- The hype behind Pokémon Go was unjustified and I anticipate a massive implosion in Nintendo’s valuation.
- Furthermore, after conducting far more due diligence, I believe Nintendo’s direct ownership stake is valued at $200 to $500 million.
- The clear winner is Google, given the length of Niantic's partnership between Google and more well-defined revenue synergies/agreements.
The funny thing about Pokémon Go was how fast the hype had built up for Nintendo (OTC:NTDOY) shareholders before quickly dissipating into thin air.
Nintendo’s most recent console generation a flop
I guess, my greatest concern with ever recommending Nintendo shares was the overwhelmingly disappointing results for the current console generation, err… what was called it called again? Oh yeah, the Nintendo Wii U. Now try searching for “Nintendo” on Amazon (NASDAQ:AMZN) or Google and it’s nowhere near the top. In fact, the older generation Nintendo for retro gamers ranked higher on both Google and Amazon than the most recent console.
Talk about a huge marketing nightmare for Nintendo, as its latest efforts to generate excitement fell on deaf ears. Many have labeled this the worst line-up of games in Nintendo’s recent console history. This is coming from diehard Nintendo fans – not me. So, the core business is doing bad, there's no fundamental argument for buying Nintendo aside from the purported hype from Pokémon Go.
The stock is trading higher on Niantic/Pokémon Go
So, if you’re wondering why the stock is collapsing, it’s due to a massive misinterpretation of Pokémon Go contribution to revenue/earnings and enterprise value. Furthermore, the core game console/software business has remained sluggish in the current generation, which is why there’s no other reason to buy Nintendo with the exception of Pokémon Go. Nintendo already lost 25.7% of its value from its recent high, and I anticipate that the stock will continue to decline based on my preliminary analysis of Nintendo’s equity position in Niantic and the minimal impact it will likely have despite the record year for the infant start-up, as it’s set to generate a blistering amount of gross bookings over the next five-years.
For investors, the last glimmering strand of hope was Niantic, which recently launched Pokémon Go to the fanfare of a massively receptive global audience that now amounts to the North America installed base of Twitter, which implies MAUs in the range of 50 million to 100 million. Maybe the figure swelled to a much higher amount by now, but I could easily imagine the game at around 75 million users given the comparison to Twitter on numerous occasions.
So, what’s Niantic worth?
As for the revenue analysis of Niantic, I believe revenue will compare to King Digital’s ARPU (average revenue per user) given the reported usage of Pokémon Go and the high-dependency on purchasing premium virtual goods to maintain a competitive advantage in a peer-to-peer environment that forces gamers to congregate in local (real world) environments to compete in local tournaments. In other words, there’s a lot of incentive to pay as you go, which implies that the penetration and usage rate should be comparable to more mature game franchises like Super Cell’s Clash of Clans or King Digital’s Candy Crush.
In FY’15 King Digital reported revenue of $2 billion with average MAUs of appx. 493.5 million (averaged over four quarters). Therefore, King’s average revenue per user was $4.05 in FY’15. I believe, Niantic at appx. 75 million users imply revenue of $4 (low-end) and $5 (high-end) per MAU, which implies that the business is on track to generate $168 million in revenue from the current user base (due to half-year contribution), and assuming Niantic attaches another 200 million active users by year-end, the incremental users should contribute approximately $200 million in revenue. 200 million additional users should translate into one quarter of contribution given the uneven pace of incremental user additions paired with a small window for monetization in the current fiscal year.
Since the growth is exponential, the revenue could far exceed my expectations, but I feel fairly compelled to make the case that Niantic will generate appx. $368 million revenue given comparable mobile franchises, and a reasonable run rate for the duration of the year. Furthermore, I would value the business at a unicorn-like multiple, which implies that it should be valued in the range of 10x to 15x sales, which gives it a valuation in the range of $3.68 billion to $5.52 billion. The figure I arrive at (low-end) is roughly comparable to the analysis done by Citigroup, which values the business at $3.65 billion as mentioned in the Quartz article.
It just so happens that the rationale for my argument is roughly comparable to other street analysts as well (this actually happens a lot). That being the case, this is in no way a glowing recommendation to invest into Nintendo.
So, what’s Nintendo’s direct investment into Niantic worth?
While Nintendo does own a 33% interest in Pokémon Co., and also invested in Niantic for a minority equity stake. The joint development between Pokémon Co. and Niantic implies some form of a revenue share agreement, or licensing agreement. I’m not sure, the details are extremely sparse, but with Niantic sustaining the vast majority of the development around AR, I would imagine Pokémon Co. involvement pertained more to gameplay and licensing of existing IP, which implies lower contribution for Nintendo than originally anticipated. I can’t imagine a game that’s likely to generate $368 million in actual revenue for current FY to be a substantial contributor to Nintendo’s reported revenue, as Nintendo provided full-year guidance of $4.769 billion for the current fiscal year.
Many of the sell/buy side analysts got duped on this one. In fact, the investors became bag holders in a sort of move that reminds you of the OTC penny stock pump and dump schemes. Given the lack of verifiable details and the pent-up hype, I decided to sit back and weigh incremental information as it emerged.
Analysts believe Niantic’s capital raise of $30 million should translate into a massive participating stake or revenue split for Nintendo. But, from my perspective, I believe the funding round was more a B round despite being labeled a “seed round.” This is because the business unit was spun-off from a pre-existing business unit within Google. The team was already assembled well in advance and preliminary technology was already put in place to execute on the AR implementation of a proven game franchise. Generally, even in a seed round, VC firms typically take on a 10% to 20% equity position, which implies that Niantic was already given a post-money valuation in excess of $300 million.
So, even if Nintendo had participated, it’s unlikely that Nintendo secured a large enough equity position in Niantic to drive next-year earnings. If anything, I believe Nintendo’s equity position is limited to approximately 5% to 10%. Of course, Google Ventures also participated, so it’s not yet clear the extent of Nintendo’s equity position. Typically, 5% is reasonable for a seed funding round when there’s participation from other VC firms. Therefore, I believe Nintendo’s ownership of Niantic can be valued at approximately $184 million (worst case scenario) to $552 million (best case scenario). This is a far cry from the $20 billion the game added to Nintendo’s market value. I know I chase after tons of unicorns, but hardly ever will I ever recommend a tracking stock that mimics the behavior of a unicorn, especially in the case of Nintendo.
Investors should stick with Google
Google has multiple avenues to monetize Pokémon Go. The mark-to-market equity gains on Niantic will be far more substantial for Google, as Niantic was originally a division within Google that got spun-out, so the developers could remain independent from Google. It doesn’t imply that Google’s ownership position is strictly limited to the investment made by Google Ventures. Furthermore, Google monetizes the total transaction revenue at roughly a 30% royalty rate from the app store and also has the ability to monetize in-game advertising.
Therefore, Google is the clear winner here not Nintendo, sorry for bursting your bubble. I also highly recommend Google despite volatility in quarterly earnings as the core business is far more compelling when compared to many other peers in the Internet/Tech universe, and incremental opportunities add significant shareholder value when including the contribution of nascent product areas like autonomous vehicles, AR, app store, and YouTube.