Why I’m Buying This Japanese Value Stock

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Nintendo (OTC: NTDOY.PK) has had a rough 2012, though it certainly brought some of the pain on itself.

With the Wii home game system getting long in the tooth, Nintendo launched the 3DS system last year to reinvigorate its portable game sales and profits, while putting the final touches on its next generation system for the home.

Unfortunately, things didn’t work out as planned for Nintendo. Smart phones and tablets from Apple (Nasdaq: AAPL  ) and Google (Nasdaq: GOOG  ) had already gained valuable mindshare in portable gaming, and Nintendo hurt its competitive position by initially setting its price point for the 3DS too high.

Nintendo eventually lowered the price of the 3DS in response, which gave a boost to system sales, and created the large market Nintendo wanted for game titles. But the price cut also means Nintendo is selling the system as a loss leader and relying on game titles to claw back probability.

A catalyst on the horizon
Unprofitable 3DS hardware sales have made profitability elusive for Nintendo over the last 12 months. But I expect better graphics, and new game play Wii U will push the company into the black when it launches this fall. Rumors point toward a November launch, and Nintendo has already said that at least 20 titles will be available at launch, and broad support from third party game developers.

One mystery remains for the Wii U, and that’s its price. This will likely be revealed on September 13, when Nintendo holds a media event in New York. The dynamics of playing games at home mean that Nintendo should have to worry about competition from Apple and Google’s Android for the Wii U, but with new home systems on the way from Sony (NYSE: SNE  ) and Microsoft (Nasdaq: MSFT  ) in 2013, Nintendo will need to set a price point that makes holiday sales of the Wii U as close to a no-brainer for parents as possible.

I think Nintendo has learned its lesson with the 3DS, and won’t over reach on price with the Wii U. And I like its competitive chances against Sony and Microsoft, too.

The value goes deeper
The Wii U isn’t all Nintendo has going for it. With Mario Brothers, The Legend of Zelda, Donkey Kong, Pokemon, Metroid, and many others under the corporate umbrella, Nintendo has a library of game franchises that hold durable value, and could one day be brought to smartphones or other game systems. To date, Nintendo has chosen to keep its franchises exclusively on Nintendo hardware, but the opportunity to leverage its franchises on other systems in the future is very valuable.

Nintendo also has a strong balance sheet. The financial strength is partly a blessing and partly a curse. With $11 billion in cash on hand, Nintendo can afford to make mistakes, and even the occasional big blunder like it did in pricing the 3DS. But the same security can also make Nintendo complacent, and potentially too stubborn to change and evolve with technology. With the Wii U launch weeks away, I’m giving the company the benefit of the doubt, and taking the fact that Nintendo has 75% of its market cap in cash as a positive. But this is a view I’m willing to reassess.

What could make it a value trap
I think Nintendo is a great value here but, as with most great value stock opportunities, there is also the chance it could turn into a value trap. If the Wii U flops, and Nintendo sticks to its current policy of only developing games for its own hardware, then it could continue to bleed red ink in 2013 and beyond. That will gradually weaken Nintendo’s strong balance sheet, and the share price will likely follow the same downward trend.

If this scenario plays out, and Nintendo shows no signs of using its valuable game franchise to take advantage of the mobile device market, I’ll probably end up selling the shares at a loss. So, early in 2013, I’ll need to make an assessment of the Wii U’s launch, and what direction Nintendo is heading in with its portable platform. If I see signs of the value trap scenario playing out, I’m going to be biased toward selling.

Foolish final thoughts
A great deal hinges on the launch of the Wii U for Nintendo. If that’s all there was going for the company, I would probably watch this event from the sidelines. The ongoing value of its game franchises and strong balance sheet are what have me willing to take a small position in Nintendo ahead of the Wii U’s launch. I’ll be looking to buy shares in the next few days, and will be back next week with another new name for the portfolio, so makes sure you check back next week!

As a reminder, you can follow along with all my real-money Orange Portfolio trades and updates here.  

Nathan Parmelee is a co-advisor of Champion Shares Pro and Share Advisor in the U.K. You can follow his real money Orange Portfolio here and his Twitter feed at @GlobalFools. Nathan owns shares of Nintendo. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (2) | Recommend This Article (7)

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  • Report this Comment On September 02, 2012, at 9:36 PM, CMFAnurag wrote:

    It appears to be a good call. I will up my position as well. I think the stock is trading so low as this is negative EPS in an already weak gaming sector that has stayed this way for several years now.

  • Report this Comment On September 06, 2012, at 6:25 PM, OceanJackson wrote:

    First thanks for covering a stock that gets little interest here at the Fool. I own and follow Nintendo as well. A few thoughts in response...

    "But the price cut also means Nintendo is selling the system as a loss leader"

    Really? Satoru Iwata, Nintendo's President - has stated multiple times publicly that the 3DS is "no longer sold at a loss". It's sold for a profit, albeit a small one.

    I think your article would have benefited from also mentioning the fact that the 3DS and its larger counterpart, the 3DS XL, are outpacing the sales of its predecessor...the DS - another fact Satoru Iwata is fond of reminding investors, AND, that their revamped E-Shop where games are downloaded, are big signs that big Nintendo profits are right around the corner.

    I would even argue that since the 3DS / 3DS XL are selling more units at a faster rate than previous handhelds - when there were no SmartPhones or Tablets to take "mindshare" as you put it, logically points to something the investment community hasn't put together yet.... that Smart-Phones & Tablets are having ZERO negative impact on handheld gaming, and that they've only served to increase the video game pie. A pie that Nintendo can now take more from.

    Another concern for Nintendo as you alluded Apple and even Google. What happens when an Apple iTV hits the market? It doesn't take much imagination to see Apple putting a video game console inside the TV, using the App store to sell games straight to the television set. In my mind, this is a much bigger threat to Nintendo than Sony or Microsoft. Sony - is also capable of creating such a device.

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