TIVP011: Nintendo (NTDOY): “Switching” It Up w/ Daniel Mahncke and Shawn O'Malley

35:00And that's another conversation I don't want to get into. But I think that there is something very compelling from a user perspective about just being able to pay for a virtual subscription and that granting access to this vast game library with backward compatibility and cross-gen support to use all kind of the gaming lingo. But then assuming this is like an Apple-like ecosystem, I guess that sounds maybe great on the surface. But my question is, doesn't this kind of fundamentally mean that Nintendo is at risk of selling fewer consoles going forward? Because I guess, at least previously, the main reason to upgrade your console or the latest generation of games is kind of gone, right?

35:44So how does this change things for Nintendo? Technically, that's a risk. And I also thought about that. But maybe, I mean, you referenced iPhones and I did it and people still buying them, right? So I think there's just something about upgrading that people generally like, but that's a weak argument. So we should go into the numbers as well. If we look at what happened at PlayStation, for example, because they did it already, like many years ago, and we see that it didn't impact their sales at all. I think the PlayStation 5 sold about 75 million units until now, and it should be about 17 quarters it's on the market.

36:18And the PlayStation 4 sold about 1.5 million more in the same time frame. Now that's the difference of about 2%, and 2 % could be caused by many different factors. I don't think, and I haven't read anything that would suggest it's about the cross-gen support. And with only two consoles per decade, and maybe sometimes even less, there's still enough room to make significant upgrades that should attract new customers. Especially since Nintendo focuses on actually innovating the consoles. So they are not just, I mean, the Wii U and the Switch, they were kind of alike. But if you consider the Wii, the first generation Wii before that, you know, it was a complete innovation and a leap of technology.

36:58just as you mentioned with all the motion control and those features and since nintendo is focusing on that i think there should always be enough arguments for buying the new console and even if volume should drop slightly more stable earnings and the higher margins such an ecosystem can provide to you would definitely compensate for that and you also that's the most important part you keep your customer base and with the customer base you have tremendous upside potential because of all the upsell opportunities that you have. So that's pretty much the main objective for all those three players who transfer to this new model.

37:34You enhance the customer lifetime value instead of just selling a new console. And as I said before, the console itself is often even sold at a loss anyway. You now have the opportunity to be a lot more profitable on the customers. And that's where the big money is, right? It's in selling games and other content through the online ecosystem. no matter the generation of the console. I think it's about a 30 % share they all take from a game sale, which is to have another connection here. Also about the share that Apple takes in the Apple App Store. To keep the Apple comparison going, that sounds like Apple's App Store, right?

38:12I mean, you just mentioned it. So how do you think about that? Yeah, it's pretty much the same premise. You have high margins once the ecosystem is up and running, and those margins seem also to be pretty safe. there's the anecdote of epic games and apple where epic games which is the developer behind fortnite tried to create its own in-game mobile payment system integrated into fortnite so they could bypass the 30 fee that apple is taking through its app store now i could elaborate on the whole story but to make it short and get to the point that is important for us apple won in court and that kind of showcased the potential to not only have high margins in that business model, but also to defend them if any developer or any game tries to bypass them.

38:59It is a promising model, right? I mean, it does sound like there's considerable earnings potential there. And you also mentioned that Nintendo's Wii U did not offer many third-party games, that could generate in-game revenues. So I guess, while I think this has already changed with the Switch, the third-party games available there are maybe less demanding than the typical PlayStation or Xbox titles and therefore also offer less upsell potential, right? And if that's the case, do you expect that to change? Yeah, I mean, you just mentioned it. The Switch already offered like 11 ,000 third-party titles, which is a huge amount, but they were mostly single A and double A titles.

39:40So not the likes of GTA, Call of Duty, et cetera, but mostly simpler games. So they're relatively cheap to develop, which also causes this huge number like 11 ,000. I think I mentioned 4 ,000 for the PlayStation 4 before. So it's a lot more, but also games where you cannot make the same amount of money off as with these huge titles. But those are games that just fit Nintendo's system and style pretty well. They work great for the handheld part as well. So with the Switch being used in handheld mode pretty often, it's important to have games that actually make sense on the handheld. But as I said, they do come with lower in-game revenues and add-ons that can be sold.

40:19so there's not too much that nintendo can take a share of so it's important for them to maybe also upgrade the kind of games that you can play on the switch too so that nintendo can sell more and insiders expect the switch 2 to be a lot more powerful than the switch one and that means that the switch 2 could potentially play even the most ambitious titles like grand theft auto call of duty or the witcher although i personally would have my doubts that we see titles like grand theft auto but even if we see something like the witcher which is a pretty ambitious triple a title i do think that would drive significantly more sales also at the customer base that usually and historically belongs to playstation and xbox we will talk about some technical details later but if it's true and i do think it is true it will make the switch to like i said appeal to a whole new audience so triple a adoption can be a game changer if either nintendo creates demand within their current customer base or if the games do perform on such a high level that nintendo could actually take market share from playstation or xbox and i think xbox is especially vulnerable they decided to no longer offer any exclusive titles i think one of the titles i love most ever is the halo franchise which used to be an xbox exclusive and they do not sell those anymore and said what they do now is they sell all the used to be exclusive titles also to playstation and if the switch 2 is able to play them also to the switch 2 and this decision probably came because they have a decline in sales and subscriptions for quite some time now and i still don't think that xbox would stop making consoles but they do seem to be hurt and maybe that's a chance for nintendo you know to grab some of their customers Two questions come to mind for me.

42:13Firstly, with the Xbox business decreasing, and we've already talked about maybe how consoles are not even necessarily what make money for these companies. Is there a scenario where they would ever just stop releasing new consoles and break that release cycle? This is the console as it exists, and it's not worth our time to continue to launch these things every single year. Secondly, I guess coming back to Nintendo, Do you think the release of Xbox games on Nintendo consoles could also drive Xbox players to Nintendo consoles longer term? To the first question, the subscription model is just so great that Xbox doesn't want to lose it.

42:55I think they currently have 34 million subs, and if they would stop making consoles, those subs would probably be gone. And Nintendo and PlayStation won't sell their Game Pass. So Xbox might say, okay, you have games here that you can sell for me. And Nintendo and PlayStation, they will like to take those games because it's an extension to their library. But if Xbox stops making consoles, Nintendo and PlayStation will not sell the subscription service of Xbox, right? That just wouldn't make any sense. So I do not think that Xbox will stop making any consoles. They also didn't initiate anything that would make you seem they would stop eventually.

43:34And maybe it's even just a short-term slump in the subscription numbers, because PlayStation kind of has the same. I mean, it's not like there's a decrease, but there's definitely a slowdown for PlayStation as well in the subscriber numbers in recent months. Yeah, I mean, it seems like there could be maybe some subscription fatigue there. And this is kind of something we saw sort of famously with Netflix two or three years ago, when there was all this concern of, you know, they have these high content costs, Are people going to continue to stay subscribed to the service coming out of the pandemic?

44:07Is it something that people still want to use when they're not locked down? And how much demand got pulled forward? Obviously, I think Bill Ackman famously exited his position after a really bad Netflix quarter. But here we are today, and Netflix is arguably doing better than ever. And so there's this question of whether there is subscription fatigue and how much that is a real thing with a brand and service as robust and compelling as Nintendo. So considering, I guess, that slowdown you mentioned around PlayStation, could it be that Nintendo missed the right moment to start a subscription service?

44:41I don't think so. I don't think that would happen because Nintendo has a very different audience, like I said before, and that's mostly untapped. I think I mentioned that Xbox had 34 million subs and Nintendo has the same amount. So they have 34 million subs but on a much larger player base they have about 130 million active players so if you put that into comparison i think there's a lot of untapped potential which shouldn't be explained by subscription fatigue because there's just so many people who never even had a subscription in the first place that they could benefit from if they should start doing that and with even more benefits coming to the subscription and the potential release of some of these blockbuster games i think there's just so much leeway left for nintendo that i don't see them having any problems in the near future there's also a huge potential for their own titles if they would keep leveraging the brands they already have there should be a huge conversion possible from the audience they have right now because everyone loves those franchises if they would have something more about the mario brand or even pokemon or something like that i could imagine there would be a huge wave of new subscriptions if they use it correctly.

45:50Now, I lack a bit of creativity to say exactly, okay, this is what you should do and it will work out. But I think while I lack creativity, I do not think at any second that Nintendo is a company that would lack creativity to do that. If we were to assume a more conservative scenario in which AAA adoption of the Switch 2 is not the success that is expected. Despite that, does Nintendo have any other advantages that could support a subscription model going forward? And if so, do those advantages differ materially from PlayStation or Xbox? I guess another way to put that is the bigger picture question here that I think is really important to understand Nintendo and their earnings power going forward is how can they leverage their IP?

46:39You're totally right. I mean, that's kind of the most important question when talking about Nintendo. And I think there are quite a few options. Now, AAA is something, so games like Grand Theft Auto, Call of Duty, etc. is more like an immediate catalyst. Whereas if you would be able to play those games and you would be able to play those games on a high quality, maybe there's a huge wave, a short-term wave, of people coming and buying the switch to to play those games while leveraging the ip is something more long-term and we shouldn't forget that people who bought nintendo consoles historically but also the switch they didn't buy that console to play call of duty right they bought the console because they wanted to have the innovation that the switch is offering which xbox or playstation are not and they wanted the titles that they love and know from nintendo and i know i repeat myself here but the biggest level nintendo has is its customer base i just said they sold 146 million switches they have about 130 million of those players to be active and when i say active active means they've played at least once in the last 12 months so you could argue with me that's not that active if you really just played one time in the last 12 months but still it's counted as an active player and like I said they only have 35 or 34 million subscribers on that huge player base and I just mentioned that Xbox has the same level of subscriptions on a much lower player base so the biggest level really is focusing on the IP and we'll get to it later but Nintendo is really doing that they are really taking part of Disney's flywheel concept of Disney's playbook and they're trying to leverage what they already have to get into this new business transition but the second strategy would also be to increase digital distribution further.

48:30So Nintendo is still the king of physical copy sales. And I could imagine that's a crown or a title they would want to pass on because it's not very much a profitable business. I mean, it's profitable, but if you compare it to digital sales, it's a lot less profitable. And they're going in the right direction. Nintendo is currently on the path to reach more of a 60-40 split in favor of software sales. and that has multiple advantages. So digital sales can firstly drive subscriptions to Nintendo's online service because it would build a habit of buying a Nintendo's online store, right? Which makes it more likely that at some point you feel the urge to want access to all those games you see in the library all the time, right?

49:16I mean, if you go in and you see a game that you like and you buy it online, maybe you already saw two or three other games that you also like. And I think the more games you see in the library, the more appealing it becomes to actually end up having the subscription one day and get access to all those games. I think that makes sense. I could also imagine that this is somewhat of a self-reinforcing cycle where you're more likely to play more games and be more active in general because getting the games online removes a lot of that friction you have when buying a game offline. You don't have to drive to a local game shop anymore or even order it online and wait for it to be delivered.

49:54It's just a much cleaner process. So if you see a game that looks interesting, you quickly download it, give it a try, and there's no frictional kind of transactional costs and there's no waiting time or other risks involved in case you don't like it. Yeah, sure. And it's kind of like a win-win, which is always the best value proposition, right? It's a win for Nintendo and it's a win for the consumer because it's way more comfortable for the players and nintendo makes a lot more money on those digital sales maybe i should also mention because it's not that intuitive why do digital sales make more money than physical ones well the margin on digital sales is a lot better because there's not a middleman involved right nintendo doesn't have to pay the game stops or the walmarts of the world a share because of the sale that happened in their store so and then you have the online subscription itself which can also work as a teaser to drive more game sales later on because when games are taken away from the library because the general idea is that a game might get added to the online game library and you can play it for about two or three months and then it can take it away again and when that happens you might have played that game for two or three months and you might have played it with a couple of friends and you like that game so much that you all decide to just buy it and keep having your progress and keep having all the fun that you had before, right?

51:14So it's kind of also like a teaser function to sell more subscriptions in the long term. And then you would have a third strategy, which would be about the blockbuster titles like Call of Duty or FIFA. I think we went through this so often again, you must have to tell me if I should stop talking about those type of games, right? No, I think it's fine. In the end, right, if it is such an important driver of subscriptions for the business and the success of this new model that Nintendo is trying to push forward with, I think it would be wrong to just ignore it for the sake of doing so. Also, I think your last point there was on Nintendo's IP.

51:51You can make one more last point on the AAA games. I give you permission, but I am excited to hear more about the IP. Trey Lockerbie What I'm talking about now are hardware and online infrastructure investments. After high-quality games didn't look too good and were kind of shaky on the Switch One, This is supposed to be a big change now on the Switch 2. And therefore, Nintendo uses a new NVIDIA hardware. And I know whenever you drop NVIDIA right now, it seems to be a pretty good sign. So I'm apparently doing this also to show the audience, hey, they're really trying to get somewhere, right? It's a hard name.

52:25Exactly. And this new NVIDIA chip is called Tigua 239. and it's a processor that allows the switch to to reach over three teraflops when docked and 1.7 teraflops in handheld mode i know if you're like me those numbers won't tell you anything and even if i tell you that teraflops are a unit of computing speed it doesn't change anything you have no idea what's going on and i don't have either i had never heard of a teraflop before this for the record me neither right i went to do this research then i saw those numbers and i was like you kind of have to integrate them because maybe there are five to ten people out there who understand them i'm not one of them so i will explain it now i think the best way to do that is putting them into perspective the switch one only managed to work with 0.5 teraflops when dark so that's a six-time increase now for the switch 2 and the standard version for the playstation 2 for the playstation 4 which might be the best comparison because i think people who played those high quality games mostly did so on a playstation 4 that playstation 4 reached about 1.8 teraflops so it's still a little more than a double for the switch 2 but generally the expectation is that the switch 2 level is now comparable to a playstation 4 pro on xbox series s and that's why all the big game developers like ea or ubisoft decided to come back and start producing games for the switch 2 again after they kind of you i mean there's no other way to rephrase it but they kind of abandoned nintendo when the wii u fiasco happened right in my opinion the switch 2 shouldn't compare to its predecessor so the switch one if it actually wants to attract customers that play games like grand theft auto madden or the witcher then it needs to compete with PlayStation and Xbox.

54:18And if the new Nintendo console is still weaker than the PlayStation 5, I'm just not so sure it's actually doing that job well enough. And although I've watched some The Witcher gameplay actually on the Switch 1, I think it was 30 frames per second, which is the industry standard for how fast a game should run, but with relatively low graphics, the game was playable which made me kind of hopeful since if it's playable on the switch one it's unquestionable that it should be a lot better and massively outperform the switch one on the switch two so i do expect ambitious games like the witcher to work on a high level and without any shakiness on the switch two i just don't know if it's good enough or if the disadvantage is so huge that no PlayStation player would say, I give the Switch to a try.

55:11And a total unknown for me is what part the handheld console could play here. Imagine you could play blockbuster games sitting on the bus or sitting on the train. I think that would kind of be like mobile gaming on steroids, right? I mean, that would be a great thing for the Switch and definitely an argument to buy the console right out of the gates. I would never consider this a base case though. So for me, it's more like an asymmetric option. If it works, it will be phenomenal. But if it didn't, I never expected it to work anyway. Not that I'm a huge video gamer by any means, but I would think that if you could play Madden, FIFA, maybe on the bus or the train, commuting to work or whatever it is, I mean, that's hard to beat.

55:58That mobility aspect, it's kind of the best of what mobile gaming promises to offer and and what console gaming can deliver in terms of graphics and that sort of thing. So, I mean, that seems unbeatable. And that's a real differentiator that maybe we've stumbled across here with Nintendo. To be totally honest, just like you, I kind of feel like the person teaching people here about gaming. And I'm out of the gaming sector for like at least five or six years. And I have a lot of friends who still play. So I also asked them, okay, how big of a leap would it be if you could play? I mean, we're in Germany.

56:29so I asked him how big of a leap would it be if you could play FIFA on the handheld console on the bus but they would all say that's kind of like a home run right there's nothing comparable and nobody would actually expect it to happen I do know that you can play FIFA on the handheld of the Switch 1 a legacy version of it they call it a legacy version I would call it dump down version because there's no multiplayer functionality and the game is basically a FIFA 18 version which is sold to you as a 2025 so nobody would do that and you know that's kind of what it depends on something like fifa if i could definitely imagine playing something like fifa if that would be playable on the handheld console and not as a legacy version but like as an attractive version of the current game i think that would be a huge huge thing for nintendo Hello.

57:21Yeah, it's hard to do that with a game like Call of Duty, right? Because it's such a big, there's so much information you're trying to process. You just fundamentally need a bigger screen to see everything that's happening. But I don't want to go down this rabbit hole too much more. And I guess I'm kind of insisting we go back to Nintendo's IP, because I do think that is the crux of what I find potentially most compelling about Nintendo as a business. And I know that you've researched Disney before, and I had you on five or six months ago now at this point, whatever it was. And we did do a whole episode on Disney together previously.

57:58So there's some obvious parallels here. And I'm curious to hear how you think of the similarities between brand power that is behind Nintendo and how it compares with Disney. And at least with the movie release of Super Mario Brothers in 2023 and its huge success, that was a real great kind of test run of how Nintendo can make good use of their IP outside of just video games and kind of step on Disney's toes in the world of movies and TV. I'm sure the answer is maybe yes, but I'll just ask it for you. Is that something they want to focus more on in the future? Well, as you said, I mean, the answer is obviously yes, but we do have to say that I feel like it's not only people outside of the company or like the general customer base, but it's also nintendo itself who are a bit surprised by the phenomenal success that they had with the movie right i mean it was the second most successful animated movie of all time beating frozen one but getting beaten by the sequel so frozen two but still it's a huge huge success for them and also one of the very few successful game adoptions right actually one if not the first game adoption was also a mario movie and was made in 1993 and was a huge flop i think both the production and the movie itself were a huge chaos there were like nine writers for that movie before the filming even started i mean fortunately nintendo tried again even if it apparently took like 30 years to gain the courage to do so i think everyone would now say it was it both nintendo and definitely also the fans the movie generated 1.36 billion dollars in revenues and it might as you mentioned also be the start of many more movies to come you have a mario sequel announced anyway for 2026 already so that's definitely in the works and you also have a zelda movie coming which is another franchise that could get a lot more adoption not only with the movie but maybe you know in the future something else too this time it will be a live action movie and they do not even have a cast yet so i wouldn't imagine it to come out anytime soon maybe we are two or three years out so that's promising and they also and i think that's the most important part they have shigeru miyamoto and i hope i didn't butcher that name on board and he's the original creator of zelda and i think the most important part if you have movies like that or if you have game franchises in general is to get the people who are actually into the game and who are developing that game into the same boat right to have all that what they usually pay attention to and what the fans love also in the movie and just generally as you mentioned i think we will see nintendo now making much better use of its ip in the years to come and i expect many similarities to disney's flywheel concept although of course for nintendo the focus will be on video games and despite this huge success as a movie they will not suddenly switch into Disney 2.0 and focus on making movies as the core of their business.

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1:04:29All right, back to the show. It is funny because Disney is sort of a company that's in hot water right now. Its returns over the last few years are pretty uninspiring. And you have these activist shareholders trying to make change with the company. But that said, though, we all recognize that there are some really compelling economics behind Disney and some features of what have made it such an enduring part of entertainment culture globally. And so if Nintendo can just tap into maybe some of the best of what Disney has been able to do without getting distracted by the cruises and the theme parks and some of the other stuff that are way more capital intensive.

1:05:12If they can specifically harness their IP in the right way, that is a really compelling narrative for maybe why Nintendo would be a good company to buy today. I guess just briefly that it took a step back. I am guilty of throwing the flywheel concept around as this kind of buzzword that never really gets explained and people in the audience might not even have any idea what it means. So why don't you just take a moment and tell us what is the flywheel concept? I mean, first of all, maybe it's important to say that while Disney does have its struggles right now, the flywheel concept is not part of that, right?

1:05:48I think it's more of a cultural thing. And that's something that Nintendo does not necessarily have to experience too. But coming to the flywheel itself, at the core of it, you have creative talent and theatrical films. So that's what everyone knows Disney for, right? The movie releases and all the phenomenal franchises they built through it. And then you have many other business segments surrounding that core. So that's Disneyland, which everybody knows. You have TV or merchandise licensing. You have some, you know, historical relics like comic strips, which is not a big business anymore but used to be and then you have also something like music and music is actually an important part that is mostly underappreciated and i would like to take the music and movie release connection to kind of explain how nintendo used the same concept so i don't know how many people here watch the mario movie but maybe if you didn't even watch it you could have heard about a song that was played in the movie and also released before the movie which was by bowser and was called peaches and this song got hundreds of millions of views online i think it was about 120 million on youtube alone i don't know have you listened to it no i mean i first listened to it a couple of days ago to be honest but i did see it before and i know that many many people especially younger kids heard this song like for about a year now so it was a huge thing it definitely brought a lot of attention to the movie and the movie itself has been watched about 170 million times as well at the box office so besides being very profitable i mean profitable in terms of i think the budget was about 100 million compared to 1.3 billion in revenues you know that sounds like a pretty good profit but it also put many many eyeballs on the entire world and on the Mario franchise and the movie and the music kind of did it in a similar fashion but they benefited from each other so maybe you've watched the song before and maybe you're a parent right and you've heard the song before and then you showed it to your kids and your kids got all excited and they wanted to go to the cinema that's kind of how music is a teaser for the movie that's supposed to come out.

1:08:07And then you also have this other connection, which is that after you watch the movie, the content of the movie mostly doesn't stick in your head for too long. I mean, you probably watched Star Wars. I watched Star Wars. I couldn't tell you what happened in movie four, right? But if you would play me any soundtrack of Star Wars, I would immediately recognize it. And that's what Disney did in almost all of their franchises. They created iconic movies, iconic characters but also iconic music and it's kind of what nintendo is doing now too i just think that's a fascinating because you never think about it you just have these soundtracks in your mind and nintendo is actually trying to benefit from that even more because they released an app which is kind of like spotify for nintendo where they release all these soundtracks of those movies i mean i don't know where exactly they want to go with that but it's just an interesting thing because it shows how much more they want to leverage their IP than they used to like 10 years ago you know and the movie itself I talk now about music and the movie and of course you have the core of Nintendo's flywheel and that wouldn't be the movie it would be game sales and there's an interesting anecdote here as well because immediately after the movie released they also released a game called wonders which was a super mario game and that game became the fastest ever selling mario game it was 4.3 million units sold in the first two weeks and just shows the huge impact a movie can have because everyone knows mario right there's it's not like a surprise if a game comes out and you are asking yourself what do i get here everybody knows what they get but this movie just created such a big hype that people thought now i also gotta get the game and then became you know the fastest ever mario game setting and then you have like kind of the last pillow which are the mario attractions in the universal studios so that's super nintendo world and japan and also in california there are no official financials because nintendo doesn't report on them i mean it's not the same as disney where they own the parks but for nintendo it's just that they do have attractions in the universal studios but obviously the universal Studios owned by Comcast and not by Nintendo.

1:10:20So what I did do is I looked into Comcast financials and they reported 17 % revenue growth in the first quarter after the opening of the Super Mario Nintendo World and 12 % in the second quarter after the opening. And they even said themselves that's mostly attributable to the Mario attraction. So it kind of had a serious and tangible impact on Universal Studios, and you could imagine even more so on Nintendo. I know a few minutes ago, on the one hand, I said theme parks are very capital intensive, and they are. I would imagine the success with the Mario attraction here sort of implies that Nintendo is going to be pretty tempted to lean more heavily onto theme parks as a way to leverage its IP.

1:11:05And I mean, I do see how it factors into the flywheel, even if it gives me pause. If I'm not mistaken, I think another attraction has already been announced in Florida pretty soon. Is that correct? Yes, that should be the Nintendo World at the new Universal Epic Universe, which opens in about three months. And it should feature the Super Mario Land and the Donkey Kong Country. I think a huge difference in Disney and Nintendo at the capital intensity is Disney owns its own parks, right? and nintendo only has attractions in the universal studios or maybe eventually they will have attractions at other parks now you could think that nintendo might be tempted to also own their own theme parks but i wouldn't be so sure if that actually happens and if so how much or how far into the future that would happen so right now i wouldn't assume they will get a lot more capital intense because they build attractions like that so it's more of the it's more like they make money of it but all the the risk and the capital intensity lies with the universal studios and nintendo also more or less quietly owns the highest grossing media franchise of all time and i think most people are not even aware it's that big at least i wasn't and we've talked about it at length today already and the franchise i'm talking about is pokemon since inception in 1996 pokemon has generated about 140 billion dollars in total revenues and another surprise might be that video games for which we all know in pokemon i mean you and me we both spent like five minutes talking about pokemon games but they're actually just a relatively small part of those revenues i think it's about 28 billion of those total 140 billion the biggest chunk by far is merchandise value, which stands at over 100 billion.

1:13:00So it is huge for the Pokemon brand. And actually, just because you mentioned it, Pokemon cards should have been about 12 billion dollars, which is also a lot more than I would have thought. Maybe to give one size comparison, because that always helps. I mentioned Call of Duty today repeatedly. I mentioned Mario even more often than that. And I would think you all also know about Marvel. Now, if you would combine all those three franchises, you would get a combined value of 105 billion. So only to match Pokemon, you would need to add the entire Harry Potter franchise and Looney Tunes to get to the same amount, to like 140 billion.

1:13:42It's insane, right? That's a really cool way to think of it. I like the way you put that. And Pokemon is just such a powerhouse. It brings back so much nostalgia for me. Immediately, I think everybody probably thinks of different things when they hear Nintendo. For me, it's Pokemon, right? Some people, it's Mario or whatever it is, but for me, it's Pokemon. I'm probably embarrassed to say that I was playing those games at an older age than maybe I should have been. I think I was probably well in the middle school and maybe even parts of high school. Whether it was the actual games or I remember sitting in class and you could download these, probably technically illegal, these simulators where you could play the original their games entirely for free.

1:14:26So Pikachu is at this point as famous as Mickey Mouse, I would argue. And if that sounds crazy to anyone older in the audience, I would just say it's a generational thing, but I would almost guess with pretty high certainty that the average Gen Alpha and maybe some Gen Z probably relate more to Pikachu than Mickey Mouse. And I did just want to ask, why does nintendo have a share in the pokemon company right because i don't think they're the ones who originally created it so maybe we could just paint some color around that but did they acquire it at some point and and do we know how valuable that share is or how big it is that's a good question nintendo was actually involved pretty much from the get-go so they they technically did buy a share if you want to say so but they were involved quite from the get-go when Pokemon was not really a thing, but more of an idea.

1:15:21And they were never on the development side. So the original idea and the game development came from a Japanese company called Game Freak. And Nintendo's part was more of the publisher and distributor for those games. And Nintendo and Game Freak were even joined by a third party a bit later, which developed Pokemon's trading card game. You know, the one that you were talking about and the one that's 12 billion of the revenues. And that company that came in for that is called Creatures. So together, those three created a joint venture called The Pokemon Company. And for that company, the shares were split evenly between all three parties.

1:16:00So Nintendo's share there is reported with 32%. However, Nintendo owns all the trademarks involved in the game. And holding your hand over the trademarks is kind of like owning the keys to the franchise. You know, I cannot phrase it differently. It's a huge thing. Because trademarks, they include everything. All the names included in Pokemon. The name of Pokemon itself. I mean, you just mentioned Pikachu. Pikachu can only be named Pikachu because Nintendo allows it to, right? Otherwise, it would be, I don't know, Yellow Mouse. I mean, sure, they would come up with a better name than that. But just to give you an idea, they own everything.

1:16:38I mean, even the iconic Pokemon ball that you see in the background here. Everything is owned by Nintendo. If you want to say, gotta catch them all. Nintendo has to allow you to say that. We're not going to get sued for that, are we? Probably not. If Game Freak or Creatures would do it, they would get sued by Nintendo. So, you know, it's just, it's a really powerful tool to have those trademarks. So, regarding Nintendo's stake in Pokemon, it is also likely a lot larger than just a third. Since the Pokemon company, it is not equivalent to the Pokemon franchise. And I know this might sound a bit complex now, but listen to me.

1:17:14I think in two minutes, or maybe three, I should break it down pretty concisely. I think you could imagine it as the Pokemon company being somewhat of an agent that works for the Pokemon franchise. So what does that mean? They are managing all the licenses. They are organizing third-party collaborations. So for example, if Lego says, hey, we want to build a set for Pokemon, then they could do it, but they have to talk to the Pokemon company and then they can say, you're allowed to do it or you're not allowed to do it. If McDonald's says, hey, we want some Pokemon toys and the Happy Meals, then they go to the Pokemon company and they say you're allowed to do it or you're not allowed to do it.

1:17:53And they also do all the marketing and publishing for the video games. So that's basically their job. But the Pokemon franchise itself, that is what at the end of the day generates all the money. You know, that's what we all know. And that's what generates the revenues. And Nintendo's share in that franchise is very likely to be much higher than just 32%. Many people who understand the industry a lot better than I do expect it to be closer to 50 % or even beyond that. Now the reasoning is pretty simple. When Nintendo and Game Freak entered into their deal somewhere in the late 90s, Nintendo was this huge global and successful company and Game Freak was just a small independent a developer.

1:18:39So just by that, you probably know the leveraging power was obviously on Nintendo's side. And Game Freak also just had a lot more to gain than Nintendo had. Nobody would know how big Pokemon became, right? So Game Freak had this idea. And if it works out, it's huge for the company. And Nintendo had many franchises that were already working pretty well. So they weren't reliant on Pokemon working out. I think what I want to say in the end is, as long as the Pokemon company is private we will probably never really know the detailed stake each company has in the pokemon franchise unfortunately you can also not reverse engineered by looking at nintendo's financial statements because on the spelling sheet the stake is pretty much valued at zero and on the income statement they kind of did the trick of putting all the profits into one basket and kind of hide it away that way so they report the pokemon profits with all the other profits made by companies where Nintendo has a stake in.

1:19:38That way, you can never really know how much of those profits actually come from Pokemon, and how many of those come from totally different companies that nobody of us knows. Obviously, I feel that the Pokemon franchise is kind of the anchor of a lot of Nintendo's IP here, and it could really, at least arguably, significantly increase the subscriptions they're able to sell and just generally increase customer lifetime value as a part of that flywheel we've described. And I think there are a lot of ways with these new games and everything they're doing now to include more microtransactions in-game or sell battle passes or whatever it is to just juice as much money as possible from everybody who interacts with the content.

1:20:22We've been going on for a while now. So it's probably a good moment to just summarize, take a step back and say, this is where we are. And that is to say, Nintendo has the largest active customer base. They have this trend toward digital distribution that is high margin, right? Because not only are you cutting a middleman, but you're reducing the hardware costs. And you have these software investments that will hopefully make the Switch 2 powerful enough to actually enable direct gameplay for the Call of Duties of the world, or whatever it is. Maybe not Call of Duty, it's a bad example. But these big, more robust AAA games on their console.

1:21:02And we've already discussed the importance of third-party games. And now we know about Nintendo's IP and Flywheel. So that's a pretty holistic picture of everything with Nintendo. Is there anything else that you think deserves mention as we consider it for the intrinsic value portfolio? There's one more thing, and that's the generational aspect of Nintendo's customer base. And I've mentioned it before, and it's kind of also visible in Nintendo's IP and franchises, but they do focus on younger players than playstation and xbox and that's part of the reason why they are not in this big blockbuster segment it's not that they couldn't be i believe if they wanted to they could have a new console which definitely plays all those games but every decision comes with a trade-off and when nintendo faced that trade-off they decided to go for a more diversified audience not necessarily geographically diversified they are just a global company like playstation is also but generationally you know they have a lot of young customers but i would say they also have a lot of old customers not the 30 to 40 year old people playstation has but it's more like maybe parents play together with their kids on a wii but they would not do it on a playstation 5 and call play call of duty with their son right at least maybe not as often and of course a younger audience also has implications for the business so playstation's older audience has a lot more purchase power.

1:22:27If you have players who are in their 30s or 40s, they have a full-time job. It's probably one of their main hobbies to after work play some games and they want to spend a lot of money on them. But the Switch initiated this huge change that I first realized in, I think it was 2020, because there was the pandemic and it drove a huge increase in console sales many people did buy a switch as well it was the first time that i realized that people in my age are starting to buy nintendo consoles again i mean you said it it was like this light switch and nintendo was just out of our head and then suddenly in 2020 it came back and i was like this could be a huge change that i just never expected and the switch too if anything i would expect that trend to continue and then you suddenly have nintendo with complete dominance in the kid space and suddenly also competing for the grown-up segment, right?

1:23:25And as we mentioned repeatedly now, this would be huge for Nintendo. Their business transformation does not depend on it, but it would be a huge catalyst to see immediate increases in subscriptions, in digital assets, and just in the overall business. I want to get to Nintendo's valuation next, though I think it is important to cover some of the qualitative risks facing Nintendo. Can you just elaborate on some of the risks before we get into the valuation for thinking about what can go wrong with this investment? Sure. I mean, there are some exceptions when there's a huge mispriced opportunity, where you can take a little more risk on that side.

1:24:06But in this case, Nintendo has a phenomenal balance sheet. They have like 15 % of the market cap just in cash and they have no debt. So there's no risk on that front. And when that's the case, the next thing I'm looking for is the price. And I try to figure out what the market is currently pricing in, and if I see a disconnect to what I think will happen. So what could the market currently be pricing in that I would consider uncertain? Well, first, the market could price in higher margins than I do, and they could expect to leave cyclicality behind completely in a matter of a couple of years, or maybe just in a matter of this generation of the switch to cycle as you will see in my valuation in a minute those are two things where my assumptions are probably below the average nintendo bull i think my margins will end up lower than they would expect them and i still do think that you will have some sort of cyclicality in the business so i do think that for example at the end of the switch 2 cycle revenues will come a bit down and maybe some boards would disagree with me on this but i think this is a more conservative scenario that also includes the risks of for example the triple a adoption so games like call of duty not playing out as well on the switch 2 and maybe even digital sales not arising as fast as we want to like i said nintendo is still the king of physical copy sales.

1:25:33And maybe it's just about the customer base wanting to buy games physically, which just makes it more difficult to go into this Apple-like ecosystem with more digital sales and higher subscriptions. All right. Well, shall we do the valuation? I think to some extent, this is what everybody's been waiting for. And I'll be curious how you approach it because you're taking this company that has previously been very cyclical. And it reminds me of the episode I did on John Deere a few weeks ago, where it's like, you have this very cyclical business that's trying to transition away from that. And there's this question of how well can they do that?

1:26:12And then how does that change? If you have a more stable business, typically you would expect people to pay a higher premium for that because there's just less uncertainty around it. And I don't know the picture around Nintendo seems anything, despite all the wonderful things we've had to say about it, it's anything but certain, right? They have this big Switch 2 release, and we're not really sure how it's going to perform, and we don't know how this bigger business model transition is going to unfold. So tell me, Daniel, did you come up with a good way to value Nintendo stock? I apologize for putting you on the spot, but I want to hear what you have to say.

1:26:45That's kind of the most important question of the episode, right? I mean, many different outcomes are possible, and nobody really knows how it will all play out. And that uncertainty always makes it difficult. You're forced to make many assumptions. That's just the nature of it. But still, I want to go further than just stating that margins will generally improve and revenues will generally grow with the Switch 2 release, because that doesn't really help anyone who wants to understand Nintendo's intrinsic value, and that's what the two of us are here for. So I've decided to take the following path.

1:27:17First, I identified the main drivers for Nintendo's financial success, which ultimately is also the success for investors. And the most important one would be margin expansion. obviously because even if we assume that nintendo's revenues will still be tied to console cycles i believe that margins will increase steadily going onward so they will not just come back after the end of the cycle and history shows that nintendo went from 39 gross margins in 2015 to close to 60 percent in 2024 and operating margins improved from only seven percent in 2015 to the high 20s and sometimes even the low 30s now.

1:27:58I expect 2 % annual growth for both the gross and the operating margins over the entire switch 2 cycle, which would give us 43 % operating margin at the end in 2032. I want to say the switch cycle, then I'm talking about an eight-year period in which the peak is reached in 2029 or 2030. I come to that conclusion by analyzing the switch 1 cycle. which started in March 2017, and it immediately more than doubled the year-on-year revenues. But as I said, it came from the Wii U, and the Wii U basically sold no consoles. I mean, 13 million compared to other Nintendo releases is nothing. So there was a huge tailwind where many people just upgraded the console for the first time after 15 years, until 2021, and that's when sales peaked.

1:28:50And after that, revenues and profits were actually quite stable, and they only more dramatically decreased in 2024 which i expected given it was known that switch 2 would be released soon and even though nintendo says the impact is not that big the impact of the switch 2 release i do think it's the major factor for less demand in recent months my valuation model suggests that nintendo is actually pretty much exactly fairly valued at its current price. So if that's the case, your returns would mostly depend on the multiple investors are willing to pay for Nintendo at the end of the cycle. Right now, the PE stands at 40, which is pretty expensive.

1:29:34However, if one believes that Nintendo can go on the path that you and me discussed today, this model is pretty conservative. And that would suggest that there's still a lot of room for upside especially long term. Now in terms of an investment decision I feel inclined to wait for a price somewhere in the low 60s. I think it's not too unrealistic that Nintendo's price is coming down slowly but steadily after the Switch 2 release even if it's successful. As you know stocks trade on expectations and expectations right now they're pretty high for Nintendo. Of course, that comes at the risk of missing out on some potential gains for the sake of more certainty.

1:30:19But in my opinion, I think that's worth it. I would be interested in your take. I would say a company that is becoming increasingly capital light, which is actually kind of the opposite of Disney in some ways. But we keep bringing up Disney because it is the closest pure comp, even though they do make these massive investments in their streaming platform. And they have a whole division of theme parks and cruises that soak up capital in a way that just isn't the case with Nintendo, or at least not yet. I think Disney is sort of an inspiring comp because we've talked about how Disney's stock has had some trouble, but all in all, it is one of the first things people think of as the epitome of a really high quality company.

1:31:03It's not like we're comparing it to some dying media brand. right? If Disney is Nintendo's pure comp, I mean, there are a lot worse things out there in the world. And generally, I've been starting to get really excited about the Japanese market, which is also why I was really excited for this episode on Nintendo. And in part, that's just because the valuations are so much lower than in the US. And also, as you know very well, and probably a lot of listeners know, Buffett has become increasingly bullish on Japan. And I think there are five conglomerates there in particular that he's built pretty sizable stakes in.

1:31:40Japan has certainly long had these issues around corporate governance where you had a management culture that was very risk averse coming out of the real estate and financial crisis they had there in the late 80s, early 90s, and people just didn't want to take on debt. Debt is kind of a dirty word, but in a lot of ways, at least in some cases, it is critical to the growth of a business. And there has to be some amount of risk-taking, right? If you don't want to take any risk, we'll just buy corporate bonds or government bonds. And in that same fold, there's this risk averseness. They're not necessarily inclined to take on debt, to feel growth, and they're not really prioritizing shareholder interests.

1:32:22Or again, at least historically, that was the perception of Japanese companies over the last 20 years. And I don't want to go too far down that rabbit hole and completely distract from the conversation on Nintendo. But in short, a lot of those things are showing some early hints of structurally improving in Japan. And in some ways, maybe that was all for nothing because Nintendo is probably more like a typical American tech company than truly a Japanese business, at least if we're going off of stereotypes. And I actually see that as a good thing. And also why the stock is so richly valued, even by US market standards, but especially by Japanese standards.

1:33:01So to me, Nintendo falls in the basket of being something like an auto zone, where it's probably a really compelling hold long term. And it's a really high quality business of really, really great assets on its balance sheet that have probably been under monetized. But I think there's just enough uncertainty and the shares are priced just richly enough that I don't feel that it's a screaming buy to go out to the intrinsic value portfolio today. But that's just my two cents. Yeah, you know, I agree with almost everything you said. I mean, I love the business, as you probably could have heard today, and I would like to be a shareholder.

1:33:42And if the stock were to drop to the low 60s again, while the long thesis obviously remains intact, I would revisit it again in an instant and I would most likely also open a position. I think at that price, surprises are just much more likely to the upside, while today, I also see surprises to the downside. And one of those positive surprises could be caused by Nintendo's substantial cash position. And you just, you know, you just elaborate on it. Over 15 % of the market cap is currently held in cash. While you could argue that buybacks or special dividend would make better use of that cash, historically, I do think it made sense for Nintendo to hold a larger cash position, considering the industry's cyclicality.

1:34:28Who knows what would have happened after the Wii U disaster without that cash. With less cyclicality going forward though, and even the Japanese government now encouraging companies to increase buybacks or dividends, Nintendo could change that strategy. And one last thing to consider, we mentioned it like multiple times today, is also Nintendo stake in Pokemon because as I mentioned, it's not valued on the balance sheet yet. So maybe it makes sense to do a quick and dirty evaluation to see just how much value that could also add to Nintendo. And assuming Nintendo holds a 50 % stake, and I would just say, I will just act as if that's a fact right now.

1:35:11And we value the Pokemon business at a P of 20, which to me seems pretty conservative. I mean, it's the highest grossing media franchise of all time. That would imply a total brand valuation of$8 billion. So that's an extra$4 billion for Nintendo. I mean, I wouldn't bet too much on it because I don't expect this day to materialize and a tangible value besides the profiture at any time soon. I mean, maybe that's somewhat of what you said about Japanese companies in general. I think an American company would just make a lot more of such a stake. I mean, they would tell you they own the biggest media franchise of all time.

1:35:51Nintendo seems to kind of hide it away. And I just don't think that is a positive net for investors. But anyway, I'm really glad I researched this business. now before we close it for today let me quickly mention that you can actually track the intrinsic value portfolio that sean and i build on the show every week you can see our position sizes and holdings in our newsletter and you can sign up for it for free in the show notes below or at theinvestorspodcast.com slash newsletters to get weekly outlines of our company breakdowns our portfolio, and even the valuation models that we do for each stock that we cover.

1:36:33Now, last but not least, Sean, without giving too much away about the company you will pitching next week, maybe you can just give us a little teaser on what the audience and me can expect. Yeah. What did I tell you guys? Daniel is a savvy investor, and I think he showed that today. And And I'm glad you're on our team. We're going to be continuing to break down a ton of compelling companies going forward. But next week, we'll sort of alternate roles. And I'll be pitching to Daniel on a brand that is arguably as iconic as Nintendo, but sort of operating in a totally different realm. And that's all I'll say for now.

1:37:13But despite being such a powerful brand, the company is much more of a value play than Nintendo is. So I think that is going to be interesting. but listeners will just have to tune in to see my pitch and daniel will give me his feedback and questions on it all right now let me close with a quote by nintendo ceo satoru ivata on my business card i'm a corporate president in my mind i'm a game developer but in my heart i'm a gamer with that said we will see you all again next week thank you for listening to tip make sure to follow the Intrinsic Value Podcast on your favorite podcast app and never miss out on our episodes.

1:37:54To access our show notes and courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decisions, consult a professional. This show is copyrighted by the Investors Podcast Network. Written permissions must be granted before syndication or rebroadcasting.