Nintendo's Got Game, and Then Some!

[City17]

SHARES OF NINTENDO, MAKER OF THE WII VIDEOGAME player, have been in free fall, much like a not-so-Super Mario whose leap has left him short of landing on one of the mushrooms in the Japanese company's most famous game.

Nintendo's American depositary receipts (NTDOY), eight of which equal one Tokyo-traded share, early Friday afternoon were at 33.50 -- about 50%% below where they stood a year ago and down over 25% this year. In contrast, shares of rival game-console makers Microsoft (MSFT: 18.62*, -0.16, -0.85%) and Sony (SNE: 25.58*, +0.05, +0.19%) have both tracked the tech market's slight 2009 gain.

The drop in Nintendo seems overdone. Says Wedbush Morgan Securities analyst Michael Pachter: "When you look at the underlying numbers, no company globally is performing better than Nintendo." Pachter has a 12-month target of about 60 on the ADRs. Sterne Agee analyst Arvind Bhatia sees "terrific comeback potential" for the shares.

Kyoto-based Nintendo (the name means "Leave Luck to Heaven") was originally a maker of playing cards and later the owner of a cab company and a "love hotel." But in the 1970s, it turned to electronic games, eventually coming out with the Nintendo Entertainment System, which plugged into a TV and let users play Super Mario Bros., the best-selling game of all time.

The company's most recent home console, the Wii, which uses motion-sensing controllers to produce screen action in sports games like tennis, bowling and golf, has sold 10 million units in the U.S. and 50 million worldwide, considerably more than its rivals. Nintendo also makes the DS handheld game player; the latest version, the $170 DSi, was the most pre-ordered game console in history before its introduction this month.

Why, then, have Nintendo shares been battered?

In January, Nintendo, Japan's third-largest company by stock-market valuation, posted a 21% gain for its third quarter, but cut its guidance for fiscal '09, which ended in March. It projected an operating profit of $5.3 billion, equal to about $2.25 per American depositary receipt, well below prior expectations of $6.3 billion.

Part of the problem was the company's newly conservative expectations for Wii sales (offset by higher hopes for the DSi). Also key is the impact of the strong yen, which makes those consoles less price-competitive in the U.S. and Europe and cuts the value of overseas earnings.

Some on Wall Street suspect that the company beat its targets in the year just ended, delivering an operating profit near $5.6 billion and ADR earnings around $2.50. For fiscal 2010, they see ADR net exceeding $3.60.

More recently, investors were shocked to hear that the Wii had been outsold in Japan by Sony's PlayStation 3 in March, due mainly to the release of two hot PS3 games: Yakuza 3 from Sega Sammy (6460.Tokyo) and Resident Evil 5 from Capcom (9697.Tokyo). Neither game was available for the Wii. It was the first time since late 2007 that Nintendo was No. 2 at home.

Since then, most press coverage has focused on the weak outlook for Japan's economy. When January-February sales of videogame software and hardware in Japan rose "only" 11% year over year -- lower than in years past -- fear grew that Asian demand for videogames is waning. Throw in the general worries over the global recession, and the result was very ugly for Nintendo shares. However, over 50% of Nintendo's stockholders and most of its influential analysts are Japanese and very locally focused. Pachter says that this has led them to overlook the still-bright outlook for Nintendo in markets outside Japan, which produce 81% of its total sales.

Videogame sales remain strong in the West. For many American gamers -- typically around 30 years old -- a $50 videogame isn't too expensive, even in hard times. Last week, researcher NPD Group said that combined U.S. first-quarter game software and hardware sales were flat with the record year-earlier $4.25 billion, but that console sales were up 1%, led by Nintendo and Microsoft. Combined March sales slid 17%, mainly because the launches of some particularly hot-selling Wii games began in March 2008. They continued through June, meaning that some industry softness is likely over the next few months. That would present a buying opportunity.

BUT STRONG GROWTH SHOULD RESUME in the second half. "People who buy videogames have no idea we are in recession," asserts Pachter. From October through February, U.S. videogame sales rose about 11%, in dollar terms. Nintendo wouldn't comment for this article, but at a recent convention, Reggie Fils-Aime, CEO of its U.S. unit, said: "Over that same time period, Nintendo is up over 50%. Let me put it a different way: the total industry has grown just over $1 billion during that time frame. Nintendo has grown over $3 billion. So do the math. We're accounting for more than 100% of the industry growth." The introduction of souped-up Wii controllers and several new games this summer should help sales.

In addition, some investors are ignoring Nintendo's solid balance sheet -- it has $9.5 billion in cash and securities, versus $4.3 billion in debt -- and its annual dividend of $1.58 per ADR. And Nintendo certainly has the financial flexibility to hike the payout or buy back stock.

At $33.50, Nintendo ADRs were trading under 10 times likely 2010 earnings -- not much for an outfit whose profits should jump 45% this year. Nintendo faces challenges, but the path to success often looks more perilous than it is -- as Super Mario knows and patient U.S. investors will learn.

http://www.smartmoney.com/Investing/Stocks/Nintendos-Got-Game-and-Then-Some/