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Overview:
We believe Nintendo offers a compelling investment opportunity, with the potential to become a long-term compounder as it transitions away from its historically cyclical nature. While not as attractively priced as when we initiated our position, we believe the stock remains fairly valued at current levels. Our investment thesis rests on three key pillars:
Switch 2's backwards compatibility unlocks sustained ecosystem growth and higher margin digital revenue.
World-class IP and expanding transmedia strategy create powerful user acquisition flywheel.
Strong moat and improving capital allocation provide compelling risk-reward.
The following report outlines these pillars in greater detail before presenting our fair value calculations and final recommendations. But first, here’s a brief business overview.
Business Description:
Nintendo’s video game business includes some of the most successful franchises in the world, which have remained popular over decades. These include Mario, Pokémon, The Legend of Zelda, Animal Crossing, Kirby, and Splatoon. Its revenue is split as follows:
Dedicated Video Game Platform: This category is the largest, accounting for approximately 94% of Nintendo's total revenue. It includes hardware, software (such as downloadable versions of packaged software, download-only software, add-on content, and Nintendo Switch Online), and accessories.
Hardware: Currently makes up 43.6% of the revenue. The Nintendo Switch family currently includes the Nintendo Switch, Nintendo Switch OLED Model, and Nintendo Switch Lite.
Software: Software sales are higher margin than hardware and make up the remaining of the dedicated video game platforms revenue. Digital sales now make up 50.2% of Nintendo's software sales, showing an increase of 2% year-over-year. This upward trend in digital sales is highly beneficial for Nintendo due to the higher margins whilst still offering significant opportunities for growth. In addition, over the last year a substantial 81.2% of Nintendo's total software sales come from first-party titles, underscoring their success in developing games that resonate strongly with their fanbase. This dominance in first-party software also suggests ample potential for expanding third-party software sales in the future. (Note, this exceptionally high percentage is may slightly unrepresentative because the Switch is late in its cycle with third party developers currently not creating new games for it). Nintendo does not provide specific details on the exact margins, but based on industry norms, it is estimated that first-party games usually command gross profit margins of around 70-80%, largely because Nintendo controls nearly all aspects of these games. For third-party titles, Nintendo typically earns between 10-30% in royalties, depending on the agreement with the developer. Physical game cards bring down the gross margin to about 50-60% for first-party titles and likely lower for third-party games, while digital sales offer significantly higher gross margins, estimated at 85-90% for first-party titles, due to the absence of physical production and distribution costs.
Switch online: There are currently roughly 123 million annual active switch players, with over 38 million paying for Switch Online. This represents a large proportion of the player base that is committed to the console to the extent that they want to pay a monthly subscription to play online.
App Store Platform: The combination of a large active user base, a digital distribution channel, third-party support, and a monthly subscription business shows that the Switch is a leading “App Store Platform” for core console gaming.
Mobile, IP related income: This includes income from visual content, smart-device content, and royalties, currently making up roughly 5.5% of revenue. This segment has nearly doubled in size over the last year, thanks in part to the Mario Movie, with theme park additions and further movies to come in the future.
Other (Playing cards, etc): This smaller segment, around 0.6% of revenue, includes playing cards and related items.
As of the end of FY24, 44.3% of revenue comes from the Americas, 24.3% from Europe, 21.7% from Japan and the remaining 9.7% from the rest of the world. This totals 78.3% of revenue generated outside of Japan.
(Note: FY24 statistics are used as current data is less representative due to the late-stage console cycle, but they still provide a clear picture.)
Investment Thesis:
1. Switch 2's backwards compatibility unlocks sustained ecosystem growth and higher margin digital revenue:
Firstly, the release of the new Switch 2 should not only boost hardware sales but also expand the user base with an increase in AAA game availability. This larger player base will, in turn, lead to a larger Nintendo Switch Online subscriber base, bringing in more high gross margin income. By adopting Apple's strategy of incremental upgrades, Nintendo can boost revenue from high-margin digital sales, reducing its cyclicality.
With the launch of the new console, we can anticipate major new titles, driving a significant increase in software sales. The trend towards digital sales is expected to persist, further contributing to a higher percentage of digital sales in total software revenue, which is advantageous for Nintendo as digital sales typically offer better margins. Currently, software sales account for about 55% of Nintendo's total revenue, and we foresee this proportion growing, leading to improved gross and net profit margins over time. However, it's important to consider that a substantial part of this growth may come from third-party software sales, which typically have lower margins compared to Nintendo's first-party sales. Therefore, the overall impact on gross margins will largely depend on the mix of first party versus third-party software sales.
As of 2019, Nintendo President Shuntaro Furukawa acknowledged that the rise of digital sales, including indie titles and add-on content, has complicated the conventional calculation of tie-rates. He suggested a new metric, "sales per hardware unit," which better reflects the overall sales performance of the platform, considering all forms of digital and physical content. As digital sales have grown, the Switch has seen a significant increase in sales per hardware unit, rising from approximately ¥41,700 in its first fiscal year to ¥98,524 by the end of FY2024. This represents a compound annual growth rate (CAGR) of approximately 13.07%, reflecting the increasing value generated per console over time.
In saying this, as of June 30, 2024, the tie-rate for the Nintendo Switch stands at approximately 8.83 software units per hardware unit. This reflects strong engagement with the platform’s broad software library. Comparatively, the tie-rates for previous Nintendo consoles were:
Nintendo GameCube: ~9.6 software units per hardware unit
Nintendo Wii: ~8.4 software units per hardware unit
Nintendo DS: ~6.5 software units per hardware unit
Nintendo 3DS: ~4.3 software units per hardware unit
Nintendo Wii U: ~7.4 software units per hardware unit
This shift in focus from traditional tie-rates to maximising total revenue per hardware unit highlights the evolving digital ecosystem on the Switch platform, distinguishing it from previous Nintendo consoles that relied more heavily on physical game sales.
To conclude, the Switch 2's backwards compatibility not only ensures smoother transitions but also fosters sustained user engagement, unlocking more consistent growth and a healthier ecosystem. This approach will unlock sustained ecosystem growth and higher-margin digital revenue, positioning Nintendo for more consistent long-term success.
Note: The transition between consoles may be slower due to backwards compatibility, but this approach helps Nintendo maintain an active and healthier overall ecosystem.
2. World-class IP and expanding transmedia strategy create powerful user acquisition flywheel:
Nintendo's transmedia expansion is rapidly accelerating, creating multiple powerful revenue streams while driving user acquisition across platforms. The company's IP monetization strategy extends far beyond traditional gaming, with recent successes demonstrating the massive untapped potential of Nintendo's character universe.
The strength of this transmedia strategy is evidenced by several key developments:
Entertainment & Media Success:
Mario Movie's blockbuster performance driving new audience engagement
Confirmed Mario Movie sequel planned for 2026
Upcoming Zelda movie in development, expanding the transmedia portfolio
In 2023, Zelda was partly blamed for UK inflation by the ONS, demonstrating brand impact
Physical World Expansion:
Super Nintendo World theme parks operating in Japan and United States
Additional theme park locations in development
LEGO Super Mario series success
Strategic retail store expansion in key markets
Mobile & Digital Reach:
Over 800 million mobile game downloads
Mobile and IP-related income nearly doubled over the last year
Currently represents 5.5% of revenue with significant growth potential
Creates new user acquisition channels for core gaming business
The power of this strategy lies in its self-reinforcing nature. Each new media venture introduces Nintendo's IP to new audiences, who then engage with other Nintendo products and platforms. The theme parks create physical touchpoints that drive merchandise sales and gaming interest. The movies generate renewed interest in classic franchises, leading to increased game sales and mobile downloads. Mobile games serve as low-barrier entry points to the Nintendo ecosystem, potentially converting casual players into dedicated console users.
This flywheel effect is particularly valuable as Nintendo maintains strict quality control over its IP, ensuring each new venture reinforces rather than dilutes brand value. With substantial untapped potential in each of these areas and a vast library of beloved characters yet to be fully leveraged, Nintendo's transmedia strategy presents a long-term growth driver that should compound value for years to come.
3. Strong moat and TSE support downside protection:
Nintendo's competitive moat, built on unique IP and loyal multi-generational user base, combined with improving capital allocation driven by TSE reforms, provides both downside protection and growth potential.
Firstly, Nintendo's player demographic, with 70% being over the age of 18 and an approximately equal male/female ratio, demonstrates the brand's enduring appeal across various age groups. This older demographic, distinct from the typical gaming community, presents a unique opportunity for Nintendo to tap into a market with potentially greater spending power. Moreover, the Nintendo Switch's design as a highly personal and social device naturally lends itself to being owned in multiples within a single household. This aspect not only broadens the potential market but also reinforces the console's role in fostering social connections and shared experiences, further solidifying the brand's appeal and market position.
Unlike its competitors, Nintendo prioritises the quality of gameplay over performance. However, the anticipated launch of the Switch 2 promises enhancements in performance, which could attract a broader audience, particularly those who value higher-end graphics. This improvement is especially significant if the Switch 2 gains the capability to support more AAA games, potentially broadening Nintendo's appeal player base.
Nintendo has also started to focus on its extremely valuable but underutilized IP recently, with the release of the Mario Movie, plans to release a sequel in 2026, a Zelda movie, and the opening of two theme parks in the coming years. These initiatives will excellently introduce the Nintendo world to a younger audience, hopefully creating lifelong connections to the brand. In 2023, Zelda was partly blamed for UK inflation issues by the ONS, so if that is not a strong sign of brand presence and loyalty, we don’t know what is.
To conclude, Nintendo has an extremely strong moat, and one that will only get better over time if management can utilise its IP, carry on making great content and improve its technology.
Additionally, recent developments with the Tokyo Stock Exchange (TSE) have led to stricter regulations on companies' capital allocation, urging them to enhance capital efficiency and improve shareholder returns. Despite the traditionally slow pace of change in Japanese business culture, Nintendo is well-positioned to use its substantial cash reserves to deliver on this when the time arises. About 28% of its cash for strategic initiatives, such as expanding its development teams, strengthening customer engagement through Nintendo Accounts, and furthering the development of value-added digital services. This will be achieved through continued share buybacks and dividend payments. The introduction of stock-based compensation (SBC) for employees will also help align the company's interests with value creation, ensuring a focus on long-term growth and profitability.
Financials and Rough Valuation:
Below are our back-of-the-napkin intrinsic value estimates based on a 10% discount rate, a 5-year timeframe, and the relevant exit multiples.
Bull: 12% EPS Growth Rate, 20 PE - $21 Per Share
Base: 8% EPS Growth Rate, 18 PE - $15.5 Per Share
Bear: 4% EPS Growth Rate, 16 PE - $11.5 Per Share
Conclusions:
The key to this thesis lies in the compatibility of the Switch 2, which is now nearly a certainty. Renowned leaker OnLeaks has released a 360-degree video of the next-gen console along with detailed dimensions, making the console’s arrival all but confirmed.
Nintendo seems to be taking a calm approach to the recent leaks, publicly dismissing their credibility without further comment. However, due to the widespread nature of the leaks, some speculate that Nintendo may reassess its announcement plans for the Switch 2, possibly bringing forward the reveal to prevent more unauthorized information from surfacing, regardless of its authenticity.
The Switch 2 is expected to be announced before the end of Nintendo's fiscal year (March 31), though some believe it could happen as early as the end of January.
With that risk discounted, execution concerns remain. However, when weighing these against the potential value unlocks—such as sustained ecosystem growth, higher-margin digital revenue, a transmedia flywheel, the production of excellent games, and ongoing efforts to maximize shareholder value—Nintendo presents an asymmetric opportunity with significant upside potential in the coming years.
With a conservative price target of $15 per share, representing a 6.84% upside to fair value, we still see Nintendo as a favourable investment. Our position makes up 15.69% of our portfolio, with an average purchase price of $12.41 per share, and we are currently up 12.43%. We maintain a LONG position in Nintendo.
Risks:
Switch 2 Performance: Potential failure to meet market expectations.
Currency Exposure: Significant foreign exchange risks given global revenue base.
Japanese Economic Exposure: Though mitigated by >75% international revenue.
Launch Timing: Delay in launch leading to further temporary sales decline ahead of release.
IP Execution: Risk of unsuccessful transmedia expansion.
Capital Allocation: Potential failure to improve shareholder returns.
Disclaimer: The content provided in this newsletter is for informational purposes only and does not constitute financial, investment, or other professional advice. The opinions expressed here are those of the author and do not necessarily reflect the views of Schwar Capital. Investing involves risk, including the possible loss of principal. Past performance is not indicative of future results. The author may or may not hold positions in the stocks or other financial instruments mentioned. Always do your own research or consult with a qualified financial advisor before making any investment decisions. To read our full disclaimer, click here.
Very interesting article really agree on it. I'm invested as well but maybe a too much of a small position. Thanks for sharing!
Hi there! Reading 1 year later. Any thought on Nintendo at current prices?
Great writeup btw!