February 28, 2011 - 12:09am EST by
2011 2012
Price: 24,000.00 EPS $1,787.84 $0.00
Shares Out. (in M): 128,000 P/E 13.4x 0.0x
Market Cap (in $M): 3,397K P/FCF 21.5x 0.0x
Net Debt (in $M): 0 EBIT 356,570 0
TEV ($): 2,323K TEV/EBIT 6.5x 0.0x

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*all figures in Japanese Yen

*FY ends on March 31

Nintendo Co is a Japanese company that develops and manufactures hardware consoles and video game software.  It has a global operation and over 85% of FY2010 sales from outside Japan.  Currently, most of its revenue is derived from consoles sales and software sales of the Nintendo DS (handheld) and the Wii (home-based console).

The recent success of Nintendo is entirely because of the popularity of DS and Wii.   Both systems have passed their peak and are near the end of their respective product cycle.  As a result, the stock has dropped off from its ¥71,900 (22x adjusted FY08 FCF) in Oct 2007 to its current price of ¥24,050.

Investment Thesis

Nintendo represents a compelling opportunity to invest in a company that

1)      generates lots of free cash flow, with virtually no debt

2)      a proven management team with a great track record (Wii, Wii Fit, Zelda, Brain Age just to name a few)

3)      Most importantly, a free call option on the new 3DS which just went on sale 2 days ago and were sold out.  If successful, earnings would increase significantly in FY12 and FY13.

4)      is unloved today because the DS & Wii systems are in run-off mode

Additionally, with net cash represents 24.2% of its current market cap (based on ¥24,050 yen/share), no debt, and the fact that Nintendo is still generating FCF from the DS & Wii, investor should be able to exit the stock with minimal loss if the 3DS end up being a bust.

Video Game Consoles: Market Share is King

In this industry, market share in terms of number of units sold determines the winners and the losers.  The manufacturer with the lead would attract 3rd party developers to develop games for its console.  The more and better the games that are available would increase demand for the console.  This turns into a self-reinforcing cycle as developers prefer to work with the leading manufacturer because the potential customer pool is bigger.

Nintendo 3DS

The link below describes what the 3DS is in detail.  The selling point is it allows its users to play games in 3D without special 3D glasses.

I cannot predict what the future would look like, but I believe the 3DS would be successful because

  • The obvious attractiveness of 3D. Apparently, it works. Here's a quote from the article linked below.

 "So after a marathon of features are we holding a device worth the 200 sheets you'll likely be paying? The answer is a resounding "yes". While some of the 3DS' in-built software is light on the ground, it's the tech it demonstrates that is really incredibly important."

  • 3DS is backwards compatible with the DS. The user can play any OLD 2D Nintendo DS games in 3D with a switch of a button. The biggest hurdle for a console manufacturer is to establish an initial game pipeline. Development of games is costly for the developer, and developing games for a new console is costlier and riskier. This backward compatibility is a major strength because the Nintendo DS was enormously successful. I want to stress playing an old game in 3D is an entirely "new" experience and is not the same as playing an old PS2 game in a PS3 player.
    • The DS has 1,844 games available and 144 of them are "over 1 million units sold" hits. Translation: it's like the Wii launching with 144 proven hit games.
    • Nintendo has sold over 144.6m of DS units. That's 144.6m potential customers for the DS.
  • I did some investigation of my own. Since I reside in North America, the 3DS is not available until next month. Stores that I have visited include Best Buy, EB Games, and Toys R Us and the sales associate all told me that they are getting a lot of inquiries and pre-orders. The level of interest is a bit weaker than when the Wii launched. I did the questioning before the Japan launch and based on the positive reception and reviews mentioned above I expect the "hype" would go up.

Earnings Power

I am assuming the 3DS would only be able to match 75% of the DS sales (I believe this is very conservative) and the DS & Wii are in run-off mode that will last 2 more years.  Although sales, sales/unit and margins are front-loaded with peak earnings and margins occurring at the 2nd or 3rd year of new product launch, I am straight-lining the sales numbers and use "over the cycle" profit margins for my earnings estimate.  Actual results in FY12 & FY13 should be considerably higher than my estimates.

Profit margin = adjusted FCF/sales

Adjusted FCF = CFO excluding working capital - capital expenditure

Nintendo should be able to sell at least 19.6m units of DS & Wii combined (It sold 29m in the first 9 months of FY2011) and 18m of 3DS in the 2nd year of 3DS launch (In the 2nd year of DS full launch Nintendo sold 23.6m of DS).  Assuming a profit margin of 16%, adjusted FCF/share would be around ¥1,500/share.  Current price implies a 12x FCF multiple.  (¥24,050 - ¥5,860)/ ¥1,500 = 12.1x


  • Yen appreciation would hurt results as the foreign subsidiaries that are responsible for 85% of sales operate and transact in local currencies.
  • the 3DS is a bust
  • Fail to develop a new console to replace Wii
  • New competitors: back in 2007, no one would consider mobile phones as competition to the video game consoles. Fast forward to 2011, consumers can choose from a variety of android phones, the IPhone/ IPad and tablets. All of which are capable of delivering the same gaming experience as the traditional handhelds. Who knows what will happen in the next 5 years? May be Apple would come up with a 3D IPad or something.


Nintendo is not a buy and hold stock.  Its revenue is based on products with 5 - 7 year life cycles.  In other words, it has to come up with "hits" every 5 years or so, just like the car companies.  Therefore, it is very difficult to "normalize" earnings and come up with a specific target price.  However, I do know that if the 3DS is successful, a 12x FCF would be too low.  During the DS & Wii cycle, Nintendo peaked at 21x of T12M FCF.  Again, my ¥1,500/share number would be lower than the actual number.  A 18x multiple + net cash would value the stock at around ¥32,800


 The Nintendo 3DS launch
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