3 Huge Risks for Nintendo Investors

Can Nintendo overcome threats to its business and return to greatness?

Jul 3, 2014 at 12:00PM

Nintendo (NASDAQOTH:NTDOY) is battling to reclaim its former glory. The previous hardware cycle saw the company introduce the DS and the Wii, two incredibly successful platforms that were ahead of the curve in terms of input mechanisms. At the height of those systems' popularity, Nintendo was frequently cited as one of the most exciting companies in tech, but the Japanese hardware and software maker failed to keep up with the hype. October 2007 saw shares of Nintendo hit a lifetime high of $78.50. As of this writing, shares of the company can be purchased for under $16.

Strong competition from Sony (NYSE:SNE) and Microsoft on the console front and the emergence of mobile platforms from the likes of Apple and Google present huge threats to Nintendo's business. Can Nintendo overcome the massive risks it faces and return to its heavenly highs?

Reliance on hardware sales is a dangerous game
Approximately 57% of Nintendo's revenue for the fiscal year ended March 31, 2014 came from hardware sales. This figure does not include the sale of controllers or other add-ons for its hardware platforms. While Nintendo has traditionally enjoyed better margins on hardware than its gaming competitors, the company's reliance on platform sales is highly problematic given current industry trends. Its Wii U console currently stands at approximately 6.5 million units sold after roughly a year and a half on the market, while Sony's PlayStation 4 managed 7 million unit sales in just five months.

Switching to handhelds, at approximately 43.33 million units sold as of March 31, Nintendo will be lucky if its 3DS handheld can manage half of the DS's approximately 154 million unit lifetime sale.

One of the biggest dilemmas facing Nintendo is that third-party publishers are showing increasing disinterest in its platforms. At present, this burdens the company with creating enough quality software to drive two distinct consoles.

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Source: Nintendo.com.

The obvious difficulties in maintaining this task appear to be pushing Nintendo toward a unified hardware ecosystem that would see similar versions of its games released across multiple systems. Such a move could benefit Nintendo's software development efforts and help its games reach a wider audience, but the move might also lead to fewer hardware sales going forward. Nintendo's core audience would only need to purchase one system to have access to the company's games, and the unified platform strategy would almost certainly limit what was possible on the company's next home console.

Creating two largely similar platforms has the potential to limit each system's individual appeal. Sony attempted a variation of this strategy with the PS Vita, yielding mostly disastrous results.

Quality of Life could be a bust
Nintendo's rapidly eroding position in the gaming market has highlighted a need for diversification. President Satoru Iwata has indicated that the company will broaden its horizons with a new venture dubbed, "Quality of Life." He has also stated that the new, health-based business will have an entertainment component, and that the new venture should challenge traditional perceptions of Nintendo as being just a gaming company.  

What exactly "Quality of Life" is remains shrouded in mystery. The company has said that its new business will not be dependent on wearable tech, and that its new branch will operate mostly separate from its gaming division. Some have pointed to the Wii Fit game series as an indication of the direction Nintendo may be pursuing.

The company will need to deliver an experience that is highly intuitive, innovative, and differentiated if it wants to compete in the increasingly crowded intersection of consumer technology and health services.

Commitment to short-term profit would be bad for long-term prospects
After posting three years of consecutive operating losses, unheard of in the company's history as a games maker, President Iwata has emphasized the importance of returning to profitability this year. Then again, he also promised an operating profit of approximately $1 billion last year before proceeding to deliver an operating loss of approximately $456 million.

For the current fiscal year, Nintendo forecasts an operating profit of $393 million, despite the fact that it also projects hardware and software sales mostly in line with those from last year. That leaves the company's new Amiibo figurines and a reduction of operating costs as the chief avenues to profitability. With plans to move into a new space and the need to develop new hardware platforms and improve its online infrastructure, a substantial operating profit would be a sign of investor appeasement at the expense of long-term strategy.

Foolish final thoughts
Nintendo's vast array of IPs and history as an innovator are evidence of the company's potential, but with declining hardware sales, the possibility that its new business will fall flat, and broader strategic concerns, there are too many threats to the company's business to make it an advisable investment at this time. 

With Wii U as the current ambassador for the company's home console vision, and mobile threatening to make dedicated handhelds irrelevant, a willingness to embrace uncertainty and an underdog position are prerequisites for those contemplating a position in Nintendo.

Leaked: Apple's next smart device (warning, it may shock you)
Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out, and some early viewers are claiming its everyday impact could trump the iPod, iPhone, and the iPad. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early, in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!

Keith Noonan has no position in any stocks mentioned. The Motley Fool recommends Apple, Google (A shares), and Google (C shares). The Motley Fool owns shares of Apple, Google (A shares), Google (C shares), and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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