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Nintendo: Time to Break Open The Piggy Bank

Virtue CFO Asif Khan believes Nintendo must use its ample cash to buy its way back to relevance - perhaps an investment in Oculus?

Just last week, Nintendo pre-announced a horrendous sales miss for their fiscal year ending March, 2014. This has led to a flurry of blog posts, articles and tweets about Nintendo's impending death. As I have said before in my articles, Nintendo is not going to die. However, this recent Wii U sales data does have me concerned as a fan of the company as well as an investor.

Nintendo's ADR, NTDOY, is the third largest holding in the Virtue LLC portfolio that I manage and I have repeatedly stuck my neck out defending the company in my Game Trader articles and also when talking to my family, friends, and colleagues. The magnitude of the sales miss announced last week, and the drastic reduction in Nintendo's estimates has me questioning a number of things going on at the company.

Were their sales expectations wishful thinking or did they actually believe these numbers could be hit?

When a company misses their own sales projection by over 60 percent, it is toeing the dangerous line of misleading investors. Either the management team is full of eternal optimists or they did not see the writing on the wall. Whatever the case may be, it is clear that management needs to change. I am not saying that Iwata must resign, rather that the whole team at Nintendo must change how they view their business and the industry as a whole because they have proven to be out of touch.

"Nintendo has a great opportunity to take a minority stake in Oculus VR, or buy the whole dang company"

Just how long can Nintendo keep its head in the sand with respects to mobile?

It is obvious that Nintendo can not and should not make its own phone, but why not try to monetize legacy content in an environment with hundreds of millions of smartphones in the pockets of people around the world? I understand that 3DS has been much more successful than the Wii U, but I believe that releasing NES titles for mobile is not going to cannibalize sales of the 3DS as much as some inside and outside the company may believe. Nintendo has an opportunity to create a tiered system for releasing their content, where some virtual console titles will be made available on mobile phones and the new AAA Nintendo titles will still be made exclusively for 3DS/Wii U. The current walled garden philosophy isn't going to cut it. Super Mario 3D World was one of the most critically acclaimed games of 2013, yet the Wii U sales still were pathetic. The idea that software sells hardware does not seem to be working, so why not sell some older software on proven hardware platforms that are still growing?

How long can planned obsolescence, incremental innovation, and proprietary intertwining of an ecosystem continue before consumers become disenfranchised and bored with the brand?

This is not just a question for Nintendo, but now seems like a great time for them to address it. The Wii U is severely underpowered when compared to the PS4, Xbox One, and upcoming Steam Machines. In a market with so many high quality choices, why does Nintendo perpetually gravitate towards being a low cost, lower tech option? The NES and SNES were not nearly as guilty of this and they remain some of the best selling consoles of all time. I dream of a day when Nintendo actually makes a machine with a lot of horsepower. We can call it the Mega Nintendo Entertainment System! The planned obsolete Wii U hardware led them to lose support from EA, which I think was a serious factor in the sales miss this holiday. There are very few consumers in Europe that are going to buy a game machine that doesn't play FIFA, as is the case with Madden here in the US. Nintendo must do a better job of creating an ecosystem that 3rd party developers want to be a part of, or else they will eventually suffer the same fate as Sega.

Why not acquire growth and innovation?

Nintendo has a mountain of cash, which allows them to take risks and fail from time to time. This is why they have been around since 1889 and have been able to adjust to market trends. Virtual Boy was a complete flop, but it was an attempt at doing something new and exciting. I had a chance to see Oculus VR's Rift Crystal Cove prototype at this year's CES, and it was a mindblowing experience. Clearly VR is a user interface that is very close to being ready for prime time, and Microsoft and Sony are putting up barriers to Oculus. Nintendo has a great opportunity to take a minority stake in Oculus VR, or buy the whole dang company. Either way, this is an example of how Nintendo could acquire innovation and show that they are still a brand that can wow people. Even if they don't acquire the whole company, supporting and developing games that use Oculus VR's innovative tech would be a great way to differentiate Nintendo from Sony and Microsoft.

If that is too crazy of an idea, why not acquire Sega or Capcom? One of the main problems Nintendo has is their development cycles are so long that they never seem to have enough quality titles available. Expanding their development teams to include Sega and Capcom is something they can easily do with their balance sheet and would be accretive to earnings within a few years. Instead of sitting on a pile of money, Nintendo should do something to grow the company before it starts bleeding cash.

Why not license existing brands out to film/TV studios in an effort to achieve profitability and improve brand recognition in key demographics?

"Wii U is not Dreamcast, and Nintendo could continue at this pathetic pace for 20 more years before going bankrupt"

Nintendo has made movies in the past, and they have had TV shows, but they currently aren't doing either. Nintendo could easily monetize their brands by licensing content to Disney, Sony or anyone else in Hollywood that wants to make money. It is a low cost, high return effort on their part and would help them get out of the hole they are in financially. At the same time, it could reinvigorate their brand in the eyes of an age group that has no recollection of the NES. Put simply, bring back the cereal, Nintendo!

Are they even trying?

The fact that I could put forth all these ideas for how to grow the company's earnings organically or through partnerships and acquisitions shows that there is a way out for Nintendo. Wii U is not Dreamcast, and Nintendo could continue at this pathetic pace for 20 more years before going bankrupt. Part of me feels like this whole generation is a "kick the can down the road" move on the part of Nintendo. 3DS and Wii U are evolutionary products, not revolutionary. Perhaps Nintendo already has its next product in the works and it will address a number of my concerns above. Maybe this recent sales miss is the kick in the behind the company needed to change course.

What I know for certain is that Nintendo still makes some of the best games in the world, it has some of the most recognizable characters in the world, and millions of fans worldwide. Not every decision at a video game company should be about profits and losses, but when a company has three straight years of losses and misses sales by an egregious 60 percent something has to change. The status quo will not work anymore, Nintendo. I have not sold any of my shares because I still believe that the company can turn this around, but it needs to realize that 2014 is a lot different than 2006.

When I bought the stock in 2010, in was with a 3-5 year time horizon. After this recent sales miss, I have realized that it will take close to 6 more years before we know if Nintendo really is going to turn it around or not. It remains the cheapest stock that I own on a number of valuation metrics, but companies are usually cheap for a reason. Nothing is going to appear undervalued when things are going well, and it is very apparent that things are not going well at Nintendo. Something has to change.

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