Nintendo's (NTDOY 0.46%) most recent fiscal report didn't give investors much to be happy about. It's telling that an operating loss of approximately $456 million, a net loss of $228 million, and a reduction of cash assets from $4.7 billion to $3.3 billion were far from the most worrying bits of information in the briefing.
The real problem facing the company is the collapse of hardware sales, as Sony (SONY 0.90%) and Microsoft look to own the home console sphere, and mobile gaming continues to push dedicated handhelds toward the brink of irrelevance. Still, Nintendo projects that it will return to profitability in the current fiscal year, forecasting an operating profit of $393 million. Can Nintendo make good on this guidance, or will it once again come up short?
Hardware lags
The past fiscal year saw the 3DS handheld sell approximately 12.24 million units worldwide, down substantially from Nintendo's initial projections of 18 million units sold. Wii U sales for the year stood at 2.72 million units, an embarrassingly far cry from initial guidance of 9 million units sold on the year. Across both platforms, the company sold approximately 86.75 million units of software, slightly better than its revised forecast had projected. Looking at the company's guidance for the current year, it's clear a similar performance is expected.
Where will the turnaround come from?
Nintendo anticipates selling 3.6 million Wii U consoles and 12 million 3DS handhelds in the coming year. The company expects to sell 87 million combined software units for the year. Given that Nintendo is suggesting that its business will essentially remain constant between this year and the last, it's worth taking a look at how Nintendo would end up $393 million in the black, an $849 million swing compared to its previous operating performance.
Built into the idea that the company can generate substantial operating profits on roughly the same sales as the previous year is the notion that Nintendo has already made sufficient organizational progress and correctly mapped its spending so as to not require additional, unstated expenditures. It hasn't. Nintendo's profit projection assumes that it will spend substantially less on research, development, and acquisitions -- a dubious supposition. The company is in the midst of a push into a new category, somewhat mysteriously dubbed "Quality of Life," as well as the development of next-generation gaming hardware. These are costly endeavors.
Nintendo's profit aim misses the point
Barring an unforeseen turn of events, Nintendo posting a substantial operating profit this year would not portend well for the future of the company. Sony sold 7 million PlayStation 4 units in less than five months after its release. Wii U will be lucky to achieve 15 million sales in its lifetime. Nintendo has never been closer to irrelevance on the home console front. The rise of mobile makes it unlikely that Sony will ready a dedicated successor to its PS Vita handheld, but the handheld market is shrinking so fast that Nintendo's next entry will almost certainly face a smaller addressable market.
The company's $150 million purchase of an unknown, non-gaming tech company in the last quarter is the type of move it will have to make repeatedly throughout the current year if it wants to rebuild a sustainable base. CEO Satoru Iwata has also indicated that the company will purchase more of its own stock.
This year is still dependent on the core business model
Per Nintendo's statements, the company is not happy with its Wii U business, so a slight sales increase over the previous year doesn't offer anything transformative. Build cost for the console is unlikely to see any meaningful reduction. Substantial stock has built up, and demand is anemic.
3DS hardware generates good margins, and a revision of the system remains a likely introduction for the year. Without a new model, the current 3DS platforms will need a price reduction to reach the company's sales target. That seemingly leaves Nintendo's Near Field Communications toys as the company's remaining earnings avenue. Activision Blizzard's Skylanders and Disney's Infinity have shown that the software-toy model can be very successful, and Nintendo has a great history of characters to mine, but Nintendo's take on the formula will be hindered by its struggling hardware platforms.
In a year in which Nintendo will be concentrated on the development of next-generation gaming hardware, the advancement of the QOL initiative, and the readying of new systems for developing markets, it's hard to imagine that the company's spending will decrease significantly. Revenue certainly does not look set for meaningful growth.
Invest in the future or become the past...
Iwata and company were once content to sit on the massive war chest built by the Wii and DS, indulging in the mistaken belief that casual gamers were now permanent members of the company's ecosystem. Nintendo neglected the investments in infrastructure and technology necessary to retain industry relevance. Now, the company will need to invent and spend its way out of the hole it has created. Investors may be antsy, but Nintendo is not in a position to deliver on its $393 million operating profit target. Looking beyond the current fiscal year, it's not a goal the company should be chasing.