“When you come to a fork in the road, take it.” – Yogi Berra
Despite the joy Nintendo the company generated for its customers over the last four decades, Nintendo the stock has historically been treacherous for patient investors and a boon for tactical traders.
As this long-term price chart shows, the ideal strategy with Nintendo’s stock has been to buy when Nintendo’s consoles are out of favor and sell at the peak of a hit console cycle, which is typically in the console’s fourth or fifth year.
Bloomberg, as of December 7, 2021
With Nintendo’s latest hit console, the Nintendo Switch, into its sixth year, the question is, “Will history repeat itself?”
We believe that things really are different this time around. As Nintendo of America CEO Doug Bowser put it during a recent podcast, Nintendo is aiming with the Switch to redefine “the lifecycle and vitality of video game consoles.” Further, in November, Nintendo management said that with help from the upgraded Switch OLED model, “we aim for a sixth year of growth, something never before experienced with our dedicated video game platform business.”
Despite these comments from management emphasizing that this Switch cycle is different, we think the current market price and consensus estimates incorrectly reflect a return to past console cycle patterns.
Here are four reasons why, beyond management commentary, we disagree with the consensus outlook.
- COVID noise. Nintendo Switch was gaining momentum going into the pandemic, and global stay-at-home advisories pulled demand forward in 2020. While this was a net positive for Nintendo as it brought more people onto the Switch platform and encouraged more third-party developers to create or port games for Switch, it also meant that Switch hardware sales this year would have a difficult comparison period.
In fact, Nintendo’s stock price decline began in early July 2021 after it announced the new Switch hardware would be an “upgrade” (Switch OLED) rather than a next-generation console, dubbed Switch “Pro” by Nintendo watchers. The implication, skeptics argue, is that potential Switch buyers will just wait for the next console generation and current users would continue to play their existing hardware.
Nintendo’s share price has languished in recent months on these concerns, particularly since management reduced its full-year hardware sales guidance due to chip shortages and broader supply chain issues.
Historically, all these factors would be good signs that it’s time to bail on Nintendo’s stock. The year-over-year growth in hardware sales will be lower and the “peak” has been eclipsed, the logic would say. Consensus estimates, as shown in the red bars below, suggest that sell-side analysts think there’s further Switch erosion from this point forward. These estimates reflect a continuation of standard console cycle dynamics, which we disagree with.
Source: Canalyst, Visible Alpha, and Ensemble Capital. Red bars = consensus forecast.
It’s worth noting, however, that despite the projected year-over-year decline against a difficult 2020 comparison, Switch momentum is still positive relative to pre-COVID demand. As the above chart shows, Switch hardware sales in the current fiscal year – based on management guidance, consensus, and our own estimates – will likely be higher compared to fiscal year ended March 2020.
If Switch were indeed losing steam, we wouldn’t likely see Switch OLED units continually sold-out and gobbled up as soon as some inventory hits the market. As of this writing on November 23, the lowest secondary market price for OLED on Walmart’s website is $481.99 – a nearly 40% premium to the retail price. On GameStop’s website, the original Switch is still retailing for $299.99 with pre-owned and refurbished versions selling with only a $20 discount to the new price. In fact, the new and refurbished versions are currently sold out completely at GameStop.
In short, if Nintendo had adequate supply, it could sell a lot more consoles this year.
This generation of Switch will eventually phase out, but we think new Switch generations will layer on top and eventually replace demand for the current generation.
- Connection to fans. As of September, Nintendo gathered over 250 million Nintendo Accounts across 164 countries. At minimum, this means Nintendo now has over 250 million emails from which it can directly communicate with its fans and keep track of how they engage with the Nintendo IP. As Nintendo unveils theme parks, flagship stores, and other events, these direct relationships will better personalize the experience for the Nintendo fan. This invaluable source of connection, data, and analytics was not available prior to 2015.
On top of the Nintendo Accounts, which includes mobile-only users, those with Switch consoles can also pay for a Nintendo Switch Online (NSO) account. As of September 2021, there were over 32 million Switch Online members against over 90 million Switch hardware units sold to date. We think penetration could increase even further as Nintendo adds more value to the membership over time.
Plans for NSO start at $19.99 per year and the basic plans include save cloud data, access to legacy NES and SNES games, and online play. In October, Nintendo released the NSO Expansion Pack which adds access to legacy Nintendo 64 and Sega Genesis games and Animal Crossing content.
In previous console generations, Nintendo would have to win back its customers whenever it launched a new platform, as would every other console maker. There was no carry-over of player data from one generation to the next. There was some backward integration in more recent Nintendo consoles, where players could play games from previous consoles on the current console, but it was limited. Switch Online changes that dynamic.
Not only can Switch owners play legacy Nintendo system games through NSO, but NSO’s cloud save data will allow you to maintain your game progress in future console generations. Put differently, your playing data will stay with you wherever you go in the Nintendo ecosystem. It’s already being implemented. If, for example, you stop playing Animal Crossing: New Horizons for four months, when you come back to play, the characters on your island will say they haven’t seen you in four months.
While it’s debatable what form the next Switch console generation will take, Nintendo has signaled through direct-to-customer relationships, opening the legacy game library, and cloud storage that there’s an intention to provide a more continuous and immersive Nintendo experience.
- Gaming platform. Nintendo’s rise to fame in the 1980s came in part because of[…]