Chit Chat Stocks - Why I Own Nintendo Stock: Round Two (NTDOY)

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Starting point is 00:00:43 investing. Options are not suitable for all investors and carry significant risk. Full disclosures are in the podcast description. Welcome to Chitchat Stocks. On this show, hosts Ryan Henderson and Brett Schaefer analyze businesses and riff on the world of investing. As a quick reminder, Chitchat Stocks is a CCM Media Group podcast. Anything discussed on Chitchat Stocks by Ryan, Brett, or any other podcast guest is not formal advice or recommendation. Now, please enjoy this episode. Welcome to Chit Chat Stocks. This is our monthly research episode. I'm one of your hosts, Ryan Henderson, and I am joined as always by Brett Schaefer. We are doing, I guess we could

Starting point is 00:01:37 call these a deep dive, although I think that term might be used a little too much. But each month, Brett or I tries to dig in to an individual stock. And as you probably know from the title here. Today, we are talking about the house of brands, the iconic house of brands, Nintendo. And Brett has been a shareholder of this company for kind of in and out for roughly three years, but more or less has been following the story for, I believe, a little over three years. And we're going to be talking about why he owns it. We've done an episode on this company before. So this will be, we will revisit the overall thesis. So it's not going to be like we're playing off of the old one but if you want any additional context or to see how we were

Starting point is 00:02:20 thinking about the company a couple years ago it might have been a year ago now you can go check that one out as well but i will uh pass things to you brett what inspired you to want to revisit nintendo yes welcome in everyone i should say as we first start here what inspired me is the fact that I did purchase some shares of Nintendo in my personal account early this year. And then we've seen developments from the management team talking about how a new console is going to be released within a year. If we look at their fiscal year, which ends in March of 2025, it sounds like from the way they're talking that the new console will be launched to the public before that time period. So I think it's an exciting time for the company.

Starting point is 00:03:10 I think the new console is going to not necessarily make or break the thesis, but perhaps could be a catalyst. It could prove that our thesis or my thesis on the stock is more right or wrong than we think. And it's going to be a big test for the business. So I want to get into it. I want to talk about what the business does, why I think it has a wide moat, why I think it's cheap and give an update on a thesis that has been similar as it was back in 2023 when we

Starting point is 00:03:39 recorded that episode but we've had quite a few updates not only on its console business but on their entertainment expansion strategy into movies and theme parks ryan a follow-up question here yeah you've written about this company a number of times uh probably i'd say around 10 times over the last three years or so. When you initially bought the stock, what was your justification? What did you write down? I can't remember exactly what I wrote down and my memory can fail me if I don't have it in front of me right now. But if I look at my personal journal from earlier this year, I justified it, which I think was a similar thesis as what it was a few years back. And here's the quote. There's three main reasons why I own Nintendo. It's one,

Starting point is 00:04:28 the business has a wide moat and is a high quality business. Two, I can trust the management team to take care of the business properly over the long term. And three, I believe the stock is cheap based on its forward earnings potential. Nintendo has a wide moat due to its well-loved entertainment IP. Nobody can replicate Mario, Zelda, Pokemon, and these other popular entertainment brands. It does not have a monopoly on family-friendly games, but it is damn near close to it. It has built trust with families over decades that kids can safely play Nintendo games. This trust cannot be replicated by a random company overnight. I think Nintendo stock is cheap if this new console is successful.

Starting point is 00:05:06 They likely trade an earnings yield of 10% plus if the new console maintains or grows the user base. There's also some upside if the entertainment expansion strategy works. Either way, the theme parks movies are showing to be a moat expander and driving growth in the gaming business. That's the summary of the thesis. That's what I wrote down in my personal journal, and we're going to expand on that, talk about the history of Nintendo, talk about the gaming business, talk about how the new console is

Starting point is 00:05:34 a huge test for the business and can confirm or disprove the thesis that I have here, talk about the expansion strategy into movies and theme parts, get an update on that, which we've had some pretty significant updates on that one. And then we're going to talk valuation balance sheet management team, how I look at this management team and the quote-unquote has maybe a bull like myself might call robust balance sheet but the bears and people that do not like the japanese uh capital return strategy they might call it an inefficient balance sheet so we might have a debate over that one okay so let's go through the history to begin with and this isn't necessarily going to be like all the way back to

Starting point is 00:06:18 its very roots because that was probably a hundred years worth of history that aren't that important for the thesis today but when people think nintendo i'm guessing most people think pokemon they think mario they think maybe the nintendo switch or the wii and they really think about this cyclical business um you know people buy the hardware they buy the games to go with it and i'll a little bit of a spoiler alert here the crux of or an important part of your thesis is that it's becoming a little less cyclical so let's go through the actual history where where does nintendo stand today relative to its last 20 or 30 years okay here's a excerpt from the notes on our first podcast quote each console is different in one way or another and some of them are hits

Starting point is 00:07:12 some of them are flops but ultimately there was one common trend none of them stuck so you'd have these massive shifts in cash flow when hardware was selling like crazy there was more eagerness to produce games from both nintendo themselves and third-party developers and with more options for games there was naturally more game sales this created wonderful operating leverage and profit margins in good times, but difficult periods when consoles evolved. This led to a culture that prioritized conserving cash for a rainy day. I think that is the history that investors need to understand. Obviously, we're not going to do a podcast on the history of Nintendo. If you want to listen to those, there's plenty of those out there. And we had even more really

Starting point is 00:07:51 on the episode last year. There's two things people need to understand. One, they've had a lot of hits and those hits have done quite well and i mean they're still in the lexicon today people know about the nintendo 64 people know about the wii people know about the switch today but historically there have been busts along with the cyclical gains unlike maybe other gaming businesses or entertainment franchises and the business model i guess or the historical business model has led the company to want to basically conserve a lot of cash, run up a lot of cash on the balance sheet. It's probably a combination of the Japanese culture as well. Let's get into what the business model is. And essentially, the business model is to first build innovative

Starting point is 00:08:41 gaming hardware, and then sell the hardware at close to cost of production, and then make money. so the way they profit is by selling first party games exclusively on the hardware this is unique to nintendo's business model and really drives a ton of the growth although we've seen some of the other gaming hardware companies like xbox and playstation get into the game's development themselves but this has been nintendo's strategy for it really since it began it has popular gaming franchises that many listeners will know, like Mario, Zelda, and even Splatoon, which is a 10 million unit seller. It has a partial stake in the Pokemon company, which produces exclusive games for Nintendo systems. Those are some of, if not the most popular, at least the top three popular

Starting point is 00:09:28 seller on the Nintendo consoles. And then if we look at the history, it's been about a, I mean, it's been a really long 30 plus years in the gaming business for Nintendo. But, you know, we could go through the GameCube, Nintendo 64, the Wii, the Wii U, all that stuff. But the short story investors need to know today is that Nintendo's gaming business model went through a boom and bust cycle for many years. I believe that is priced into the stock right now. And it's almost like the market is expecting that to continue. When they would launch new innovative hardware, at first consumers would love it because it would be a new form factor. For example, the motion sensors with the Wii that was innovative people were like oh this is exciting I can play

Starting point is 00:10:13 these sporting games or Mario Kart and stuff like that and then they would think of the hardware as a gimmick after a couple years it would fall out of favor with the system and since they make most of the money through exclusive game sales losing hardware players meant to collapse in profits because you lose the active players they're not buying games and the games are how you make money So then, well, all that operating leverage goes to waste. My main thesis is that Nintendo has improved its business model by emphasizing longevity and player durability with its new hardware system called the Nintendo Switch. Earnings durability, to me, means the stock deserves a higher earnings multiple than today.

Starting point is 00:10:58 And then growing cash on the balance sheet, which we'll get into later on another section, can be returned at a healthy rate to shareholders and actually will, i'm pretty confident will be returned to shareholders if this new console is successful and then new entertainment form factors can help grow the earnings pie so it's the three things we're going to mainly talk about today earnings durability on gaming consoles returning cash to shareholders and then movies theme parks all that good stuff ryan anything else before we dive into the first section? No, I shared the revenue chart since 2005 there on the screen for anyone who's just listening. Basically went through a big boom and bust during the WE period, kind of was

Starting point is 00:11:43 not earning much throughout the early 2010s. And then the switch was a huge boom as well. And it looks like you'd maybe be entering sort of a bust period where people are using it less and less. But there's a couple of things, and Brett's going to get into this, I believe, that are maybe misleading from that. And we'll talk about some of the durability. So let's dive into each part of the thesis. Let's talk about why you think the active users are durable and ultimately the profits are as well. yep and when ryan mean says active users he means active users on the nintendo switch so the switch was launched in 2017 it combined nintendo's handheld and console hardware divisions

Starting point is 00:12:29 and that was the main innovation with the product now nintendo is i think always will be someone that wants to have i wouldn't call them quirky but maybe really innovative is the way to call it when they launch something new they have they want to have some new innovation that delights their their players and people really liked the fact that with the switch unlike any other console before it you could not only play on the tv but you could immediately pick it up and play on the go as a handheld as well it was this hybrid console people loved the flexibility and it took off like a rocket after the first few years now unlike other prior consoles that saw sales peak after a few years and quickly collapsed nintendo's hardware and software sales for the

Starting point is 00:13:12 which have remained strong into year eight of the system so previously it would be after maybe three or even four years that sales would totally collapse and now we're almost double of that so i think that in and of itself has proved that they're much better at keeping players around than they have been historically so for example in fiscal year 2020 which ended in march of 2020 so right before the pandemic barely had a pandemic impact nintendo uh sold 21 million gaming hardware units and 169 million software which would be basically game units and remember software units are important because that's what drives the profits 21 million i guess is historically been what you would think was the peak because that was a couple years after the

Starting point is 00:14:05 system launched. And then I think a lot of investors were predicting that, well, it's been three years. If someone wanted to buy a Switch, they'd already buy it and then sales would fall off a cliff. But if we look at fiscal year 2023, three years later, Nintendo sold 18 million hardware units and 214 million software units. Remember, software units drive profits. So they had 18 million new hardware units that year in year i think that would be year six and if you look at fiscal year 2024 which ended in march of this year they sold 16 million hardware units and 200 million software units and its new zelda game sold over 20 million copies on its own i might share the screen here but i'll definitely include it in the newsletter their active users have

Starting point is 00:14:52 consistently grown since the switch has launched and did not reach a peak like the old consoles they're at 128 million. As of the end of last quarter, actually just released it as we're recording this this morning. And we've gone from basically 19 million to 38 million to 66 million to 91 million to 108 million to 121 million to 128 million. It's been steady, steady growth. I think that is six straight years of growth. And that is a great sign because historically, the chart looked like a bell curve. And now it looks like a linear grower. And yeah, growth has slowed down they're not gonna they're not gonna become a billion you know user business at least if they do well the stock will be the stock will do incredibly i would not expect that

Starting point is 00:15:38 whatsoever you know there's it's the gaming business it's not like the smartphone business or something like that and you can see this on the income statement now ryan you have a follow-up on that before i get to the profit part yeah and it's it's households right it's not just you know This is a system for probably multiple people at once. It's not like you're selling to every single individual like you would with a smartphone. So, yes, the likelihood that they get to – the likelihood that there are even a billion households that could afford to play a Switch is probably pretty low. So yeah, obviously there's going to be some sort of diminishing growth as they scale up past 100 million.

Starting point is 00:16:24 Yeah, exactly. And I think that they have some smartphone games, which I'm sure have plenty of users, but those aren't really as profitable or not nearly as profitable as the Switch. And I guess maybe to level set expectations for investors, our expectation or my expectation, I should say, is not necessarily that these active users continue to grow at that impressive rate, but that they really stay stable and are over 100 million once this new console is released. And if they grow, well, that's great because we'll make even more money.

Starting point is 00:16:55 Now, if we go to the profits, you can see basically this durability in software sales showing up on the income statement. Profits have been stable from fiscal year 2020 in the US dollar terms up to today, and they're up massively in Japanese yen terms. Now, as a note, the yen has depreciated a lot against the dollar, which is a headwind for profits in US dollar terms right now because of how much of its sales come in Japan. So for your US shareholder, which I think most of the people listening to this are, that hurts for you today. I can't predict what the yen is going to do. It's been a rough few years for that. I wouldn't expect it to continue, but if it does, hey, maybe take a

Starting point is 00:17:38 vacation to tokyo or something like that and go visit the nintendo museum and the nintendo theme park if we look at in the newsletter i'll have both the charts from here uh for for in the yen and the u.s dollar and i would note that the chart looks abnormal or maybe not as linear of a grower due to the pandemic period where there was an abnormal profitable period where software sales went up and a ton of people were buying video games and playing video games at home because of the pandemic. If you exclude that year, I think the profit growth looks much, much better. And if you exclude the yen depreciating a ton, which we can't predict, it also looks much, much better. So why did this happen? So why are active users high? I think that's the real

Starting point is 00:18:22 question because we can look at those numbers and you can say, well, it's good, but was that a fluke? Will it continue? I think there are four main reasons why the active users have grown. one success of nintendo switch online and the nintendo account so previously nintendo wasn't really great at retaining users having these software systems that go along with stuff people complained about it the online stuff was terrible all that good stuff nintendo switch online is a kind of software subscription similar to you know xbox live or i forget what the playstation one is called you pay a flat fee every year get access to a a lot of legacy titles online play and it has tens of millions of subscribers right now and then you have nintendo accounts which drive

Starting point is 00:19:07 everything together across all the nintendo platforms or i won't call them all platforms there's really one gaming hardware platform but anything nintendo and there's i think over 300 million active accounts second is they reinvested a lot into the flagship games and franchises years into console releases so that zelda game invested a ton of money into that put it out in year seven of the console or maybe even year eight and it sold 20 million units i mean that was something that they did not do previously third is they updated the hardware with improved form factors like with the light model and the oled models years into the release to drive maybe new customers or people to get you know an upgraded version and then lastly this is also

Starting point is 00:19:55 important they embraced more third-party development which can drive software sales and obviously they take a take rate on that so that drives profits as well now as we'll get into and right kind of the follow-ups on this section before we start this next one they have announced as i mentioned earlier the successor to the switch that's their quote and that's a it's a translation into english from japanese so sometimes there might be some stuff lost in translation but i think that one's pretty clear there will be a successor to the switch at least sometime this fiscal year meaning by march 2025 yeah i think that covers the durability well and it is very important if you're looking at this on an aggregator to toggle between local

Starting point is 00:20:41 currency so japanese yen for them although they earn a lot in usd as well um and the u.s dollar reporting because of the strength of the u.s dollar lately it's been there is a quite a large differential there so it kind of makes it look like maybe it's more cyclical than it is let's talk about the catalyst that you just mentioned the switch to this is something that has been i think every year that we've owned nintendo we've thought switch 2 is coming it's coming and it's finally feels like it keeps getting pushed back but it's finally here what are your expectations here and why do you think this can be a big catalyst okay so the new console we'll call it the switch 2 we don't know what the name is going to be so that's just a place

Starting point is 00:21:29 holder for this podcast is reported to be a similar form factor to the switch but with updated capabilities now that means better screen faster processing stuff like that and i think the key is from these rumors is that we're not seeing a huge change in the form factor we're seeing this hybrid mobile and console uh at home gameplay which people loved and that will make it i hope less risky from a from a business perspective because in the past they've taken a lot of risk on some stuff you had the wii u the wii the nintendo 64 some other stuff a lot of them were successful but a lot of them were flops and maybe not taking as much risk and focusing more on the games and the actual game side of thing which they have done over the last few years i think will

Starting point is 00:22:19 play well for the nintendo switch too so compared to our recording last year we now have a release date um and the year following the new switch launch is going to be very important because that's going to prove or disprove, finally, that the software sales and the profits are durable like we think. My expectations are as follows. First, I expect it to drive growth in hardware sales as the core Nintendo customer refreshes the console. This year, which would be fiscal year 2025, Nintendo is guiding for 13.5 million hardware unit sales. I expect around 20 million are higher for the next few years after the Switch successor is launched. Second, I expect a surge in software sales. Not only will new hardware be in the hands of players, which, you know, when you

Starting point is 00:23:06 buy hardware, you got to buy at least one game, right? But Nintendo will likely launch new software titles. For example, it has been years since an updated Mario Kart has been released. This is Nintendo's most popular and profitable title. This year, Nintendo is guiding 465 million units of software sales, which I should say for the trough before the new console releases, I think that is pretty darn good. And I expect software sales of 200 million or higher in the years following this new console released. And both these developments should drive that active users chart that we shared earlier that I mentioned, you know, have hit 128 million to steadily grow or at least remain stable because the key here is not necessarily as we mentioned that this new

Starting point is 00:23:53 console doubles active users but really keeps them stable keeps them over 100 million and if all this occurs i think nintendo's gaming profits can grow from around 3.5 billion usd over the last 12 months to an average of 5 billion dollars each year for the first three years following the new console launch i think depending i guess if the yen collapses versus the us dollar again that throw a hiccup into the mix. But I don't think that is crazy to expect. Having this slight jump where if this is the cyclical trough, which previously the cyclical trough was operating losses, and now it's $3.5 billion in earnings, or maybe a little less for fiscal year 2025. I think having it jump $1 billion, $2 billion is not crazy. Ryan, what do you think about these?

Starting point is 00:24:41 anything you disagree on with my expectations for the switch how are you looking at it no i think the biggest thing here the most important thing to understand for anyone who hasn't kept up with the nintendo story is that you are not restarting from square one there will be a lot of incremental like added on hardware sales but there will be a lot of people that it's not like you're starting your account all over again. A lot of the games that you've played previously, you'll probably be able to port over. It's got the backwards compatibility or the forwards compatibility in this case. The hardware has the backwards compatibility with old games, is what I'm trying to say. And it just makes it like if you're a user, you have a little more

Starting point is 00:25:27 inclination to buy the next hardware when you know that a lot of your progress and any old games will be saved as well. So it really is a big jump relative to where they were between the Wii and the Wii U. But no, I think that covers it well. And I think to kind of summarize this a little bit, it's important to look at the hardware sales chart, which I just shared there. And you can see that it looks a bit like a mountain right now. It kind of peaked in 2021 and then has come down since, and that is the number of consoles sold. And then look at that relative to the software units sold, because it gives you the perspective that these users are sticking around. It's not just new users that are buying games. It's old users that continue to buy games as well,

Starting point is 00:26:20 because the software units is stable, is maybe the term I would use. It's maybe declining a little bit, but it's relatively stable, especially compared to the number of hardware units being sold. Anyways, I think that covers this kind of second part of the thesis well, unless you have anything to add there. I would ask you, what do you think about the earnings projections? Because that's what really matters for investors at the end of the day. Anything, does that make sense to you? $5 billion for one of the new console releases? Yeah, I think it's difficult to, I mean, that seems reasonable, but I think it's kind of difficult to forecast because we don't know what the hardware lift will be. Yeah, well, okay.

Starting point is 00:27:11 Well, saying that hardware lift that I'm predicting is correct, does that make sense? What was the hardware units again that you mentioned? $20 million a year. Next few years, $20 million. I don't know. I think that could be optimistic. just because there's if we're looking at it relative to the 2021 period where there was like a huge i guess i mean there's

Starting point is 00:27:38 been a lot of switch original switch sales that came before 2020 but if you're looking at it relative to the 2021 period i think there's going to be a lot of people that are like okay i'm content with my existing console especially if the game if you can download the new mario kart on the existing switch i don't know if there will be that much incentive a lot of people will want to be able to do that you don't think so no you'll be able to play the old one on the new switch but the new games i think they'll stick with the new console that's what that would be pretty dumb business decision i think to not do that no gaming console company does that i i well you can you know you can buy like the you know with third-party developers

Starting point is 00:28:27 like i don't know let's take electronic arts or something like that if i'm on an xbox one i can still buy the newest version of third-party games uh not necessarily i mean the new college football game is only on the new ones which i forget which but it it can be a console driver like i guess it it depends sometimes it's on the old ones sometimes on the new ones but i wouldn't think a flagship you know maybe not with mario but either way do you really think 20 million is that tough when this year in year eight of the supposed console drop we're at 13 and a half million you don't think they can add seven and a half million or what would that be six and a half million units yeah maybe maybe it sounds a little more reasonable when you think about the trough

Starting point is 00:29:21 because there are people that buy every version there's a lot of people that buy every version the light the oled the original 20 million i think is certainly achievable especially in the first year of launch the few years after it it's doable i don't know i wouldn't bank on it But either way, it's going to be a lift to sales and earnings. Yeah, yeah, exactly. ETFs to the platform as well. The breadth of FinChat's data is truly one of a kind. We use FinChat every day, and I've personally been using the AI Copilot more and more to summarize earnings calls and conference transcripts. To get 15% off any paid plan,

Starting point is 00:30:26 go to FinChat.io slash chitchat. That is FinChat.io slash chitchat. To get 15% off any paid plan today. The link is in the show notes. Earlier in the show, you heard us talk about the investing platform public.com. That's where you can trade options with no commissions or per contract fees and you get a rebate of up to 18 cents per contract traded. NerdWallet recently gave public five out of five stars for options trading. If you want to see why, go to public.com and start getting a rebate of up to 18 cents per contract traded paid for by public investing options not suitable for all investors and carry significant risk. Full disclosures in podcast description, US members only. Let's go through some of the other entertainment segments because this is

Starting point is 00:31:14 something that was, I believe, maybe not a huge part of our original thesis, but definitely something we had discussed on our old show, which is kind of expanding the brands beyond gaming. what has happened here and like since we last spoke about it what are some of the developments that have happened here and are you more or less optimistic that this can be a meaningful part of the business yeah so i titled this one growing conviction on other entertainment segments so i think i am more optimistic than i was a year ago i think we've seen confirmation and some of our ideas were from their actual announcements here so on last year's podcast we discussed nintendo's investments outside of gaming, and really to drive the entertainment flywheel with family

Starting point is 00:32:00 friendly franchises. Or you might maybe think of it as a hub and spoke model with gaming at the center, they have a chart that they always like to talk about in their annual presentation where they have the gaming console in the middle, the Nintendo account connecting everything and then they spokes of mobile apps, merchandise, theme parks and visual content, which means movies and tv shows kind of connecting back to the games so what they're trying to say there and they are a bit i'd say vague sometimes to put it mildly is they're using these new entertainment form factors that they're investing in to try to create as i say you're a virtuous cycle to keep the hardware software gaming business uh yes invigorated is the word they use i don't know if i'd call it

Starting point is 00:32:50 invigorated i always love how the the translation to english kind of gets some funny stuff sometimes but over the last year we've seen a lot of improvement for the strategy especially in the movies i mean the super mario movie launched last year it is now one of the best selling animated films ever i think top five and here's how it impacted the other and ip segment we had basically stable in yen terms mobile and ip related income and then right after the movie launched, we've seen it basically double. You can see that chart in FinChat. And you can really guess when the movie was launched. It was in early 2023. And the quarters that have followed, we've seen the licensing revenue and the returns from that that they're getting paid is that one

Starting point is 00:33:34 of the producers is coming back to their balance sheet. But that's one movie. And it's really not a profit driver when you have one movie and nothing else, right? But it's just, I think, just the beginning of a new segment for Nintendo that can drive profits over the coming decade and growing profits. I mean, over the last 12 months, we've seen two announcements. First, they announced the production of a Zelda movie. And then they also announced another movie related to the Mario universe. The Mario movie is coming out early 2026. As this catalog grows, they will not only earn more money at the box office, but they will also earn more licensing revenue to streaming platforms such as Netflix. And then on top of the direct movie revenue, they have shown

Starting point is 00:34:20 that a movie can be and can drive franchise sales from existing gaming titles. This would be abnormal, but the, I guess, only explanation for Mario sales seeing a boost in early to mid 2023 would have to be the movie. So I think they proved that out. If you look at, and Charlotte will have in the newsletter here, the sell-through on some Mario titles grew 1.3x and 1.4x on a couple various ones here after the movie released. And these are games that had been out

Starting point is 00:34:53 for two, three, four, five years. So really, that's great. And what's also even better is that the incremental sales on existing games are extremely high. So driving those incremental unit sales can be a huge profit driver. I think we can't also forget the Nintendo worlds at universal theme parks, which aren't really

Starting point is 00:35:14 driving much in profits today, but will be slowly built out and fully operational over the next five years. And there's four of those around the world. There are no Disney worlds. No, you're not going to see the 10 billion, I think it's 10 billion, maybe it's 7 billion in operating profits from Disney and their theme parks, you're not going to get that anytime soon, or probably ever. but five years from now i think if you add in the theme parks the direct movie revenue the indirect gaming revenue i think this can drive a billion dollars in earnings at for nintendo perhaps on the optimistic side because just from one movie we've seen a sizable jump in this and really in the first inning yeah i like i like the theme parks obviously

Starting point is 00:36:02 uh it's not entirely owned by nintendo so they're they're sharing the economics with uh universal but the uh with the movies it's it it's nice because it builds more brand notoriety and it creates probably further game sales they showed uh we showed that graphic here kind of shared our screen it helped the mario game sales immediately after the movie but to be totally honest i thought this would have had a bigger revenue impact than it did because it was i think it did 1.2 1.3 billion dollars at the box office it has been in the top 10 movies on netflix for like five months, maybe longer, and it didn't even double the mobile and other related income, I would have expected this to be a much bigger boost.

Starting point is 00:37:07 Yeah. Well, I think mobile and IP related income, maybe I should pull it up. Maybe we should pull it up in USD terms. Let me see. Hopefully I have it. Yeah, I already have it up on FinChat. So i'm talking through it but i want to look at that number some for maybe some perspective for the listener so okay usd trailing 12 months loading loading loading it's before the movie launched i guess the yen is depreciated which is always throws a you know a wrench into the mix we already had 300 to 400 million in usd uh and revenue from the mobile and ip and other related income so i think there was already some stuff from the mobile games and the other licensing stuff for like merchandise and it jumped up to uh 600 million after the movie so i think it was a

Starting point is 00:38:00 decent boost but yeah you're right not you know they're only a co-producer they're not the whole producer here they're not going to have a billion dollars in revenue coming from one movie but i think that's that's a that's a decent boost and over time as we get 10 movies in the catalog over the next decade hope hopefully that's part of the thesis uh that that can grow and be i think maybe not a billion dollars in earnings but if you combine the theme parks and the indirect gaming revenue i think that's possible but obviously a billion dollars there might might be optimistic okay let's talk about the balance sheet the And we've alluded to it, but they've been hurt a little bit by holding money in the yen currency on their balance sheet.

Starting point is 00:38:50 Do you want to talk about what's going on here? And just, it is a fortress. Well, they're allowed to hold stuff out, I mean, in foreign bank accounts too, but. They're not earning as much interest as they maybe could, or maybe they're not deploying it at as quick of a rate as people would hope. Yeah. Or they have so much cash that investors complain a lot. Probably the biggest complaint is not necessarily that it's in the end, but, well, hey, you don't need all this. Give it back to us. It is a lot of cash. Why don't you go into the numbers? Yeah. So at the end of last quarter, which just came out this morning, this cash pile,

Starting point is 00:39:25 which I include, if you look at their balance sheet, they'll do cash, short-term investments, and then long-term investments. I include all three. I basically add them together, and then I've taken the current yen to USD conversion and it is $18 billion in USD. This is a huge net cash position. It is 30% of the stock's current market cap of around $60 billion. And as I mentioned, investors wonder why

Starting point is 00:39:50 they keep such a high net cash position. Japan's central bank keeps interest rates close to zero. Although I will say, if you look at a chart, it's quite hilarious. They just bumped it up to 0.25%. from 0.1% for the central bank rate. So hey, maybe that's improved a slight amount, but it's essentially zero and it's been zero for a long while. So investors look at it and say, well, you're profitable. You generate cash. You've generated cash probably every year since

Starting point is 00:40:22 the switch has launched. Wouldn't you be better equipped to special dividend billions of dollars out to us as investors? And well, yes, they probably would. They probably could do a $10 billion dividend, it'd be fine instead of that robust balance sheet. But on the other hand, I understand where they're coming from philosophically. They want a sturdy balance sheet that can survive a multi-year downturn because they've gone through downturns before and while they have it now. Now, investors seem to take this information a lot of the times and then put a huge discount on this management team. However, I think a little bit more positively going forward with this balance sheet strategy for two reasons. One, the company does return

Starting point is 00:41:03 cash to shareholders. They pay a healthy dividend and have bought back stock periodically. I mean, the shareholder yield at one point is up over 4%. Today, it's quite low because they're reinvesting a ton into this new console launch. But I expect that to improve once we see the cash coming in after the next console. And second, as I mentioned, if this new console is successful, the cash will start pouring in and they've already built up this cash pile on the balance sheet that they want to have for the conservative nature and preparing for any sort of multi-year downturn, economic downturn, whatever. They want to be a longstanding company. They've been around for a hundred years and the management team doesn't want to be the ones to screw it up and

Starting point is 00:41:43 send out the bankruptcy. But since they already have this $18 billion, they can now start returning cash to shareholders at a much more aggressive rate versus the new cash that comes in. So I think versus the earnings that come in over the next couple of years, they'll be able to dividend that out or put in a buyback. Yeah. I think what I would like to see if I were a shareholder is maybe not one big special dividend, but either A, sherry purchases or them just increasing the regular dividend because they certainly have the capacity to do it. And they have, but they can do a lot more. They can pay out a lot more with that regular dividend. Yeah. I think I agree with you where with this management team,

Starting point is 00:42:32 it would be nice if they committed to some sort of... I know people don't like this because for some companies, it forces the management to focus on the dividend and make sure the dividend is sustainable. But if they committed to a sizable dividend increase and said, we're going to pay this out, unless earnings fall off a cliff, I would like that a ton. I would applaud that because they have the cash. And given the fact, historically, they've under maybe paid out the cash they have in the balance sheet back to shareholders, this would be like, okay, we're committed to doing for whatever it is, you know, it's going to be $3 billion a year, $2 billion a or whatever. I mean, that'd be a huge jump and something that says, okay, look, I'm getting $3

Starting point is 00:43:16 billion back every year. They've committed to that. It's not some sort of special dividend thing that I got to hope for or some huge buyback I got to hope for. I know it's coming and it can be more predictable. Okay. Let's talk through the valuation. What is the stock trade at and what do you think it's worth? Today, Nintendo has an enterprise value of about $40 billion if I just take the market cap and subtract out the net cash. Now, there could be a lot of hidden value in the investment portfolio that today I'm valuing at zero. I think it is something that could be a nice cherry on top, but I'm not exactly sure when or if they would monetize these investments over the next decade.

Starting point is 00:43:58 So I'm going to let it sit there. I don't know if that's going to matter. And hey, if it does, well that's good i'll be happy but if we come back to the actual operational businesses i think the company can grow gaming earnings to about five billion dollars once this new console is released as i mentioned earlier and then that the movie and theme park earnings can grow to a billion dollars so consolidated i think six billion dollars in annual earnings are doable $6 billion versus an EV of $40 billion, that's attractive, right? $6 billion in earnings would be a 10% yield on a $60 billion market cap, which is what they have. That means subtract out to that EV, it's much higher. We're in the teens. And if they can do $6 billion in earnings for multiple

Starting point is 00:44:48 years, like I think they can, well, versus a $40 billion EV, that is even more attractive. I think they can generate probably their entire EV in cash flow over the next 7 to 10 years conservatively. And I think they can generate around half over the next 3 to 4. Now, maybe I'll pause before we get into what I think the stock is worth, which is really not too important. It's obviously not a precise science, but anything there not make sense to you, Ryan? What are your thoughts on that? the valuation work and how you look at valuing the tender stock. All right. New sponsor alert. This episode is brought to you by our friends at Yellow Brick

Starting point is 00:45:34 Investing. Yellow Brick is an aggregator of the best stock pitches across the internet. By tracking thousands of blogs, newsletters, fund letters, podcasts, and more, they collect and summarize the best stock pitches and bring them to you in a single place. Think of it like a modern value investors club. I genuinely use Yellowbrick every single week here to try and discover new small cap ideas for the weekly power hour episodes that we do. And the best part is you get tons of features for free. Try it for yourself. Simply go to joinyellowbrick.com and search a company or ticker that you're interested in. You are bound to find a great report on just about any company. That is joinyellowbrick.com. Now, I think the earnings figure is certainly

Starting point is 00:46:20 achievable and it's worth remembering when they first launched the switch i think they probably surpassed everyone's expectations in terms of earnings power so if it gets any sort of reaction like what they had with the original switch i suspect there'll be even more upside to those earnings the it seems reasonable i mean the biggest thing here is that they have this big cash pile right so market cap is is quite off relative to its enterprise value and i think people just look at that as they can't value it on an enterprise value basis they have to say it's worth zero yeah the cash isn't worth that 18 billion dollars is going to come back to you over the next five years but i guess people can disagree right that's for me if if we started to

Starting point is 00:47:08 see management be a little more, not aggressive, but I don't know. They're profitable. They're profitable at what most people would probably consider the bust part of the cycle. And they're still sitting on that cash ball. I would like to see them, I guess, be a little more aggressive with the dividend. If you started to see that, then I think you could really start to lean more towards valuing the cash at something um but yeah i think any way you slice it the numbers here feel reasonable and if they do achieve these numbers it will be uh seen most likely as cheap yeah i would i'd follow that and say if they start returning more cash to shareholders i think you're going to miss out on some of the

Starting point is 00:48:00 returns. So my thesis is that this is being undervalued, this potential, and you get a lot of returns if they start doing that. Obviously, it's not guaranteed. I still think we make money if they keep up this conservative balance sheet. But at some point, if I'm right here, they're going to have, what, $40 billion in cash from the balance sheet and an EV of, if it doesn't move, or a market gap here, if it doesn't move of $60 billion. So I think at some point you know you're coming up with a what's the saying a movable object unstoppable force i think the hope would be i think the hope would be that they don't end up with 40 billion dollars in cash on the balance sheet and that it gets returned yeah exactly exactly we have seen i

Starting point is 00:48:44 didn't put this in the notes but the japanese government the central bank uh whoever the regulators are have told businesses and said look everyone's being too conservative we need some of this cash that's kind of just sitting on your balance sheets to get returned back to society and we've seen a lot of companies do more buybacks, stuff like that and I hope Nintendo does as well and I've seen a little bit of progress there

Starting point is 00:49:08 now, what do I think the stock is worth? Or, sorry, you have something to follow up there Ryan? Yeah, I was going to say, just from like a governmental standpoint and society in general, it's not very productive for a country to have cash just be doing nothing, like you

Starting point is 00:49:24 want those to be employing people or you know having it returned to people it doesn't do much to have it just sit exactly think about and i know the shareholders aren't technically all individuals but and this is a sidebar uh if you dividend out this 10 billion dollars well then japanese people can go consume more things and they'll consume more nintendo products it's a self-fulfilling cycle but I digress. What is the stock worth? I don't have a precise answer. I think generally the USADR is worth probably $25. That's my thinking. It's not precise. I think that's a range, maybe $20 to $30. And I think it could be pushing $30, $40, $50 if this thesis becomes fully correct or if it's even

Starting point is 00:50:13 better than I think. Today, the ADR, the US ADR trades at $12, so close to a double. And I think the downside is protected. Because you have the balance sheet that's already built up at a way too big amount. And the fact that they're about to launch this new console, and they're still earning about $3 billion a year. And for some of the best entertainment assets in the world, these franchises of mario zelda pokemon splatoon whatever animal crossing all 10 million dollar or excuse me 10 million unit sellers consistently i think this makes a great risk reward because the downside again as i said seems like we have a margin of safety here i'm not talking about the stock like if there's a signal downturn there could be a what you would call it

Starting point is 00:51:03 margin collapse. There could be some sort of few year period where the cash flow goes negative. If a new console goes down and the stock could go down and it will go down then. But for the business durability, the franchise durability, I think there is a margin of safety at these prices when would you sell good question i think i would sell first off i would sell nintendo stock if this new console is a clear flop i mean a clear flop means weak hardware sales weak software sales declining active users the thesis would be proved wrong and there's plenty of other things i can go into as a or excuse me like take and reinvest like You know, if the console is a flop, I don't think I'm sitting in this company for another

Starting point is 00:52:03 five years waiting for the next one to show up. I think there's some other ideas I have. I would hope there's other ideas I have that I could put the money into. The second reason is, well, and some of the never sell people might disagree with me here, but I would sell if it got to a premium valuation. For example, let's say it shoots up to 30 times my $6 billion earnings estimate. That would be probably 3, 4x from here. I have concerns they are willing or can grow much from that earnings base.

Starting point is 00:52:33 I don't think they want to. I don't think they can either, given that they're in a niche of family-friendly content. And unlike at Disney, they're not making $10 billion a year from theme parks. I don't want a company that's no growth at 30 times earnings. I don't. I think unlike another stock, maybe in my portfolio that has a long runway for reinvestment, Think of a retailer that has like 100 stores that I think can get to 1000. I believe selling a stock such as Nintendo at a huge multiple of earnings does not present a big error of omission risk. If that makes sense, Brian, what are your thoughts there? i think it makes sense the difficulty for me is and i guess this is why i don't own it

Starting point is 00:53:22 maybe right now i think in general after discussing this with you today if there is a time to be a nintendo shareholder or start being a nintendo shareholder now feels like a good opportunity given kind of the opportunity set that's in front of nintendo Yeah. But I worry that in four or five years, we're in the same boat. They have to reinvent themselves. And we're saying, what a great opportunity in front of them. Even though it's not nearly as cyclical, it is still very tied to the hardware. And if there were a hardware flop it would potentially be multiple years of difficult earnings lack of profitability i don't know i just it doesn't feel like it's like permanent users yeah i i understand where

Starting point is 00:54:19 you're going for there i think the chance of a hardware flop is low though i think it's quite low given and maybe we can reiterate this the fact that they have nintendo switch online the fact that they had the nintendo accounts and the fact that they're going to do unlike any other console generation the backwards compatibility stuff and the i know we talked about kind of the debate on whether like a new flagship game like mario kart would only be for the new console update well a lot of the games and the third party games can really get developed across all the titles and you know there's a lot of the publishers that decide well do we want to reinvest in this old form factor or not or something like that but when nintendo basically said prior and

Starting point is 00:55:02 historically said well no we're actually eliminating all these users and you have to do only this new one now they're giving people the option and they're investing more in these third-party developers for example ea electronic arts they used to be a huge um i want to say hater but Nintendo and EA used to not like each other. And EA would never publish games on Nintendo. And now that's changed. And I think that's an example of a third-party embracement. For the stock today, I think it's, as you mentioned,

Starting point is 00:55:37 given the new consoles coming out here, pretty good timing if you want to buy. Now, I understand that it can be risky. It's not for everyone. Obviously, this is not investment advice. but if profits inflect higher after this new console releases, Wall Street could aggressively bid up the stock as what happened after the switch launch. And the earnings multiple could go from below market today to above market with earnings growth. So you not only get earnings

Starting point is 00:56:06 growth, but you also get multiple expansion. I think that can end up being a multi-bagger in years. I think that really sums it up here. Ryan, maybe to end it, what would cause you to own the stock? What would cause you to buy shares, to invert it from when I would sell? If there's a time for me to buy it, it'd probably be now, I think. I really do like the opportunity set in front of them. And it really feels like earnings will inflect higher. But as we've moved away from managing money, managing other people's money, I more find myself looking for businesses where I can buy them and just not really ever touch them. Where I'm not that concerned about any given year's results stuff where it feels like if they pay a dividend today that dividend

Starting point is 00:57:08 is just going to continue to grow or if they're buying back stock they're going to continue to allocate more and more money towards that with nintendo it just it's more ups and downs it's something you got to monitor a little more closely and so i worry that it's just a business model that i don't feel that inclined to own yeah it's fair well i think the thesis is that the business model is maybe a little better going forward yeah but we'll we'll see it's not guaranteed to happen either way we're going to see what what is more correct uh over the next five or ten years well maybe i'll ask you what price makes sense to you what earn what market cap like 30 discount from here 40 discount because obviously as we've talked about you like the franchises you think

Starting point is 00:57:56 they're durable but you know as ad nauseum we've talked about the console cyclicality is always going to be there what price makes sense to you from a margin of safety um it makes sense now it's just i think the there's sort of a limit to the upside in terms of earnings power okay let me start with you here if they're trading at 18 billion dollar market cap would you buy yeah okay 30 yeah probably 40 yeah probably but it's that's probably i would buy it i would buy it now it's just okay i'm when i think about it relative to some of the other companies that i am considering it feels like the upside on some of those other ones in terms of earnings

Starting point is 00:58:48 power like is maybe higher for longer yeah lower on the watch list yeah yeah makes sense i don't know i'm not i'm not entirely out of it might buy some shares there was some friction to buying shares last time but i guess you could probably just buy the adr and it's i think no adr is pretty liquid yeah actually i should say that as a disclosure for any investors i know that it's a Japanese listed company. They have some ADRs around the world. I know we have over half our audiences in the US, so that's the majority of the listeners. The ADR, which is N-T-D-O-Y, is going to be the one you're going to want to buy in the US. It is not one of those ADRs that's super thinly traded. So you're going to be able to buy some shares and it's at a pretty cheap price.

Starting point is 00:59:40 I think that's going to do it. I think that covers most of the conversation. So I will wrap things up here. Thank you all for tuning in and listening. If you made it this far, I do want to remind everyone that Brett and I are not financial advisors. Anything we say or discuss here on Chit Chat Stocks is not formal advice or recommendation. I will be covering potentially two stocks for my research report in two weeks. Double header. Yeah, maybe a double header here. So little tease there. I talked about them last episode in terms of the two companies, but either I'm going to pick one or I'm going to do both. The two companies

Starting point is 01:00:15 are Paycom and SEMrush. I think they're both in kind of a unique position right now. But anyways, I'll finish up with this disclosure. Thank you all for tuning in. We will see you next time. You

Chit Chat Stocks - Why I Own Nintendo Stock: Round Two (NTDOY)

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