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What Does a $1.1 Billion Share Buyback Mean for Nintendo?

By Keith Noonan – Feb 15, 2014 at 7:00AM

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Nintendo has recently completed a massive buyback to the tune of $1.1 billion. How did this purchase come to be and what does it mean for the future of the company?

After years of denying that a change to its model was necessary, Nintendo (NTDOY) can no longer afford to ignore reality. One way or another, change is coming to the company. President Satoru Iwata has already announced a series of strategies intended to once again get the company moving in the right direction. Whether or not these strategies come to fruition is another matter entirely. The financial makeup of the company is also in flux, as Nintendo has purchased 9.5 million of its own shares.

The buyback rang up to the tune of approximately $1.1 billion and it was set in motion by the death of former company President Hiroshi Yamauchi. Many of the shares inherited by Yamuachi's heirs were sold to the company's treasury. Nintendo now expects losses of greater than $330 million on the year, and the company's home console hardware business has never looked weaker. What does this billion-dollar buyback mean for Nintendo?

The real end of the Yamauchi era
One of the reasons that the Yamauchi family put up so many shares is that Japan is a country with very high inheritance taxes. While the former President's relatives received both cash and stock assets, Nintendo has confirmed that all of the inherited stock would be subject to taxation. As such, it is highly likely that the inheritors sold the stock to make tax payments. Still, that does not mean that the Yamauchi family has faith in the direction of the company, and it is expected that they will sell more of their shares in the coming years.

The 9.5 million shares that Nintendo purchased for its treasury stock constituted approximately 7.4% of the company and brought Nintendo's treasury holdings to approximately 17%. The buyback comes amid ongoing troubles and a share price that is hovering around 10-year lows. Had the Yamauchi family's shares hit the open market, Nintendo's price would have undoubtedly hit its lowest point in a decade and a frenzied sell-off may have occurred. What's more, such a scenario would have enabled outside forces to gain significant stakes in the company at bargain-bin levels.

Nintendo would rather buy than be bought
Nintendo's buyback initiative can be viewed as a move to ensure that the company's management is not pressured by activist investors or those who seek to challenge the company's strategy. As much as the move is likely intended as a defense mechanism against a hostile takeover or threats to the board, President Satoru Iwata has stated that the buyback could prove instrumental in the company's own mergers and acquisitions strategy. While the substantial buyback may create liquidity issues, shares could conceivably be offered to the companies that Nintendo is interested in courting.

With Nintendo's home console presence being destroyed by Sony (SONY 0.84%) and Microsoft (MSFT -0.04%) and mobile gradually eroding the company's handheld dominance, Nintendo needs to tap into its substantial war chest. Third-party publishers have rejected the Wii U in favor of the PlayStation 4 and Xbox One. This unfortunate scenario tasks Nintendo with creating enough quality software to drive two distinct platforms, a herculean challenge the company is ill-equipped to shoulder. Nintendo will need to pursue aggressive partnerships or acquire new developers in order to maintain its presence in the gaming space. A desire to expand into creating "quality of life" software also suggests that Nintendo will need to diversify its holdings.

More buyback measures will follow
The buyback has prevented a cratering of Nintendo's share price and substantially reduced the likelihood of an investor revolt. Prior to his passing, Yamauchi owned approximately 11.1% of the company. The 7% stake that Nintendo has recently reacquired from his heirs leaves an outstanding 4% stake that the company will likely purchase in the next several years. Such a move would further protect the board and embolden current management to pursue their desired course.

Nintendo's board shores up control
Nintendo's $1.1 billion share buyback highlights the company's precarious position. The company will likely need to implement further buybacks in the coming years if it hopes to maintain investor satisfaction. Operating with a greater percentage of treasury shares will give Satoru Iwata and company the opportunity to weather the storms created by the company's short-term performance.

With the Wii U delivering monumental levels of failure and the company's QOL ventures not slated to debut until 2015, it's all but certain that this year will see lots of distressing news for Nintendo. Expect the frequently repeated chants of "Nintendo is doomed" to reach a fever pitch in 2014. For better or worse, the buyback will allow Satoru Iwata to apply noise-cancelling earplugs and carry on in his quest to find the right tune.

Keith Noonan has no position in any stocks mentioned. The Motley Fool owns shares of Microsoft. 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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