Last Friday, shares of Nintendo (OTC:NTDOY) fell, even as the gaming giant reported a sales surge for its recent quarter and fiscal year. Chalk it up to management's dour outlook for the upcoming year, in which Nintendo anticipates declines in revenue, operating profits, and dividends.

Nintendo's management is known to be conservative, both in terms of its guidance and its business strategy. Though Nintendo's core console and software businesses are doing quite well, the company has been slow to enter the booming mobile gaming category, or exploit its beloved IP through other avenues, though it's beginning to take baby steps in both of those directions.

That's what attracted activist investor ValueAct Capital to recently take a $1.1 billion stake in the video game giant in the first quarter. It's unclear whether Nintendo is merely being conservative, or whether the current Switch console cycle has hit its ceiling as the COVID-19 pandemic leads to a slowdown in consumer spending.

A young man sits on the floor of a dark room playing video games.

Image source: Getty Images.

Q1 results

Nintendo had a strong fiscal 2020, with the three-year-old Switch leading the way (the company's fiscal year ends in March): 

Metric (currency in billions Yen)

FY 2019

FY 2020

FY 2021 (est.)

Switch units

16.95 million

21.03 million

19 million

Switch software units

11.86 million

16.87 million

14 million

Total revenue

1,201

1,309

1,200

Total operating profit

249.7

352.8

300

Data source: Nintendo earnings release.

As you can see, the company is guiding for lower 2021 results across the board. This may be due to some pull-in of demand from 2021 into March of 2020 as people began to hunker down for quarantine, which may have boosted the 2020 figures above and "stolen" sales from fiscal 2021.

One case in point may be the recent game Animal Crossing: New Horizons, which was just released on March 20 and sold an amazing 13.41 million units in the first six weeks. That's more units than the first two versions of Animal Crossing sold in their entirety. 

Graph showing much higher Animal Crossings New Horizons versus prior versions.

Image source: Nintendo.

In addition, while sales of overall Switch units grew, sales of regular Switch consoles actually fell to 14.8 million units in 2020, while the Switch Lite, which was only introduced in September 2019, sold 6.2 million units.

With the Switch cycle entering its fourth year, it's quite possible annual units sold may have peaked, though it's not certain. Rumors are that Nintendo will release another high-end version, a Switch 2, or "Switch Pro" model, sometime around the middle of the 2020 calendar year, with an updated CPU and a magnesium alloy body.

If a Pro version is released, that could give Switch sales an added boost over Nintendo's guidance, though it's unclear whether a new model is already incorporated into its 2021 projections.

Trying to ramp new businesses

Nintendo also reported on new business lines that are currently small but are growing fast. Digital sales surged 71.8% in 2020 to comprise 34% of all software sales, up from 24.8% of software sales in 2019. The second category, a combination of mobile gaming and IP licensing income, contributed just 51.2 billion yen, up 11.2% year over year, but only amounting to about 4% of sales, as the company currently only has six mobile games outstanding.

In March, the company added multi-player capability to its mobile 2019 release, Mario Kart Tour, which management claimed led to an uptick in usage and Gold Pass subscriptions. On the licensing front, Nintendo inked new partnerships with Levi Strauss & Co. (NYSE:LEVI) for Mario-inspired jeans and t-shirts, as well as toymaker Lego, which is releasing a new Mario-inspired Lego set.

A murky road ahead

Nintendo will no doubt do better than most in the stay-at-home economy, but it's an open question as to whether the short-term boost will last, especially if the COVID-19 slowdown leads to a recession. It's also an open question as to whether ValueAct may agitate for more substantial changes to Nintendo's strategy amid stalling growth. ValueAct believes Nintendo can transform itself from a mere console and software maker into a "broader entertainment company," according to its letter to investors last month. 

Of course, Nintendo has been around since 1889 and is very set in its ways, so we'll have to see if the company's tepid guidance changes ValueAct's stance from a friendly large investor to a more aggressive activist.