Nintendo (NASDAQOTH:NTDOY) has a long runway of growth as it develops its online experience. From digital downloads to subscription-based multiplayer, this area holds significant potential for the company.
And on top of this recurring, high-margin revenue, Nintendo is expanding more into mobile where it has already logged hundreds of millions of downloads for its first few titles.
A full transcript follows the video.
This video was recorded on Oct. 16, 2018.
Vincent Shen: For these other long-term opportunities that Nintendo sees, you've mentioned a couple of them. Let's talk digital and online. Nintendo reported that digital sales for the Switch were up 87% in fiscal 2018, but still a very small part of the business at just $573 million, about 6% of total revenue. Fast growing, though.
Dan Kline: It's something Nintendo can do better than other publishers. Because most of the biggest-selling titles are actually titles they own, cutting out the middleman is a huge increase in revenue. In theory, it could allow them to sell you a game directly cheaper and still make more money. The negative on digital downloads, and what's been holding them back, is speed. I don't know, do you own a game console?
Shen: Yes, I do, but not the Switch.
Kline: Have you ever downloaded a game?
Kline: It's slow. It can take all day.
Shen: They're huge files these days.
Kline: Yeah. The Switch games are simpler because they don't have the top-tier resolution. Some of the Switch games, you could decide at dinner, "I'm going to download this game," then by the time you're done, it's done. This is an improving technology that creates a really easy way to put games into people's hands. You no longer have to stand in line in stores, you can get things on release days, you can charge more to get it three or four days early, which they've done on some of their games. This is going to be a growing area. But it's something that's more dependent on internet than it is necessarily Nintendo.
Shen: Their Switch Online offering only launched last month, on September 18th. This gives players the ability to access online multiplayer, certain voice chat services, cloud saves, and other features. The corresponding online subscriptions for the PlayStation and Xbox made a lot of money for Sony and Microsoft. We've talked before, in the context of these video game companies, how digital downloads, not only in terms of the lower cost of distributing games digitally, but all the different add-ons and in-game purchases that can be made are really boosting the margins for those companies. The Switch Online requires a monthly or annual subscription. It's $4 a month or $20 a year. I think there's another three-month option, as well. That's a lot cheaper than the competing services. The rationale for that has been that Nintendo's Switch Online offers less functionality than what PlayStation or Xbox offers.
Kline: They've always had digital downloads. Since the Switch launched, you could always buy games, but there was no multiplayer. The reason they waited is because Nintendo has to build something with family friendly tools in place. I can subscribe and know my child is going to be playing games in a PG environment, which is certainly not the case with Sony and Microsoft.
Shen: Sure. There were delays for the Switch Online. It was actually originally slated for fall 2017, ended up being pushed a full year. But I think this shows us that, as innovative as Nintendo can be with their devices, management also has a reputation of being pretty conservative when approaching certain uncharted territory -- in this case, with this digital online offering.
Kline: The potential for backlash for them is very huge. I'm sure you've dealt with some of the negativity in online gaming. You're playing a game, and there might be words you don't want your kids hearing, there might be racism or taunting, or who knows what. Nintendo goes very carefully because they don't want to be in a situation where any of their family friendly games -- even when they take an NC-17 game or an adult game and port it to Nintendo, they generally tone it down a little bit, take some of the blood out, take some of the violence out. This was all in the traditional line of Nintendo very carefully protecting its brand.
Shen: Another feature of Switch Online is access to some of the games from the company's very long history, their storied library. The popularity and value of the Nintendo library of titles, I think it's really undeniable at this point. A good example of just how valuable it's been for the company is in the limited runs that they offered for the NES Classic and the SNES Classic. These were shrunken-down versions of those original classic consoles. The first one, the NES Classic, had 1.5 million units, limited. It sold out in no time. The SNES Classic for fiscal 2018 sold 5.3 million units. Each of these holds about 20 or so games.
Kline: You simply couldn't find them. I would love to own either one of them, and they were not available.
Shen: People love some of these classic titles that much. They still love them. That's something that's also offered with the Switch Online subscription.
Kline: It fits the age group. If you have an eight-year-old and he's never played Castlevania before, he's not going to feel like it's outdated. Because the Switch doesn't have the whizz-bang graphics of the Xbox One or PS4, the younger user, who's been playing games on their mobile phone or their parents' mobile phone, all of those archived titles are very fresh and very exciting because they haven't started playing Call of Duty and the very immersive, high-end games. So, that subscription price, I'd be shocked if they don't achieve a pretty high penetration pretty quickly. It's almost an incidental cost at this point.
Shen: Yeah. An even bigger opportunity than Switch Online, in my opinion, is taking all this intellectual property that Nintendo has, these very famous franchise characters, and leveraging it outside of Nintendo's core territory, in terms of video games. That's why a lot of investors are tracking the company's progress in mobile. In the annual report, management said about its smart device games or mobile games, "We plan to expand our smart device business into one of our major pillars of revenue, and in doing so, strengthen the foundations of the business, generate synergy with our dedicated video game business, and maximize business for Nintendo as a whole."
The smart devices business grew 62% year over year to $370 million in fiscal 2018. Again, this is a small but fast-growing part of the Nintendo empire. What do you think?
Kline: I think it's important. It used to be a very walled world. If you wanted Nintendo characters, you had to buy a Nintendo device. I don't think they should take every game and port it to every platform. We've seen recently, Sony having the new Spider Man game exclusively was a driver for video game sales. But I do think selectively taking titles -- bringing a version of Mario Kart that's appropriate for a smartphone to a smartphone -- is probably going to make people want to play the full version of the game and do all the things you could do in Switch. Or, if you've ever played it in a Dave & Busters, all that kind of stuff. You can't do that on a smartphone. But you can bring the experience, you could build the base. Look what they've been able to do with Pokémon. Pokémon Go is a Nintendo-related product -- the ownership of all that is complicated. That took a character that was previously only a 3DS character, in terms of video games, a Nintendo console character, and made it, if not still the biggest, for a time the biggest mobile game. That showed the enormous potential of taking Mario or Donkey Kong or Zelda --- actually, it's not Zelda, it's Link who's the character in Zelda -- and bringing all those to other devices. If they do it carefully, it could be very, very big.
Shen: Yeah. An example here. Super Mario Run was the first mobile title. It launched in 2016, has been downloaded over 200 million times. Again, this is a case where Nintendo was late to the game, just as it was with online multiplayer service. But this part of the business reminds me a little bit of Walt Disney. You have all these beloved characters. All the company has to do is bring them to more mediums. In the process, they expand their fan base and their audience, which ultimately attracts more people to its core video game business. It's a nice ecosystem play, if they can develop it successfully.
Kline: They have the IP. We've talked about this before, it was always a little strange that they didn't license it out. And I understand when consoles were the whole video game world, you weren't going to take Super Mario and bring it to Xbox, because maybe people wouldn't buy a Nintendo console at that point. But now, a console is not competing with a smartphone. Those are different gameplay experiences. It's different times of day, different locations. They really should bring as much as they can everywhere, as you said, to grow their fan base, to make everything bigger and make these characters bigger.
Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Daniel B. Kline owns shares of Microsoft. Vincent Shen has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Walt Disney. The Motley Fool recommends Dave & Buster's Entertainment. The Motley Fool has a disclosure policy.