Taking Stock of Nintendo's Switch-Fueled Revival

Before the success of the Switch, Nintendo's (NTDOY -0.78%) video game console business was on its last legs. The Wii U was a disappointing follow-up to the original Wii, and its prospects for success in the market looked dim.

The Switch, however, was exactly what the company needed to reinvigorate this business. This unique console outsold its predecessor in less than a year and helped the company to reverse an eight-year streak of declining revenue.

A full transcript follows the video.

This video was recorded on Oct. 16, 2018.

Vincent Shen: Dan, the big catalyst for the company in the past 18 months has been that new console, the Switch. You are a proud Switch owner. What's the special sauce here?

Dan Kline: It's important to say that while the Nintendo brand was in a strong position before the Switch. They own a lot of great IP. Tons of games you've heard of, characters you know. They were struggling in the console business. They had the Wii, which was a megahit. When that cycle died off, the Wii U was, let's just say, not a megahit. The Switch was really a home run in that it's something totally different. It's a video game console in that you can plug it into your television and play video games on your television console. It's also a tablet portable device. You can carry it, like I'm holding it now, and play it with controllers on the sides. You can prop it up and take the controllers off and use it as a mini-television. It sort of gives families a device that they can all play around the living room television. That's sort of why I bought it. And, while they're traveling, it's an alternative thing for the kids to do. It doesn't need to be internet-connected for the vast majority of gameplay, so you don't run into the kid playing on his iPad and then it loses the connection and he can't play. It's a very different take. Also, they didn't go for, the highest resolution, a million pixels, 4K. It's just a good game experience, so they were able to keep the price down, comparatively.

Shen: For Nintendo, the management philosophy has always been about that fun, unique entertainment experience. I want to talk a little bit, though, about the financial impact that the Switch has had.

Kline: On the company or me personally? Because it's cost me quite a bit of money. [laughs]

Shen: In the games, I'm sure. But, I can't overstate that the success of the Switch has really helped to breathe new life into Nintendo's business. If you look at the financials, Nintendo reports their results in Japanese yen, which we converted to dollars. There might be small differences in our numbers if you guys calculate something on your own, depending on the conversion rate you use. Overall, revenue declined for eight years straight starting in 2010. During that weak period, as you mentioned, Nintendo had released the very ill-fated Wii U. Investors pretty much watched as the top line went from a peak of $16.4 billion to $4.6 billion. Huge decline. Then, that lead-up period to the Switch, fiscal 2017, for example, which ended in March of that year, revenue was down 3%. That was, of course, though, the month the Switch made its debut. March 2017, Switch makes its release. The company's definitely on a weak streak. Fast forward to one year later, as of March 2018, fiscal 2018 results, that year saw revenue more than double to $10 billion thanks to all the momentum from the blowout sales of this new console. As of June 30, Nintendo has sold almost 20 million units of the Switch. It took less than 10 months for the Switch to outpace the lifetime sales of the Wii U. That's how bad the Wii U was and how strong the Switch is.

Kline: The Switch filled the market niche. Go you go back to the Wii, unless you only had young kids, very few people only had a Wii. The Wii was the secondary gaming device in the house, the one that mom and dad played with, as well. The Wii U didn't really fit that niche. It was a little too expensive. The Switch was just a very logical package. And, those numbers were actually hurt by the fact that they couldn't make them as fast as they were selling them. They were very difficult to get in the first four or five months it was out.

Shen: That's also because these things were absolutely flying off the shelves. I think overall, the approach that management has taken to the Switch and some other small but really fast-growing parts of the business, like digital, like mobile, that to me right now is the most compelling part of the Nintendo investment story.

We go back to Matt's mailbag question. He cited specifically the strong company brand, their reputation for innovation, very valuable intellectual property, mobile apps, e-sports potential. These are all tailwinds and opportunities for Nintendo. I think he's really on point with this list. If you read the letter to shareholders from company president Shintaro Furukawa, he lays out some of the company's goals and strategies going forward in the 2018 annual report. These include the desire to, No. 1, expand the digital business, including Nintendo Switch online, which we'll talk about; No. 2, leverage the company's IP in the massive installed base of smart devices around the world; and No. 3, make Nintendo characters available for theme parks, film, and other merchandise -- exactly some of the things that Matt highlighted.

We'll talk about each of these efforts. In the context of the Switch, it's good to see management learn from the mistake that they made with the Wii U. A big part of the failure there, I think, was to draw interest from some third-party developers -- any, really -- which really limited the library of titles available for that console. By opening up the Switch platform to all these other developers, this deeper library of third-party titles -- which includes, sometime, some more intense games, like action games, for example, that Nintendo doesn't produce themselves.

Kline: It also includes -- and this is, I think, a very smart play -- some inexpensive retro titles. If you have an Xbox One, maybe you can buy a compilation that has a bunch of old games. But you can't just be like, "I want Tekken 2," and it's $4.99 in the game store. That's how it works on the Switch. There's all sorts of price points you can hit. Some of it is just, they ported over other cool old titles that maybe were out of print.

Shen: All this serves to expand the Switch's target market. Even the more dedicated adult gamers, people who usually will turn more to the PlayStation or Xbox or PC games, they have something to enjoy now, in terms of titles available for the Switch.

Nintendo reports the top-selling games for the Switch that it publishes specifically. These are names like Super Mario Odyssey, Mario Kart 8 Deluxe, Splatoon 2. Of the ten best-selling Nintendo titles, together, they've already moved 48 million units as of the end of June 2018. 18 months into its release, 87 million games sold for the Switch. That already puts it within reach of the lifetime game sales of the Wii U, which came out to about 102 million units. Again, you can see how quickly it's ramping up.

Kline: They've also approached game releases really well. They handle them more like a movie coming out. It's not a crowded schedule, and when something like Mario Kart came out, you knew it was coming. There was a heavy pre-order push. They've been very smart. They have all this intellectual property, but there isn't a new Mario Kart every year. There isn't a New Super Mario Brothers every year. They space these things out to meet consumer demand. I would say, those top games you talked about, I bet most Switch owners own 80-90% of the top titles.