Description

AAOI has done some incredibly detailed work on Nintendo.  Here is my take on the long pitch as well:

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Buy Nintendo: new Switch 2 console cycle mid/late 2024 start should drive excitement, financial upside and multiple expansion; continued IP monetization through new theme parks and movies; margin expansion from subscription, digital, licensing

Summary: 

I like Nintendo (7974 JP) stock. I like it on an absolute basis and relative basis vs. other names in video games and media.  The Nintendo Switch 2 launch (probably will be announced mid 2024, and launch late 2024) is the main positive catalyst for Nintendo.  

The new Switch launch should drive a large 4-5 year upcycle in revs and earnings for Nintendo.  Prior launch cycles have driven the stock up 40-400% if you buy around 1 year before launch and hold for a few years with an average gain of +216%.   

Also, Nintendo has started successfully monetizing its IP and platform in other ways (e.g. through movies, theme parks, subscription services, more digital downloads, iOS games, becoming a 3rd party game platform, toys, etc.).  The Mario Brothers movie grossed $1.4bn at the box office.  The theme parks are built and operated by Universal Studios (Nintendo get IP license revs off it) and have been successes.  A live action Zelda movie is coming (perhaps in 2025-2026).  Continued success in movies and theme parks (which seems likely given recent success) should continue to drive the multiple higher and higher #s as it shows that they are diversifying and creating other avenues for profits and growth (in a capital efficient manner). 

I think there’s 40%+ upside in the stock (25x 400 yen fiscal 3/2026 IFRS EPS = 10k yen stock, vs. the stock at  7,200 yen now,  20.7x P/E ex cash) from the new Switch 2 launch, and it’s a secular grower as they figure out other ways to monetize their IP and build out a Disney like flywheel (as the movies and theme parks also help sell more games and toys and vice versa).  The vast majority of revs and earnings are tied to the hardware and games though.   ~90% of gross profits still comes from video game hardware and software though,  but around 10% (and growing) comes from the growing IP segment like movies, theme parks, licensing, etc.   

And they have immaterial debt, and ~22% of their market cap in cash.  So there’s likely added upside from potential capital return.  

From a macro standpoint, Japan is doing well economically and corporate reforms are helping Japan Inc.  It also has Warren Buffet’s stamp of approval.  And Japan’s monetary policy normalization should also be supportive yen.  So I like owning Nintendo stock (unhedged) given these other tailwinds. 

Stock Charts

The stock has also recently started to break out, of a long term top, which is bullish

5 yr:

Stock chart since 1983

New console launches have usually driven the stock up a lot if you buy it before the launch and hold till the launch or a few years after

Rough gains in prior launch cycles: 

• NES 1983 launch; stock from 1983 till 1986 +335%

• Super Nintendo 1989 launch; stock from 1988 till 1990 +300%

• Nintendo 64, 1996 launch; stock from 1995 till 1998 +170%

• GameCube 2001 launch; stock from  2000-2002 +40%,  GameCube was disappointing, and this coincided with the 2001 recession

• DS 2004 launch; stock from 2003-2004 up +77%

• Wii 2006 launch; stock from  2005-2009 +412%

• Wii U 2012 launch; stock from 2011-2014 +58% < this was also a disappointing console

• Switch 2017 launch; stock from 2006-2021  +332% < this cycle lasted the longest, partly  helped by the COVID bump

The average gain here is +216%  with a range of +40% to +412%

Admittedly there is some cherry picking the end dates here,  but you get the picture:

This cycle is a bit different from prior cycles that were more boom and then bust by the time the next console is out.  However that’s partly because Nintendo has done a better job extending the Switch 1 lifecycle with new iterations.  And the COVID stimulus + stay at home period helped as well.  The growth of 3rd party games, subscription, regular game cadence, movies, and theme parks, and margin expansion tailwinds have also helped the stock and earnings be less cyclical this time around, which is helpful for the multiple and future growth / compounding. 

Macro

Japanese stocks in general have been doing well because the economy is getting out of deflation from all the economic & corporate reforms and stimulus in Japan over the last decade. 

Japanese companies broadly have been focusing more on shareholder value creation, ROE, capital return, etc. 

Nikkei 225:  5 yr

Nikkei since 1970s

Short interest is negligible 

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Details

New console upcoming, Switch 2

This is the first new console launch for Nintendo since March 2017 with the Switch 1.  There are lots of rumors and signs that the Switch 2 will launch sometime in 2024 (e.g. sources are talking about a 2H 2024 launch, they demoed it to developers to get new games under development, etc.).  Even if it doesn’t launch in 2H, it’ll probably launch soon after, hence keeping the excitement live. 

• Prior console cycles have driven multiple years of growth (e.g for 4-5 years) in hardware and software sales

• The new Switch 2 is the same form factor as the Switch 1 and is mostly a performance upgrade,  this removes a lot of the execution risk around this (e.g. prior Nintendo console iterations like the Wii-U and GameCube which weren’t as popular and were totally new form factors and untested) 

• Backwards compatibility, which is likely, will also lessen the risk of an air pocket in sales prior to the launch

Of course, the hype and the announcements of the new launch will probably be enough to get the stock to keep going higher through 2024.  This is usually the case with most video game companies / game developers with 1 big driver (e.g. TakeTwo with Grand Theft Auto / Red Dead Redemption,   CD Projekt with Cyberpunk 2077, etc.).  Usually, even if numbers are choppy around the launch and leading into the launch, people will ‘look through it’ since that’s gamers waiting for the next cycle. 

Most sell side #s don’t bake in the Switch yet, partly because Nintendo likes to keep everything under wraps and a secret 

So consensus numbers are far too low and will come up a lot.  In prior console cycles, revs and earnings grew by huge amounts.  

It’s also rumored that they may increase the price of the hardware to $400 (mostly to account for the better specs) and software games to $70 (up from $60)  for the next cycle, which would be added upside.  I think gamers will continue to pay the higher prices, especially given all the inflation and it’s still a ton of value (on a cost per hour of entertainment basis). 

Valuation 

Most analysts / consensus numbers, don’t model in a new Switch.  So current numbers are low.  The stock seems fairly valued at 24x fiscal 3/2025 P/E and 22x 3/2026 P/E on consensus #s

• 17x fiscal 3/2025 EV/EBIT, 15x Fiscal 3/2026 EBIT on consensus numbers

• 2.6% dividend yield, with potential for more capital return

  • As a reminder 22% of the mkt cap is in cash, and there’s no debt

But earnings can easily be 40% higher with a new Switch in year 2 of a new Switch launch (and heading higher for a few more years).  

• A mid 20s multiple is in the same ballpark as where other video game makers trade relatively

So the stock could trade at 25x ~400 yen in EPS fiscal 3/2026,  15.5x EV/EBIT.  or 10k yen, vs. the stock at 7,200 now,  so there’s ~40% upside.  And revs and earnings should continue growing rapidly for years after that. 

• 25x is a similar multiple to where the stock traded in prior upcycles,  and on a relative basis it’s similar to peers  

• That’s only 20.7x P/E ex-cash

• Another plus is this is IFRS EPS, so it’s cleaner 

Financials

• Numbers have historically been lumpy / volatile year to year though depending on game launches, hardware launches, etc. 

  • Fiscal 3/2026, I think they can do $14.7bn revs and $3bn in net income

• About 45% of revs are hardware, 50% software, 5% are IP/license revs/other

• Solid margins 

  • EBIT margin range around 20-35%

  • Gross margin 40-60%

• Net income margin 15-30%,  this is valued off IFRS EPS

• FCF conversion around 80%

• ROIC 15-25%

• Gross and EBIT margins have been expanding generally as more and more games are being sold digitally (which cuts out retailers) plus subscription revs.  They have more high margin IP revs too.  They’ve also been growing their 3rd party games sold on the platform digitally,  which has been a growing / higher margin revenue stream

Balance sheet - super clean

• No debt  

• 22% of its market cap is in cash,  $14.2bn in cash

• $64.9bn mkt cap

• $50.8bn EV

• At times they have done extra dividends and stock buybacks.  Given the corporate reform to be more pro shareholder friendly across Japan, this is another possible (and likely) positive catalyst 

Business Summary / Review

Nintendo has also finally been undergoing a process of monetizing its great IP and content over the last few years, which has been helping the multiple.  The animated Super Mario Brothers movie in 2023 was a huge hit and grossed $1.4bn, it made $196mm in EBIT for them (10% of EBIT boost).  I saw the movie and it was great.  

Nintendo content and games are loved everywhere and by all age groups.  Many of their games and content are evergreen and have a lot of longevity over many decades (e.g. Mario, Mario Party, Mario Kart, Zelda, Smash Bros, Pokemon, Animal Crossing, etc).  Every year, about 80% of their software revenue comes from these 1P titles (many are pretty evergreen),  so it’s actually a pretty steady base for software.  Unlike Xbox and PS, Nintendo doesn’t focus on having the most cutting edge graphics and hardware, it relies on quality game play. 

3rd party games make up the rest (20% of software).  The 3rd party game opportunity has been growing as they’ve been becoming more of a gaming platform (vs. traditionally being mostly a 1P game developer).  The Nintendo Switch 2, with better graphics, will accelerate this trend as developers can create more advanced games too.  But I don’t think it’ll be the next great gaming platform since there’s a lot of competition here.  

They have 117mm annual playing users.  Nintendo now also has 38mm annual subscription subscribers (who pay between $20-$50 / year) for extra content, games, the ability to play online, etc.  This has been growing steadily and is a high margin, more recurring rev biz.

After the huge success of the Mario Movie, they announced that they’ll be making a Zelda movie which will be 50% financed by them (rather than licensing out IP with the Mario Brothers movie).  This will probably come out sometime in 2026.  

The new Super Mario World Theme Parks have also been a big hit and drives the Nintendo flywheel.  They’ve partnered with Universal Studios (Comcast) and are rolling out more Mario Theme parks around the world given their success.  They have 2 now (one in Japan and Universal Hollywood), and they’re building 2 more to open in 2025 (Singapore and Florida).  These theme parks cost ~$470mm to build,  but Universal is responsible for construction costs and operating them.  Universal Studios pays Nintendo IP license fees and some fee per attendee, but they haven’t disclosed the economics - but it’s relatively small financially vs. Nintendo overall.  

Like other game publishers, they’ve been benefitting from a shift from physical to digital, more subscriptions and add-ons, which has much higher gross margins 

There’s usually a 4-5 year bump in software and hardware sales post new launch

​Risks

• Nintendo has historically been pretty cyclical, and tracks their console cycle up and down.  However, the recent Switch 1 cycle has been much longer and steadier since they’ve done a better job refreshing the Switch and continuing to make new games.  And there are more 3rd party games on the platform now too.  Plus they’re doing more in other forms of monetization like movies, parks, toys, subscriptions, digital add ons, etc.  which has made the company less cyclical and able to grow more consistently and secularly 

• There may be a drop off in sales ahead of the Switch 2 launch as gamers wait for the next console,  but investors generally look through that 

• FX: but I think the Yen will strengthen as they normalize monetary policy, and the US is on a cutting / easing cycle

Comp Sheet

USD / Yen  5 yr

USD / Yen since 1960s

Catalyst

- Nintendo Switch 2 launch

- Continued growth all around in gamers, subcriptions, etc. 

- Hot new games

- Further success of theme parks / movies

- capital return (buy back and/or dividend)