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VALUE INVESTORS
Asia INC.
Glorious
prospects for
Super Mario & • Nintendo maintains a valuable competitive
edge over its rivals by dominating the
Co. in infinite rapidly growing video game market for aged
and female players
battle for • Nintendo is financially healthy and stable
with negligible leverage and low cost of
gaming •
equity
Growth prospects remain positive for
Nintendo due to introduction of new
industry products, and existing products performing
strongly
• Recovering global economy is expected to
boost video gaming industry pushing up
Nintendo’s sales figures and share price
– Equity Valuation of
Nintendo Co., Ltd.
Research Analysts
Li Zhi
Zhili2007@business.smu.edu.sg
Despite the recent sales growth in emerging subsectors. Additionally, women are broadly
markets, the video game industry is still highly beginning to enjoy video gaming, reflected by
dependent on the developed countries. The fact newly introduced “customized” products such as
that the 10 largest markets accounted for more than “Project Runway” by Nintendo and female
74% of total sales worldwide in 2009 clearly advertisement leaders like the “Frag Dolls”, an all-
supports that diagnosis. In fact, the “Big Five” girl team of gamers recruited by Ubisoft to
(US, UK, France, Japan, China) solely accounted promote women in the gaming industry.
for more than 60% of total global Video Game Another recently observed trend in the industry are
sales last year. Consequently the economic setback collaboration strategies among game
has affected these core markets most severely, with manufacturers to lighten the cost-pressure of game
Japan’s real GDP growth rate for instance development and open strategically relevant, new
dropping from -0.7% in 2008 to -6.4% in 2009. US markets. Examples for this tendency are
real GDP growth fell to -3.15% in 2009, down Nintendo’s cooperation with local TV-networks on
from growth of 1.1% in 2008. the creation of new characters as well as
Electronics Arts partnership with Hasbro to
develop online version on current Hasbro products.
Nintendo Company Analysis and Nintendo Wii. It also positions itself in the
higher end of market, being one of the innovators
Brief History in the video games market operating both in Japan
located in Kyoto, Japan. Founded on September The Nintendo DS already is becoming the best-
23, 1889 by Fusajiro Yamauchi, it produced selling portable console ever with 80 million units
handmade hanafuda (playing) cards. According to sold globally, and is expected to beat the 100
Nintendo's Touch! Generations website, the name million-unit console record set by Sony's
"Nintendo" is translated from Japanese to English, PlayStation 2.
meaning "Leave Luck to Heaven".
Nintendo supplies the local market with game
Nintendo developed into a video game company in consoles and software manufactured in its three
the 1970s, becoming one of the most influential in major Japanese manufacturing plants located in
the industry and Japan's third most valuable listed Uji, Okubo and Ogura.
company, with a market value of over US$85
Nintendo distributes their products through its
billion.
subsidiary companies based in North and Latin
Nintendo is also currently the majority owner of America, Western Europe and Australasia, making
the Seattle Mariners, a Major League Baseball it a prominent market leader in the video games
team in Seattle, Washington. market abroad. Products are sold through mixed
Satoru Iwata, president and CEO of Nintendo, retailers worldwide, as well as Nintendo's flagship
wide product portfolio ranging from Nintendo successfully enticed many gamers to choose
and Japan-based toy-producers are regarded as THQ 20,68 52,15 0,47 1,23 0,37
Take- 7,35 -20,65 0,81 1,53 -
Nintendo’s competitors in a reasonable peer-group. Activision
Blizzard 14,45 16,38 3,24 1,29 -
Choosing a Multiple
Navarre 6,44 6,37 - - -
Due to the worldwide financial crisis many Nokia 12,56 14,66 0,90 2,82 0,89
GameStop 8,13 9,34 0,32 1,09 0,62
companies in the video gaming industry were still
suffering from negative earnings in 2009. To avoid * (Cur. PE/One year forward Growth)
any bias in the peer group selection – to exclude Figure 3: Current P/E (x-axis) to one-year Forward
companies with a negative P/E ratio – we chose the Growth (y-axis)
“Expected Price to Earnings Ratio” (forward P/E)
for next year based on analyst forecasts as the most
relevant multiple for our Relative Valuation. As a Figure 3
counter check, we also examined the current Price Relative Valuation regarding three scenarios:
to Sales (P/S) and Price to Book (P/B) ratio, as
Market Price Estimates
well as the Price/Earnings-to-Growth ratio. In Relative Pessimistic Optimistic
order to eliminate extreme statistical outliers and Valuation Based (assume Base (assume 90th
On: median) percentile)
distortion, we have composed a reference group of
16 companies, which reflects Nintendo’s areas of Forward P/E
¥26.245,30 ¥30.538,34 ¥57.274,04
business to derive average industry figures. P/S ¥15.365,23 ¥26.020,41 ¥49.747,37
Based on Nintendo’s results for 2009, the obtained P/B ¥16.764,27 ¥24.575,57 ¥50.652,89
industry averages were calculated a “base value” Valuation According to Multiple
Figure 7: Illustration of smoothed out growth rate Nintendo in the upcoming years, we have decided
for 2011 to 2013 to take into consideration 4 main factors:
a) Historical Results of the Company according
to their usual growth trends
Figure 7 b) The current worldwide economical situation
1. Forecast of Growth c) Prediction on Nintendo’s launch of new
console
detailed in our 3-stage growth model analysis, c) Success of Nintendo’s launch of new console
Nintendo’s performances follow a recurrent According to various sources and concordent with
pattern. Basing our growth rate estimation on this Nintendo’s product innovation cycle, the video-
first factor leads us to assume the following game firm would release an update of the
forecasts: successful Wii beginning of 2011. The “Wii 2”
– Based on their product launch patterns, would offer both better graphics by providing an
Nintendo’s growth rate should increase HD resolution and more sensitivity in its captors.
consequently within the next 3 years. The release would is predicted to bump Nintendo’s
– In 2013, Nintendo’s growth rate should reach performance as it would respond to the critisim and
its peak and start decreasing before complaints of many of its users. Moreover, the
experiencing the final stage of stabilization. launch of a new Nintendo DS would also be in the
pipeline for 2011.
a) Worldwide Economic Situation. The juxtaposition of both events would have a
Over the years, Nintendo’s sales growth trend has direct positive impact on the firm’s revenue.
been highly correlated to the world GDP growth However, because those two events represents
rate. Nintendo’s performances have therefore simple update of existing products, their impact on
always perfectly matched the world’s economy. Nintendo’s growth rate would not be as significant
Hence, we have decided to compute Nintendo’s as the one experienced in 2005 (163.35%).
future growth rate by taking into consideration the d) Impact of competitors on Nintendo’s historical
expert forecasts from IMF (International Monetary and projected financial performances
Fund), and additional sources on the world
The release of competing products have always
economy for the next 3 years. Based on these
somewhat affected Nintendo’s trend to a certain
expert analyses regarding the performances of the
extent. In the last 4 years (since the release of the
worldwide economy, we have attempted to extract
“Wii “), the impact of Nintendo’s competitor’s
a general trend in order to be accurate and realist in
products on its performances has been rather low,
our calculation. For the next 3 years, our forecasts
as Nintendo has succeeded in positioning its
for the world GDP real growth rate will be around
product on a different level of entertainment and
3.10% for 2011, 4.00% for 2012 and lastly 4.50%
therefore conquering a quite different target
for the year 2013.
Plugging those three numbers in the following graphs below show the effect of the adjustments on
equation, we derive a cost of equity for Nintendo the net income and return on equity for the years
of 7.35%. 2007-2009.
4. Adjustments Figure 11
continue innovating new products for the rapidly are 126.14% and 9.5% respectively, mainly due to
changing technological market with shorter the sales of the Nintendo Wii doubling from 2007
product life cycles. Due to the conservative to 2008. Though earnings growth rates is believed
accounting measures that require R&D expenses to to slow down to 5% according to the recent
be expensed in the same period of occurrence, the economic growth forecast of 5%, Nintendo’s
value of the assets created by research does not continuous expansion plan allows the investors to
show up on the balance sheet, resulting in believe in the optimistic growth momentum.
As Nintendo is operating globally and expanding The urgent debt problems in the USA, Europe and
to emerging markets of late, its long-term growth Japan are likely to cause rising inflation in the
rate will be determined by the growth rate of the upcoming years on a worldwide level. Since
world economy. In accordance with IMF forecasts Federal Reserve (FED) in the US, as well as the
and historical figures from the last 10 years, we European Central Bank (ECB), is predicted to take
assume the GDP of 1st world countries and measures to oppose inflationary tendencies, higher
emerging markets – Nintendo’s main sales-regions risk-free rates are the logical consequence. As a
– to grow with 4.50 percent per year on average. side effect of increased inflation and debt troubles,
Since Nintendo’s business is highly exposed to we expect the country risk premium for Japan as
traditionally low-growth markets such as Japan, its well as the equity risk premium to increase
growth rate will stabilize slightly below world slightly.
economy growth at 4.00 percent from 2017
onwards.
Scenario Analysis
To account for the dynamic nature of the current
Figure 14 illustrates the exposure of Nintendo to
the world markets: economic environment, we have formulated
scenario analyses to account for extreme
conditions on either sides of our base valuation of
Figure 14 Nintendo.
As a consequence of the growth and ROE figures
Bear Bull
explained above, a constant Equity Reinvestment
Rate to Equity of 30.76 percent will be necessary Years of Extraordinary Growth 1 5
in the stable growth period according to the ROE (Extraordinary) 3.27% 32.33%
standard growth formula:
Disclosure appendix
Analyst certification
The following analyst(s), who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject
security(ies) or issuer(s) and any other views or forecasts expressed herein accurately reflect their personal view(s) and that no
part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in
this research report: Li Zhi, Anthony Chan Yu, Ralf Dreischaerf, Neo Siong Sze, Carlos Palacios, Amaury Guillement and
Christoph Schiller
This report is designed for, and should only be utilized by, institutional and private investors. Furthermore, SMU
INTERNATIONAL Value Investors Inc. believes an investor's decision to make an investment should depend on individual
circumstances such as the investor's existing holdings and other considerations.
SMU INTERNATIONAL Value Investors Inc. believes that investors utilize various disciplines and investment horizons when
making investment decisions, which depend largely on individual circumstances such as the investor's existing holdings, risk
tolerance and other considerations.
SMU INTERNATIONAL Value Investors Inc. believes an investor's decision to buy or sell stock should depend on individual
circumstances such as the investor's existing holdings and other considerations. Different securities firms use a variety of terms as
well as different systems to describe their recommendations. Investors should carefully read the definitions of the
recommendations used in each research report. In addition, because research reports contain more complete information
concerning the analysts' views, investors should carefully read the entire research report and should not infer its contents from the
recommendation. In any case, recommendations should not be used or relied on in isolation as investment advice.
Forecast
Growth -21,09% 13,93% 13,93% 13,93% 11,45% 8,97% 6,48% 4,00%
Year Ended 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Net Sales or Revenues 966.534,00 1.672.423,00 1.838.622,00 1.450.785,46 1.652.943,32 1.883.270,61 2.145.692,57 2.391.391,11 2.605.831,61 2.774.783,14 2.885.774,46
Cost of Goods Sold 565.399,00 968.403,00 1.040.274,00 870.471,28 991.765,99 1.129.962,37 1.287.415,54 1.434.834,66 1.563.498,97 1.664.869,88 1.731.464,68
Gross Margin 401.135,00 704.020,00 798.348,00 580.314,18 661.177,33 753.308,25 858.277,03 956.556,44 1.042.332,64 1.109.913,25 1.154.309,78
Depreciation, Depletion & Amortization 25.633,20 31.214,80 36.434,20 35.242,56 36.995,03 42.150,05 48.023,40 54.715,16 60.980,47 66.448,71 70.756,97
Selling, General & Admin Expenses 131.418,00 172.436,00 192.772,00 145.078,55 165.294,33 188.327,06 214.569,26 239.139,11 260.583,16 277.478,31 288.577,45
Operating Expenses – Total 722.450,20 1.172.053,80 1.269.480,20 180.321,11 202.289,36 230.477,12 262.592,66 293.854,27 321.563,63 343.927,02 359.334,42
Operating Income 244.083,80 500.369,20 569.141,80 399.993,08 458.887,97 522.831,13 595.684,37 662.702,17 720.769,01 765.986,23 794.975,37
Non-Operating Interest Income 33.987,00 44.158,00 30.181,00 21.761,78 24.794,15 28.249,06 32.185,39 35.870,87 39.087,47 41.621,75 43.286,62
Earnings Before Interest And Taxes
278.070,80 544.527,20 599.322,80 421.754,86 483.682,12 551.080,19 627.869,76 698.573,04 759.856,48 807.607,98 838.261,99
(EBIT)
Interest Expense On Debt 0,00 0,00 1,00 1,00 1,00 1,00 1,00 1,00 1,00 1,00 1,00
Pretax Income 278.070,80 544.527,20 599.321,80 421.755,86 483.683,12 551.081,19 627.870,76 698.574,04 759.857,48 807.608,98 838.262,99
IncomeTaxes 115.348,00 176.532,00 169.134,00 188.904,45 216.641,67 246.829,26 281.223,31 312.891,31 340.340,17 361.728,06 375.457,99
Minority Interest -37,00 -99,00 -91,00 100,00 100,00 100,00 100,00 100,00 100,00 100,00 100,00
Net Income Before Extra Items/Preferred
162.685,80 367.896,20 430.096,80 232.751,41 266.941,45 304.151,92 346.547,45 385.582,73 419.417,32 445.780,92 462.704,99
Div
Extr Items & Gain(Loss) Sale of Assets 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00
Net Income Before Preferred Dividends 162.685,80 367.896,20 430.096,80 232.751,41 266.941,45 304.151,92 346.547,45 385.582,73 419.417,32 445.780,92 462.704,99
Preferred Dividend Requirements 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00
Net Income Available to Common 162.685,80 367.896,20 430.096,80 232.751,41 266.941,45 304.151,92 346.547,45 385.582,73 419.417,32 445.780,92 462.704,99
EPS 1.271,89 2.876,54 3.363,12 1.819,99 2.087,33 2.378,30 2.709,81 3.015,04 3.279,61 3.485,76 3.618,09
Liabilities
Accounts Payable 301.080,00 335.820,00 356.774,00 290.157,09 330.588,66 376.654,12 429.138,51 478.278,22 521.166,32 554.956,63 577.154,89
ST Debt & Current Portion of LT Debt 0,00 0,00 9,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00
Income Taxes Payable 90.013,00 112.450,00 83.551,00 72.539,27 82.647,17 94.163,53 107.284,63 119.569,56 130.291,58 138.739,16 144.288,72
Other Current Liabilities 75.564,00 117.104,00 98.650,00 87.047,13 99.176,60 112.996,24 128.741,55 143.483,47 156.349,90 166.486,99 173.146,47
Current Liabilities - Total 466.657,00 565.374,00 538.984,00 449.743,49 512.412,43 583.813,89 665.164,70 741.331,24 807.807,80 860.182,77 894.590,08
Long Term Debt 0,00 786,00 15,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00
Other Liabilities 698,00 3,00 5.660,00 7.253,93 8.264,72 9.416,35 10.728,46 11.956,96 13.029,16 13.873,92 14.428,87
Total Liabilities 467.355,00 566.163,00 544.659,00 456.997,42 520.677,15 593.230,24 675.893,16 753.288,20 820.836,96 874.056,69 909.018,96
Shareholders' Equity
Minority Interest 138,00 98,00 25,00 25,00 25,00 25,00 25,00 25,00 25,00 25,00 25,00
Preferred Stock 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00
Common Equity 21.791,00 21.705,00 21.651,00 21.700,00 21.700,00 21.700,00 21.700,00 21.700,00 21.700,00 21.700,00 21.700,00
Retained Earnings 1.220.295,00 1.380.431,00 1.432.959,00 1.552.660,25 1.689.945,02 1.846.366,69 2.024.591,86 2.257.131,86 2.522.491,70 2.817.726,45 3.137.865,74
Treasury -156516 -156184 -155396 -155.400,00 -155.400,00 -155.400,00 -155.400,00 -155.400,00 -155.400,00 -155.400,00 -155.400,00
Adjustment for Research Asset 97.633,40 96.909,40 110.788,20 116.062,84 132.235,47 150.661,65 171.655,41 191.311,29 208.466,53 221.982,65 230.861,96
Total Equity 1.183.341,40 1.342.959,40 1.410.027,20 1.535.048,08 1.688.505,48 1.863.353,34 2.062.572,27 2.314.768,15 2.597.283,23 2.906.034,10 3.235.052,70
Total Liabilities & Shareholders'
1.650.696,40 1.909.122,40 1.954.686,20 1.992.045,50 2.209.182,63 2.456.583,58 2.738.465,43 3.068.056,35 3.418.120,19 3.780.090,79 4.144.071,65
Equity
Note: Payout ratio is not stable over time. Therefore a valuation based on Dividends would underestimate the value of equity for Nintendo. Additionally Corporate Governance in Japan tends to be weak and
dividends therefore do not reflect the real FCFE, which is why we chose a FCFE model.
1st 03 2nd 03 3rd 03 4th 03 1st 04 2nd 04 3rd 04 4th 04 1st 05 2nd 05 3rd 05 4th 05 1st 06 2nd 06 3rd 06 4th 06
Net Income (accumulated per year) 11450 2885 34545 67267 22635 46445 67757 87416 14115 56824 92185 98378 15551 94676 131916 174290
Net Income 11450 -8565 31660 32722 22635 23810 21312 19659 14115 42709 35361 6193 15551 79125 37240 42374
Net Sales (accumulated per year) 83821 211382 439489 504135 82153 188009 439589 515292 70684 176364 412339 509249 130919 298817 712589 966534
Net Sales 83821 127561 228107 64646 82153 105856 251580 75703 70684 105680 235975 96910 130919 167898 413772 253945
Operating Income (accumulated) 7245 28771 102627 100120 17467 40013 102627 111522 3754 19613 82783 90349 28802 67111 167633 226024
Operating Income 7245 21526 73856 -2507 17467 22546 62614 8895 3754 15859 63170 7566 28802 38309 100522 58391
Proportion of Annual Income 17,02% -12,73% 47,07% 48,64% 25,89% 27,24% 24,38% 22,49% 14,35% 43,41% 35,94% 6,30% 8,92% 45,40% 21,37% 24,31%
Proportion of Net Sales 16,63% 25,30% 45,25% 12,82% 15,94% 20,54% 48,82% 14,69% 13,88% 20,75% 46,34% 19,03% 13,55% 17,37% 42,81% 26,27%
Proportion of Operating Income 7,24% 21,50% 73,77% -2,50% 15,66% 20,22% 56,14% 7,98% 4,15% 17,55% 69,92% 8,37% 12,74% 16,95% 44,47% 25,83%
1st 07 2nd 07 3rd 07 4th 07 1st 08 2nd 08 3rd 08 4th 08 1st 09 2nd 09 3rd 09 4th 09
Net Income (accumulated per year) 80251 132421 258929 257342 107267 144828 212524 279089 42316 69492 192601 243272,95
Net Income 80251 52170 126508 -1587 107267 37561 67696 66565 42316 27176 123109 50671,954
1450785,4
Net Sales (accumulated per year) 340439 694803 1316434 1672423 423380 836879 1526348 1838622 253498 548058 1182177 6
Net Sales 340439 354364 621631 355989 423380 413499 689469 312274 253498 294560 634119 268608,46
Operating Income (accumulated) 90631 188784 394036 487220 119192 252183 501330 555263 40401 104360 296656 334901,09
Operating Income 90631 98153 205252 93184 119192 132991 249147 53933 40401 63959 192296 38245,09
Proportion of Annual Income 31,18% 20,27% 49,16% -0,62% 38,43% 13,46% 24,26% 23,85% 17,39% 11,17% 50,61% 20,83%
Proportion of Net Sales 20,36% 21,19% 37,17% 21,29% 23,03% 22,49% 37,50% 16,98% 17,47% 20,30% 43,71% 18,51%
Proportion of Operating Income 18,60% 20,15% 42,13% 19,13% 21,47% 23,95% 44,87% 9,71% 12,06% 19,10% 57,42% 11,42%
Current IMF-Forecast
Year: 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
World GDP Real Growth Rate (%) 2,70% 3,80% 4,90% 4,70% 5,30% 5,20% 3,10% 2,70% 3,10% 4,00% 4,50%
Net Sales Growth Rate -9,14% 2,12% 0,11% -1,20% 89,77% 73,20% 9,94% -21,09% 8,02% 20,00% 30,00%
Net Sales 503,75 514,41 514,99 508,83 965,61 1672,42 1838,62 1450,79 1567,10 1880,52 2444,68
Net Income Growth rate -36,81% -50,65% 163,35% 12,54% 77,16% 47,65% 8,45% -16,60% 14,69% 13,94% 13,94%
Net Income 67,27 33,19 87,42 98,38 174,29 257,34 279,09 232,75 266,94 304,15 346,55
Average. Growth Rate (2011-13): 19,34% Av. Growth Nint.: 19,34% 19,34% 19,34%
2010 (exp.) 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999
Return on Invested Capital 22,46% 22,06% 16,79% 10,38% 9,65%
Return on Equity 18,56% 22,47% 23,14% 17,70% 10,37% 9,65% 3,73% 7,55% 11,38% 11,57% 7,40% 12,25%
Note:
Historic Average growth applicable since there were no negative earnings and relatively stable size of the company in the past
Company Data:
(¥ in millions of YEN)
Forecast Earnings 2010 ¥232.751,41
Forecast Sales 2010 ¥1.450.785,46
Figure 16
Figure 2
Figure 2 displays the most important markets in regards to consumption per capita:
Figure 17
Figure 3
Figure 3: Current P/E (x-axis) to one-year Forward Growth (y-axis)
Figure 18
Figure 4
Figure 4: Displays the expected range of fair prices for Nintendo according to possible scenarios (grey:
pessimistic, red: optimistic)
Figure 19
Figure 5
Figure 5 illustrates the decisive input-factors utilized in our FCFE valuation model for Nintendo. We will
further elaborate on the derivation of the figures in the following parts.
Figure 20
Figure 6
Figure 6 illustrates the expected growth periods explained above. For detailed figures please refer to the
attached spreadsheets.
Figure 21
Figure 7
Figure 7: Illustration of smoothed out growth rate for 2011 to 2013
Figure 22
Figure 8
Figure 8 shows the quarterly numbers in sales, net- and operating income (in million Yen) and the
proportion of annual Net sales per quarter:
Figure 23
Figure 9
Figure 9 highlights the impressive correlation and puts into perspective the performances of Nintendo in
relation with the global economy for the upcoming years:
Figure 24
Figure 10
According to Bloomberg the currently 2.34% are a good estimate:
Figure 25
http://www.bloomberg.com/markets/rates/japan.html
Figure 26
Figure 12
Return on Equity 2007-2009:
Figure 27
Figure 13
Figure 13 demonstrates how FCFE and Net Income developed over the last five years and underlines the
core finding, “high-growth years and equity reinvestments strongly correlate”:
Figure 28
Figure 14
Figure 14 illustrates the exposure of Nintendo to the world markets:
Figure 29