Nintendo Finally Comes Back Down to Earth

Heading into the current fiscal year, Nintendo (NASDAQOTH: NTDOY  ) and its investors had a lot worry about. The company's Wii U console had posted decent launch numbers, but there was already a good deal of skepticism about the device and a pervasive belief that it would fail to reach the lofty heights of its predecessor. The 3DS handheld was also posting disappointing numbers on the heels of a poorly planned launch. In order to assuage investor worries and instill confidence in the company's direction, President Satoru Iwata issued a series of ambitious sales and profit targets and emphasized that hitting them was his commitment. Nintendo would sell 9 million Wii U units, 18 million 3DS units, and achieve an operating profit of approximately $1 billion in the fiscal year.

After the company's first two quarterly reports returned numbers that made it clear Nintendo would not be hitting any of these goals, many called for forecast revisions that remained curiously absent. Now, Nintendo has finally revised its guidance numbers leading up to the Jan. 29 release of the company's third quarter report. What do these numbers mean for the company and the industry at large?

Coming to terms with reality
When news hit that the Wii U sold approximately 460,000 units in the first half of the fiscal year, most could see that the system was floundering. That didn't stop Iwata and other Nintendo figures from issuing excuses and suspect interpretations that seemed to downplay the fundamental issues at hand. In an earlier Fool article, I projected that Nintendo was on track to miss its 9 million Wii U targets by at least 6 million units. Nintendo's recently revised forecasts now backup that assertion.

Nintendo currently expects to sell 2.8 million Wii U units on the year. Even this lowly target is one that it will likely miss by a small margin. That an optimistic interpretation of available numbers is needed to see the Wii U reaching its newly lowered goal should provide a fairly accurate view of the state the console is in. The system has two big games releasing this year in Mario Kart 8 and Super Smash Bros., but there's no reason to believe that either of these titles will have a significant effect on the console's performance.

The companies you're not competing against just beat you
With the release of the Sony (NYSE: SNE  ) PlayStation 4 and the Microsoft (NASDAQ: MSFT  ) Xbox One, the Wii U looks to have been made roundly irrelevant in North America and Europe. The PlayStation 4 sold 4.2 million units at the tail end of 2013, with the Xbox One posting 3 million units in roughly the same amount of time. While the successful launches of these two platforms is not in itself an indication of the dismal future awaiting Wii U, the software lineup for Nintendo's system should make it abundantly clear.

At this point, Nintendo has to decide how it will handle this undeniable truth: the Wii U is a dying system and one that is on track to underperform the GameCube by a significant margin. Price drops and software bundles may increase adoption by small amounts, and a hypothetical SKU that ditches the system's GamePad controller in favor of reaching a mass-market price point is probably the best move. Still, the writing is on the wall. Nintendo will be stuck maintaining a dud device for the next two years as it cedes the console space to Sony and Microsoft.

Can Nintendo hold on to handheld?
While the company's 3DS handheld has been performing somewhat admirably in the face of rapid and disruptive growth in the mobile sector, the shifting market threatens Nintendo's handheld empire and long-term future. The company has revised its 3DS hardware sales to 13.5 million units on the year, down from 18 million units. Given the typical lifecycle of a Nintendo handheld, it's likely that 2013 will be one of the best years for the system's performance. The 3DS is nearing the end of its third year on the market, and Nintendo will need to have the perfect successor ready if the company hopes to stay healthy.

Thinking about change isn't enough
While Nintendo and Iwata had once forecasted an operating profit of approximately $1 billion for the year, current company projections anticipate a loss of greater than $300 million. After frequent and emphatic denials that the company needed to revise its strategies, Iwata has taken the monumental step in admitting that Nintendo will at least consider changes to its model. Calls for the company to go third party or fully embrace mobile ignore that Nintendo is greatly dependent on its hardware business and such a move would likely require massive downsizing and restructuring. For these reasons, you can expect Nintendo to continue releasing hardware. You can also expect the company to sink if this hardware fails to resonate with consumers. 

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