Over the last seven years, shares of Nintendo (OTC:NTDOY) have lost more than 80% of their value. The video game giant's current consoles -- the Wii U and 3DS -- have been immensely disappointing, selling much less than their predecessors, and falling far short of Nintendo's expectations.
No doubt, managements' recent missteps have destroyed billions of dollars of shareholder value. Yet, far removed from its all-time high, Nintendo stock may be compelling from a value investing standpoint. Though immense operational challenges remain, Nintendo appears to be trading at, or at least near, its breakup value.
A mountain of cash
Although Nintendo has not been consistently profitable since 2011, the company is sitting on an immense mountain of cash: Nintendo's prior consoles, the Wii and DS, were runaway successes, generating billions of dollars in profits.
Unfortunately, not all of that profit has remained on the balance sheet -- Nintendo's cash pile, which was comprised of $7.4 billion in cash and cash-equivalents as of the end of June -- was once nearly double in size. Nintendo has continued to pay dividends and bought back stock, but persistent annual losses have certainly taken a toll.
Nevertheless, with a market cap of just $12.5 billion, Nintendo's cash pile represents nearly 60% of the company's current valuation.
Mario, Zelda, Donkey Kong ...
The market may be attributing the other 40% to Nintendo's operations, but the company has another valuable asset that is not reflected on its balance sheet: its vast, and immensely valuable, intellectual property.
Nintendo owns the rights to many of the world's most iconic video game franchises, notably Mario, Zelda, and Donkey Kong (among many others). It's hard to put a definitive price tag on the rights to these characters, but two relatively recent deals suggest a ballpark figure in the range of $4 billion.
That's the price Disney paid for Marvel In 2009, snapping up the comic book company largely so it could secure the rights to its well-known super heroes. Three years later, Disney struck again, dropping another $4 billion on Lucasfilms (read: the rights to Star Wars).
Are Mario and Link as iconic as Darth Vader or The Hulk? At first glance it may seem like a stretch, but Nintendo's characters are undeniably recognizable -- past surveys have found Mario to be more familiar to children than Mickey Mouse. Nintendo has not exploited its characters much outside of video games or related merchandise, but the opportunity is clearly there: the video game-focused film Wreck-It-Ralph, released in 2012, was a commercial hit, and ultimately generated nearly half a billion dollars in box office revenue.
If Nintendo's IP were put up for auction, it's not difficult to imagine that there would be many interested buyers: The ability to use its characters in films, theme parks, and other mediums might attract an entertainment giant like Disney, while third party video game publishers such as Activision Blizzard or Electronic Arts would presumably jump at the chance for the rights to their industry's most established franchises.
Hobbled by a stubborn management team
With $7.4 billion of cash, and perhaps $4 billion worth of IP, the market is currently valuing Nintendo's core business at around $1 billion -- fairly cheap for a company that generated nearly $700 million in sales last quarter and was, in the somewhat recent past, producing annual net profits in excess of $2 billion.
That may, however, be fair in the context of Nintendo's current situation: Rather than a misstep, Nintendo's recent performance may be evidence of an ongoing trend, one that threatens the company's very existence. The rise of smart phone and tablet gaming seems to have stolen many of Nintendo's customers, and though some investors have urged the company to consider bringing its games to more diverse platforms, Nintendo's management has steadfastly defended its long-standing strategy.
In other words, things may get much worse before they get better. If mobile devices continue to erode the market for Nintendo's products, annual losses could mount, and the company could continue to bleed cash for the foreseeable future. At the same time, its refusal to release games on other platforms runs a real risk of significantly devaluing its IP: If children are not playing its games, they will, over time, become less familiar with its characters.
A traditional value investing approach seeks profitable firms trading at a bargain valuation. Nintendo isn't profitable, but based on the value of its assets, appears quite cheap. If it can turn its business around, and deliver consistent profits going forward, the beaten-down stock could be poised for a significant rebound in the years ahead.