of the biggest reasons for the Wii's early success. Nintendo's technological advances and product innovation are also vital to Nintendo's survival in the console war. Nintendo has about 70% of sales coming from overseas and is vulnerable to changing foreign exchange rates.^[4] Lastly, the video game industry as a whole may potentially run into stiff competition from mobile gaming and/or Massive Multiplayer Online Games (MMOG).

Company Overview

Business and Financial Metrics

Business Segments

Electronic Entertainment Hardware

Consoles: Wii: Introduced in 2006, the Nintendo has sold about 5.84 million Wii systems, about two million more than Sony's PS3s sold. Wii uses a wireless controller that senses motion and rotation and markets to the casual gamer with a simple, easy to play system. Oh the other hand, the PS3 and Xbox 360 are highly advanced technology products with sophisticated processors and graphics.

Consoles: GameCube: Introduced in 2001 to compete with the PS2 and the original Xbox, GameCube was the least expensive of the three previous generation consoles, but reached only a 17% market share. Today, the GameCube faces additional competition from the new PS3, Xbox360, and Nintendo's own Wii. The GameCube sales dropped 66% in 2006 and will most likely be obsolete in the next year or two.

Handhelds: Nintendo DS: Introduced in 2004 and, combined with sales from the DS Lite, has sold over 40 million units as of March 2007. The DS features dual screens (bottom display is also a touch screen), built in microphone, and has wireless (WiFi) capability. The DS Lite was introduced in 2006 as an upgrade in terms of weight and functionality.

Handhelds: Game Boy Advance (GBA): Introduced in 2001, the Game Boy series has sold over 79 million units worldwide. Game Boy Advance was upgraded in 2003 with the GBA SP which was more compact and had a brighter LCD screen.

Electronic Entertainment Software

Given the 80%+ margins on software, it comes as no surprise that Nintendo has historically developed most of its own software in-house. However, with the disappointing performance of the previous-generation GameCube console, Nintendo has increasingly worked with third party software companies to develop titles (see Content is King). The company realizes near pure-profit licensing revenue from third party developers, as Nintendo bears little to no development costs.

From 2003-2006, software sales contributed to just under half of sales revenues for Nintendo; starting in 2007, hardware sales grew faster than software sales--likely due to Nintendo's strategic decision to open up development to third party software companies for its Wii platform.

Other

Trends & Forces

Game Content is Key

Software has the ability to make or break a console. Much of Sony's dominant global market share--69% as of early 2006--enjoyed by its previous console, the PlayStation 2 (PS2), can be attributed to its library of games, which totaled nearly 1,500 as of April 2006. Its most popular game franchises include the Final Fantasy, Grand Theft Auto, and Gran Turismo series.

Nintendo's previous-generation Game Cube console offered only 271 titles in comparison. Though the company owned some of the most popular video game franchises (e.g., Mario, Legend of Zelda), the introduction of the Wii brought a shift in game content strategy for Nintendo, which had historically shunned software companies and produced the majority of their own titles internally.

Wii: Adding Third Party Game Developers

Nintendo increased R&D spending--up 23% from last year--much of which is likely going towards software production. However, with the Wii, Nintendo has reached out to third party developers such as Electronic Arts (ERTS), Namco Bandai (TYO:7832) and Square Enix (SQNXF). As of early June 2007, the Wii console offered 58 game titles; five titles had sold over one million copies, and two of these were produced by third party developer Ubisoft (EPA:UBI), a French company. In comparison, the PS3 has 46 titles out and has only one game title has sold more than a million copies as of June 2006.

A key benefit attracting software development for the Wii console is that its relative simple technology allows companies to develop Wii games at a fraction of the cost compared to games for the advanced graphics-heavy PS3 or Xbox 360 consoles. Development costs for a Wii game can run as low as $5 million, compared to as high as $20 million for a high-definition PS3 game. ^[5] Also, the popularity of the Wii allows third party developers to move away from depending heavily on Sony and its best-selling PlayStation 2.

More Console-Neutral Games

Nintendo's The Legend of Zelda and Microsoft's Halo franchise are titles available exclusively on their respective gaming console platforms. However, as game console manufacturers increasingly depend on third parties to develop software titles, an increase in multi-platform games (i.e., titles available across different consoles) can even out the playing field. For instance, Square Enix has developed the Final Fantasy series exclusively for Sony in the past, but will make available several Final Fantasy variants for Nintendo's consoles. In addition, best-selling titles such as Madden, Call of Duty, and Tony Hawk are being developed for all three major game consoles by Nintendo, Sony, and Microsoft.

As game differentiation between the consoles lowers, price becomes increasingly important--and the Wii is poised to dominate from a price perspective.

Better Graphics vs. a New Experience

Sony and Microsoft developed their respective next-generation video game consoles under the belief that consumers demand better graphics and games that are more complex and sophisticated. Nintendo continued to follow this strategy of advanced graphics and gameplay, and their sales volume still dropped about 40 million units between NES and GameCube. The design of the Wii, on the other hand, was aimed introducing a new experience that would appeal to a broader audience than hard core gamers.

North American success: vital

North America is the largest video game market in the world, accounting for 45% of hardware volume and 49% of software volume. As a result, Wii's success is dependent on the continued acceptance of Nintendo's alternative approach in this very important region. In the past, the North American consumer has preferred the first person shooter games, including the extremely popular Halo series for Xbox. This type of game fits well with the advanced graphics and capabilities of the PS3 and Xbox360.

Wii's casual gamer approach has been most effective in Japan, although its initial success in North America has been significant. Nintendo's offering continues to outsell both Microsoft's and Sony's consoles in the U.S.;n June 2007, Nintendo sold 382k units, nearly double that of Xbox (198k) and four times that of PS3 (99k).

Japan: Casual Gamers

Nintendo has been highly successful in its native Japan, also home to Sony and often considered the birthplace of video games. Unlike their North American counterparts, Japanese consumers have preferred role playing games, such as Nintendo's Zelda games and Playstation's Final Fantasy games; Xbox sales have been poor in Japan historically.

Nintendo has been successful with its casual gamer approach, as evidenced by sales of both its handheld and Wii hardware units. As of March, 2007, the DS/DS Lite sales have reached over 40 million units worldwide, approximately 14.9 million more than sales of Sony's PSP. Combined DS/DS Lite and the Wii sales outpaced those of its Sony's PSP and PS3 offerings by factor of 5 to 1 as of May 2007 in Japan.

Nintendo's Standout Design Mentality

Technology and innovation are critical to meeting the increasing demands of consumers, and Nintendo's approach to technology and innovation has been different than that of Sony and Microsoft.

• Nintendo's DS and DS Lite platforms integrate touch screen and voice recognition technology into games such as Brain Age and Nintendogs (the latter sold 6.7 million units in 2006). Their handheld offering also uses a free wireless service to allow DS console owners to interact and communicate with each other
• Much has been said about Nintendo's Wii's game control technology, which translates human movements into action with the context of a video game (e.g., users swing the controller like a bat in a baseball game). The "brains" behind this technology is a $2.50 chip developed by Analog Devices (ADI) that measures movement in three dimensions
• Xbox 360 and PS3 utilize competing high-definition graphics (see Blu-Ray vs. HD-DVD). If one high-definition technology emerges as the clear winner, the respective console could reap great benefits

Favorable Foreign Exchange Rates

Nintendo is exposed to global foreign exchange rates, as nearly 70% of Nintendo's sales come from outside of Japan. On top of that, Nintendo holds a significant amount of assets denominated in foreign currencies. In 2006, Nintendo's net foreign exchange gain was $192.3 million and the company gained about $400.7 million from exchange rate changes on cash and cash equivalents in 2006. Nintendo is vulnerable to changes in exchange rates for better or worse--appreciation of the Japanese yen against the US dollar or Euro would signify a change for the worse.

Increased Competition, Decreased Market Size

Console video games face two direct threats from mobile gaming and MMOG (Massive Multiplayer Online Games). Mobile gaming is played on mobile phones or handheld computers, and while mobile games are currently considered inferior to console video games, the convenience and ubiquity of mobile phones poses a potential threat to steal share from Nintendo's handheld business and casual gamer customer target.

A more immediate threat to the console gaming industry is MMOG, many of which have proven to be extremely popular (e.g., World of Warcraft, Starcraft, and Everquest). As the name suggests, MMOG games allow players to compete against other players across the globe in huge multiplayer scenarios via the Internet. MMOG encompasses many different game genres that mirror its console video game rival such as RPG (role playing game), first person shooter, and racing. Games like World of Warcraft and Everquest can demand an incredible amount of time and dedication to the game leaving little time for console video games. Both the PS3 and Xbox360 have online capabilities which in many ways directly competes with MMOGs, but Wii does not currently have that ability.

In addition to increased competition, the U.S. video game market contracted significantly in June 2009.^[6] Sales of video game equipment and software fell 31% to $1.17 billion in June 2009 which represented the largest decline since 2000. Software, hardware, and accessory sales decreased 29%, 38%, and 22%, respectively. In addition to the current economic weakness, the declines are thought to be caused by consumers waiting for price reductions before purchasing items. NTDOY's Wii and DS were the best selling consoles of their kinds, showing NTDOY's current dominance in the console market. Year to date overall video game sales are down 12%, but those in the industry are expecting the second half to be strong, as there are many big releases planned for the 2nd half.

Competition

Nintendo's primary competitors in the video game industry are Sony (SNE) and Microsoft (MSFT). In the video game console arena, Nintendo's Wii stacks up against Sony's PlayStation 2 and 3 and Microsoft's Xbox 360, while in the handheld segment, Nintendo's DS/DS Lite competes primarily with Sony's PSP. As seen in the charts below, Sony's previous generation console, the PS2, has outsold all next-generation newcomers since November 2006, when both the Wii and PS3 launched. And to put the overall console gaming market into perspective, while the Wii has sold over 3 million units in 8 months, Sony's PS2 has sold the between 100 and 120 million units worldwide since its launch in 2000 ^[7]. In the U.S., the PS2 still accounts for over 40% of game use according to Nielsen GamePlay metrics due to its enormous installed base. ^[8]

Sony's new PS3 console has been plagued by high prices ($499-$599 at launch depending on hard drive size) and production delays which put it about a year behind the Xbox360, which launched in 2005 ($399 for a typical unit). Xbox360 has shown success in North America and Europe, but the Japanese market has not adopted Microsoft's console, as it lags both Sony's and Nintendo's offerings. The Both the PS3 and Xbox360 have HDTV, and Internet capabilities. Sony's Blu-Ray and Microsoft's HD-DVD technologies support high definition. Blu-Ray, in particular, is a proprietary format developed by Sony, which hopes to establish the standard for high-definition video; if the PS3 helps Blu-Ray gain consumer acceptance, then Sony would very likely see windfalls from licensing fees from movies, etc.

Wii not only has the advantage of being the lowest priced of the three consoles ($149 for a base unit), but Nintendo makes approximately $50 in profit for each hardware unit sold. ^[9] As a result, the company increased operating profit by 150% over the previous year and its operating margin currently stand at 23.4%. It has been widely reported, on the other hand, that Microsoft and Sony have subsidized their technologically advanced consoles in the hopes of growing an installed base and generating profits from high-margin software and licensing revenue.

References

1. ↑ "Software Top 100-2009 Edition" 11/13/09
2. ↑ ^{2.0 2.1} "Nintendo 2009 Annual Report" Nintendo Investor Relations, 8/25/09
3. ↑ "Nintendo’s Wii Sales Fall in U.S. for Eighth Straight Month" Bloomberg News, 11/13/09
4. ↑ ^{4.0 4.1 4.2} NTDOY 2008 Annual Financials (March 31, 2008).
5. ↑ http://money.cnn.com/magazines/fortune/fortune_archive/2007/06/11/100083454/index.htm
6. ↑ Gabriel Madway (July 16, 2009). U.S. video game sales post largest decline since 2000. Reuters.
7. ↑ http://games.techwhack.com/1190/playstation-2-wii/
8. ↑ http://www.betanews.com/article/PS2_Still_Most_Played_Game_Console/1185465698
9. ↑ http://money.cnn.com/magazines/business2/business2_archive/2007/05/01/8405654/index.htm
10. ↑ ^{10.0 10.1 10.2 10.3} Revenue was converted from Yen to the US dollar at the exchange rate of 1US = 118.05 Yen

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