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Equity ResearchAsia
SMU INTERNATIONALSMU INTERNATIONALVALUE INVESTORS INCVALUE INVESTORS INC..
Glorious prospects for Super Mario & Co. in infinite battle for gaming industry
- Equity Valuation of Nintendo Co., Ltd.
Nintendo maintains a valuable competitive edge over its rivals by dominating the rapidly growing video game market for aged and female players
Nintendo is financially healthy and stable with negligible leverage and low cost of equity
Growth prospects remain positive for Nintendo due to introduction of new 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
March 25, 2010Research Analysts
Amaury [email protected]
Ralf [email protected]
Neo Siong [email protected]
Anthony Chan Chiu [email protected]
Carlos Lopez [email protected]
Christoph [email protected]
Key Data
Recommendation Strong Buy
Target Price 40824.67 Yen
Issued Shares 127.88M
Market Cap 4.08 Trill. Yen
52-week-range 20.130 – 31.900
Current Price 31.900
Object 2
Disclaimer & DisclosuresThis report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it
Nintendo’s Corporate Profile:Nintendo Co., Ltd. is a Japan-based company mainly engaged in the leisure machine business. The Company operates in two business segments. The Leisure Machine segment is engaged in the development, manufacturing and sale of portable and console game machines as well as game software. The Others segment is engaged in the manufacture and sale of poker cards and karuta (Japanese-style playing cards), the sale of Pokémon (a Japanese animation character) goods, the management of intellectual property rights and the provision of electronic registration services of home use console machines, among others.
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Industry and Sector Analysis
Market for Video Games 2009
Along with every other sector, the video games sector has
harshly been affected by the economic crisis over the past
2 years. Growth in sales in video games globally was
lethargic, reaching more than US$66.2 billion in 2009,
with just an increase of only 0.4% over the prior year. On
the positive side, the emerging regions of Asia Pacific,
Middle East and Africa saw sales increase of more than
7% to 21%. In contrast, all other major regions
experienced rough declines in sales in 2009.
Figure 1 underlines the abrupt halt in software as well as
hardware sales in 2009:
2004 2005 2006 2007 2008 20090
10
20
30
40
50
60
70
-10%
0%
10%
20%
30%
40%
50%
10 12.5 1724 28.5 30.5
19.5 2021.5
28
36.5 35.5
Video Games Value Sales Performance by Type
video games harware retail value RSP video games software retail value RSP
Hardware y-o-y value growth (%) Software y-o-y value growth (%)
Bill. U
S $
Figure 1
Largest Markets for Video Games
Despite the recent sales growth in emerging markets, the
video game industry is still highly dependent on the
developed countries. The fact that the 10 largest markets
accounted for more than 74% of total sales worldwide in
2009 clearly supports that diagnosis. In fact, the “Big
Five” (US, UK, France, Japan, China) solely accounted for
more than 60% of total global Video Game sales last year.
Consequently the economic setback has affected these
core markets most severely, with Japan’s real GDP growth
rate for instance dropping from -0.7% in 2008 to -6.4% in
2009. US real GDP growth fell to -3.15% in 2009, down
from growth of 1.1% in 2008.
Figure 2 displays the most important markets in regards
to consumption per capita:
UK USA France Australia Canada Italy Japan Spain Germany China0
20
40
60
80
100
120
140
160
180
Per Capita Toy Consumption in 10 Largest Markets
2009
US $
per c
apita
Figure 2
Key Trends
One key market issue for the future of the video games
and consoles industry is the challenge of changing
demographics, which has undeniable implications to the
industry structure. The industry players are beginning to
see the aging population as an opportunity: Financially
comfortable baby boomer grandparents are increasingly
targeted to buy video games for their grandchildren. At the
same time, pioneer video-gamers of the first generation,
mainly 35-40 year olds, continue to spend their increasing
incomes on video games. On the other end of the
spectrum, children are getting exposed to video games
younger, caused by strong growth in both pre-school and
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infant games-subsectors. Additionally, women are broadly
beginning to enjoy video gaming, reflected by newly
introduced “customized” products such as “Project
Runway” by Nintendo and female advertisement leaders
like the “Frag Dolls”, an all-girl team of gamers recruited
by Ubisoft to promote women in the gaming industry.
Another recently observed trend in the industry are
collaboration strategies among game manufacturers to
lighten the cost-pressure of game development and open
strategically relevant, new markets. Examples for this
tendency are Nintendo’s cooperation with local TV-
networks on the creation of new characters as well as
Electronics Arts partnership with Hasbro to develop online
version on current Hasbro products.
Video gaming consoles typically have a life-cycle of
around 5 to 6 years from introduction to retreat. Generally,
after a burst of sales at their initial adoption, hardware
sales tend to slow down over the years and console
manufacturers and software companies benefit largely
from long-term revenues in game sales.
In the past, Nintendo has been highly successful with its
interactive, natural gesture interface console “Wii”, which
propelled it to the top of global toy and game
manufacturers in the recent years, capturing an overall
market share of almost 10%. Consequently all three
dominating leaders in the video gaming industry –
Nintendo, Sony and Microsoft – are aiming to develop
cutting-edge motion sensor technology for their next
generation consoles. Microsoft is expected to release its
long promised “Project Natal” in the recent future – a
ground-breaking motion sensor console – while Nintendo
announced a follow-up for its “DS” coming with an
innovative 3D control panel by the end of 2010.
Considering the usual product life-cycles, we are
expecting the release of additional features and devices for
Nintendo’s Wii plus a “next-gen” successor before the end
of 2011. Sony also remains on path to developing new
control schemes for a natural gesture interface for its
games
Besides new control schemes, interactive gaming will
continue to be among the key selling points of new
products. At the same time, success would rely greatly on
the popularity of the characters, upon which blockbuster
games are based on.
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Nintendo Company Analysis
Brief History
Nintendo Co., Ltd. is a multinational corporation located
in Kyoto, Japan. Founded on September 23, 1889 by
Fusajiro Yamauchi, it produced handmade hanafuda
(playing) cards. According to Nintendo's Touch!
Generations website, the name "Nintendo" is translated
from Japanese to English, meaning "Leave Luck to
Heaven".
Nintendo developed into a video game company in the
1970s, becoming one of the most influential in the
industry and Japan's third most valuable listed company,
with a market value of over US$85 billion.
Nintendo is also currently the majority owner of the
Seattle Mariners, a Major League Baseball team in Seattle,
Washington.
Satoru Iwata, president and CEO of Nintendo, managed to
pick up the pace of competition through the launch of the
Wii console in 2006 and announced further breakthrough
releases for the coming years.
Nintendo Co., Ltd.
Nintendo is one of the leading global market players for
both video hardware, and software games. Products
include Game Boy, Mario, Donkey Kong, Pokémon and
The Legend of Zelda.
Although Nintendo is purely focused on the production
and distribution of hardware and software for the video
games market, it offers a wide product portfolio ranging
from Nintendo Game Boy Advance, Game Cube,
Nintendo DS and Nintendo Wii. It also positions itself in
the higher end of market, being one of the innovators in
the video games market operating both in Japan and
abroad.
The Nintendo DS already is becoming the best-selling
portable console ever with 80 million units sold globally,
and is expected to beat the 100 million-unit console record
set by Sony's PlayStation 2.
Nintendo supplies the local market with game consoles
and software manufactured in its three major Japanese
manufacturing plants located in Uji, Okubo and Ogura.
Nintendo distributes their products through its subsidiary
companies based in North and Latin America, Western
Europe and Australasia, making it a prominent market
leader in the video games market abroad. Products are sold
through mixed retailers worldwide, as well as Nintendo's
flagship specialty stores.
SWOT Analysis
Strengths
• Nintendo is one of the major innovators in the market of
video games and achieved great success through launching
new products like the Wii console
• Nintendo was able to expand its customer base by
releasing products that target women and older customers
such as Wii Fit and Big Brain Academy
• Formidable television advertising campaigns
successfully enticed many gamers to choose Nintendo
game consoles rather than their competitors
Weaknesses
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• Although being above competition in delivering gaming
experience, Nintendo fails to meet up to date technical
standards like graphics.
• Nintendo guards against market saturation and
implemented a rule on five games that a licensee may
produce for a Nintendo system. This prevented Konami
from collaborating with Nintendo for the development of
new game software due to its strict limitation control. In
the final analysis, this becomes a limiting factor for
Nintendo to expand much wider marketability of its game
consoles.
Opportunities
• The video game industry continued to show growth,
driven by expansion of software sales, a growing base for
the new generation of console hardware as well as
favorable sales of handheld hardware.
• Nintendo announced the release of a new console for
2011 with new features that might make an even bigger
customer base accessible.
Threats
• Competing companies like Microsoft and Sony
announced to release new consoles that will have a similar
game play as Nintendo’s Wii combined with better
graphics.
• Strong censorship and restrictions implemented on new
software games developed for Nintendo consoles frustrate
other game developers who may otherwise have
considered collaborating.
• Piracy is expected to remain an issue for the games
industry and manufacturers are expected to continue
developing and implementing new strategies to overcome
this problem.
• The growth in online and mobile gaming is expected to
remain a potential threat to value sales growth in the video
games sector
Financial Overview
Nintendo has been performing well in the past years. The
growth boost through the Wii console has been slowing
down, and a negative growth is expected for 2010.
A closer look at the balance sheet shows that Nintendo is,
and has been 100% equity financed.
Further information can be found in the full company
report.
Relative Valuation of Nintendo
Major Competitors
In order to back up and cross-check the DCF-valuation
(FCFE) with a complementary approach we compiled a
relative valuation based on the most relevant multiples of
Nintendo, and other comparable companies with similar
business activities and characteristics.
Nintendo’s main areas of business can be summarized as
production of video-gaming consoles, development and
distribution of video-gaming software, and manufacturing
of electronic toys mainly for the Asian market, especially
Japan.
For that reason we have identified Microsoft, producer of
the “Xbox” and Sony Computer Entertainment with the
“Playstation” as Nintendo’s main competitors in its core
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market of gaming consoles. However, since both
companies are operating in several other industry sectors
besides video games, a Relative Valuation based only on
multiples of Nintendo’s top competitors is not feasible,
especially as Microsoft for instance maintains a
significantly higher market capitalization with an approx.
$250 Billion. (3.37 Trill. Yen; Sony: 3.16 Trill. Yen).
Peer Group
Nintendo is also a major developer and distributer of video
gaming software and (electronic) toys. Consequently,
other game development companies and Japan-based toy-
producers are regarded as Nintendo’s competitors in a
reasonable peer-group.
Choosing a Multiple
Due to the worldwide financial crisis many companies in
the video gaming industry were still suffering from
negative earnings in 2009. To avoid any bias in the peer
group selection – to exclude companies with a negative
P/E ratio – we chose the “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 counter check, we also examined the
current Price to Sales (P/S) and Price to Book (P/B) ratio,
as well as the Price/Earnings-to-Growth ratio. In order to
eliminate extreme statistical outliers and distortion, we
have composed a reference group of 16 companies, which
reflects Nintendo’s areas of business to derive average
industry figures.
Based on Nintendo’s results for 2009, the obtained
industry averages were calculated a “base value” for
Nintendo, with 2 additional scenarios for variant market
conditions. (See figures below as well as attaches spread
sheets)
Peer Group and Multiples for Relative Valuation:
Name of
Company
Forward
P/EP/E P/S P/B PEG*
NINTEDO 14,98 12,68 2,44 2,35 0,91
Sony
Corporation 35,13 -81,32 0,44 1,04 -
Microsoft 13,48 14,75 4,34 5,77 1,56
Sega Sammy 19,01 - 0,75 1,18 -
Mattel 12,87 13,99 1,48 1,49 1,66
HappiNet 9,42 10,48 11,67 0,64 -
Nihon 32,81 77,31 1,78 1,35 -
Apple 16,57 18,98 4,43 5,79 1,31
LeapFrog 13,18 21,57 1,23 2,42 0,35
Konami 14,21 18,29 0,84 1,23 0,63
Electronic Arts 29,81 54,25 1,56 2,12 0,66
THQ 20,68 52,15 0,47 1,23 0,37
Take- 7,35 -20,65 0,81 1,53 -
Activision
Blizzard 14,45 16,38 3,24 1,29 -
Navarre 6,44 6,37 - - -
Nokia 12,56 14,66 0,90 2,82 0,89
GameStop 8,13 9,34 0,32 1,09 0,62
* (Cur. PE/One year forward Growth)
Figure 3: Current P/E (x-axis) to one-year Forward Growth (y-
axis)
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0.00 10.00 20.00 30.00 40.00 50.00 60.000%
25%
50%
75%
100%
125%
150%
PEG (Cur. PE/1 year forward Growth) Linear (PEG (Cur. PE/1 year forward Growth))
Current P/E
One-y
ear f
orwa
rd gr
owth
Figure 3
Relative Valuation regarding three scenarios:
Market Price Estimates
Relative
Valuation Based
On:
Pessimistic
(assume
median)
Base
Optimistic
(assume 90th
percentile)
Forward P/E ¥26.245,30 ¥30.538,34 ¥57.274,04
P/S ¥15.365,23 ¥26.020,41 ¥49.747,37
P/B ¥16.764,27 ¥24.575,57 ¥50.652,89
Valuation According to Multiple
Using the P/E ratio and the PEG multiple, Nintendo
currently is clearly undervalued since its market value is
significantly lower than the resulting base value (27 000
Yen < 30 500 Yen). Assuming positive conditions for a
future scenario, all multiples computed underline the
finding that Nintendo is undervalued compared to its
peers. Regarding the relevant Forward P/E, a target value
of 35 000 Yen to 45 000 Yen is a reasonable objective for
the share-course.
Figure 4: Displays the expected range of fair prices for Nintendo according to possible scenarios (grey: pessimistic, red: optimistic)
Forward P/E
P/S
P/B
0.00 ¥ 20,000.00 ¥ 40,000.00 ¥ 60,000.00 ¥
Figure 4
Please notice:
The calculations outlined in the previous paragraphs are based on
the data set obtained on 10th of March 2010 from Google Finance,
Marketwatch.com as well as Company Reports and WebPages.
Recent developments on the stock market strongly indicate that the
tendency of our assessments is correct, as Nintendo’s stock is
currently trading slightly above 31,000 Yen and Multiples and
averages for the entire industry have moved upwards noticeably.
FCFE Valuation
1. Choice of Model
We examined Nintendo’s Capital structure and dividend
spending habits to determine a model for valuation. One of
the most remarkable characteristics of Nintendo’s
corporate financial strategy is that it maintains a very low
debt-to-equity structure, a ratio close to zero for many
years. (Total interest expenses on debt amounted to 0 Yen
in 2007, 0 Yen in 2008 and only 1 Yen (millions) in 2009,
indicating that Nintendo operates with almost no leverage
at all. There is no hint that Nintendo might deviate from
this policy in the near- and mid-future.
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Nintendo constantly paid out a certain portion of its
earnings as dividends to shareholders in the past 10 years.
However the payout-ratio has been fluctuating
considerably in accordance with increasing and decreasing
annual earnings. On top of that Nintendo’s cash-payments-
to-FCFE ratio has been far from 1 during the last periods.
Therefore a valuation based on Dividends would
underestimate the value of equity for Nintendo.
Additionally, corporate governance in Japan tends to be
weak, thus dividends therefore do not reflect the real
FCFE.
Historical Cash Flow statements have been available for a
relevant period of time, which - in combination with an
examination of the overall macroeconomic environment as
well as Nintendo’s current product portfolio – can best be
used in a Free Cash Flow model. Since Nintendo’s level
of debt has been very stable over time we decided to apply
a FCFE model in order to evaluate Nintendo.
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 5
2. Growth Stages and duration of growth
Looking at Nintendo’s historical growth pattern over a
period of 10 to 15 years, it is obvious that a limited
number of crucial drivers have mainly determined
Nintendo’s growth. First, Nintendo’s main products –
video gaming hardware and software – typically can be
categorized as consumer discretionary. Consequently
Nintendo’s growth and its market success are highly
dependent on the general global economic situation. Since
business cycles usually fluctuate in intervals of three to
five years, Nintendo’s prospects for growth of sales and
earnings are directly liable to these macroeconomic
factors.
One of the most essential drivers influencing Nintendo’s
growth clearly is the introduction of new products,
especially “next generation” consoles and the market
appreciation of these releases. It is no coincidence that
earnings were low and growth rates negative from 2002 to
2004 with Nintendo’s rather unsuccessful “GameCube”
console taking a beating from Sony’s top-selling
“Playstation 2”. In contrast, net income and growth rates
have almost been doubling from year on year since 2005
due to the introduction and remarkable market success of
Nintendo’s “Wii”.
Taking into account of worldwide economic downturn in
2009, and that Nintendo’s blockbuster products “Wii” and
handheld console “DS” are approaching their sales-peak,
Nintendo’s sales and income figures turned down sharply
from 2009, resulting in a negative growth rate. Looking
forward into the future, Nintendo, currently coming from a
relatively low sales and growth level, has huge potential
for increasing growth rates in the next few years after
excessive boom periods from 2005 to 2008.
Nintendo Co. Ltd Page 9
Nintendo‘s Road-Map to Valuation
Sales
Growth Forecast (%)
Operatin
g Margin (%)
Equity
Reinvestmen
t Rate (%)
Tax Rate (%) &
Interest
Expenses
Adjustments
EBIT
Net Income
FCFECost
of Equi
ty (%)
Equity
Value of
Operating Asset
s
+ Value
of Cash and ST
Securities
= Value
of Equit
y
Number of Share
s
Fair Value
per Share
Main Value DriversValue DeterminantsCash Flow FiguresValue of Equity
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One major, and frequently underestimated factor when it
comes to future growth potential in the video gaming
industry, is the “demographic progression” – kids acting
older than their actual age – and the increasing number of
female and older-age players grabbing a joystick or a
gamepad. By introducing social- and health-oriented
gaming concepts (e.g. “Wii-fitness”, “Dr. Kiwashima’s
Train Your Brain”), Nintendo has succeeded opening the
market of video games and attracting large groups of new
customers. Particularly among these recently “acquired”
customers – mainly female or of advanced age – Nintendo
has a unique competitive edge over its rivals, which might
be sustainable for Nintendo for a few years since its “life-
style and family brand-image” are difficult to duplicate.
Hence, we believe that Nintendo will be able to benefit
from its current market position, and realize extraordinary
growth rates during the upcoming years, especially when
the economy starts to recover on a global level. To
precisely account for Nintendo’s historically fluctuating
growth pattern and its strong correlation to the success of
its innovations and business cycles, we decided to apply
three particular stages of growth:
1. Extraordinary Growth Rate:
Increasing growth rates are expected in the next three
years as a result of an economical recovery, and a
persistent market expansion into new areas of business
by Nintendo (female and aged customers) with existing,
successful products (Wii, DS) and promising product
innovations such as the recently announced “Nintendo
3DS”.
To account for the high variability in growth rates and
the compounding effect, we have smoothed out the
predicted growth for the next three years by applying
the Expected Compound Annual Growth Rate (CAGR)
in our calculations. (Please refer to figure 7 and the
attached appendixes for further elaboration)
2. Transition:
Three to four years of decreasing growth rates would
follow, when the current product portfolio has exceeded
their life-cycles, and when competitors compensate and
offset Nintendo’s competitive edge regarding
interactive family games and motion-capturing (e.g.
expected introduction of Microsoft’s “Project Natal”
for the Xbox by the end of 2010).
3. Stable growth rate:
Terminal value is computed with stable growth rate
based on the level of global growth rate, since Nintendo
is an internationally well-diversified company.
Figure 6 illustrates the expected growth periods explained
above. For detailed figures please refer to the attached
spreadsheets.
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021-20%
0%
20%
40%
60%
80%
Historical Growth Rate Extraordinary Growth Rate Transition 2
Stable Growth Rate
Figure 6
Figure 7: Illustration of smoothed out growth rate for
2011 to 2013
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2011 2012 20130%
5%
10%
15%
20%
25%
30%
35%
Net Income Growth rate Av. Growth Nint.: CAGR Nintendo:
Figure 7
3. Forecast of Growth
3.1. Growth Rate for year-end 2009 to year-end 2010
To forecast future growth rates for the expected
extraordinary growth period from 2011 to 2013, we first
estimated Nintendo’s past growth rate for the most recent
financial year from March 09 to March 10. Examining
Nintendo’s historical sales based on quarterly figures since
2003, there is an apparent pattern regarding the proportion
of annual sales throughout the four quarters. Generally the
4th quarter is the weakest period of the year after a usually
very strong 3rd quarter, most probably due to worldwide
festive sales. On average, the 4th quarter accounted for
18.51 % of annual incomes over the last few years.
Extrapolating Nintendo’s recently released sales figures
for the first three quarters of 2009 we expect total annual
revenue of 1.45 Bill. Yen, corresponding to a growth rate
in sales of -21.09 percent, and an expected Net Income of
232,751.41 Mill. Yen in 2009.
Figure 8 shows the quarterly numbers in sales, net- and
operating income (in million Yen) and the proportion of
annual Net sales per quarter:
1st 033rd 03
1st 043rd 04
1st 053rd 05
1st 063rd 06
1st 073rd 07
1st 083rd 08
1st 093rd 09
0 ¥
100,000 ¥
200,000 ¥
300,000 ¥
400,000 ¥
500,000 ¥
600,000 ¥
700,000 ¥
0%
10%
20%
30%
40%
50%
60%
Proportion of Net Sales Net Income Net Sales Operating Income
Figure 8
3.2. Forecast of Growth 2011 to 2013
To come up with an adequate rate of growth for Nintendo
in the upcoming years, we have decided to take into
consideration 4 main factors:
a) Historical Results of the Company according to their
usual growth trends
b) The current worldwide economical situation
c) Prediction on Nintendo’s launch of new console
d) Impact of competitors on Nintendo’s Historical and
projected financial performances
a) Historical Results and trends
As observed in the graph below and as explicitly detailed
in our 3-stage growth model analysis, Nintendo’s
performances follow a recurrent pattern. Basing our
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growth rate estimation on this first factor leads us to
assume the following forecasts:
- Based on their product launch patterns, Nintendo’s
growth rate should increase consequently within the
next 3 years.
- In 2013, Nintendo’s growth rate should reach its peak
and start decreasing before experiencing the final
stage of stabilization.
b) Worldwide Economic Situation.
Over the years, Nintendo’s sales growth trend has been
highly correlated to the world GDP growth rate.
Nintendo’s performances have therefore always perfectly
matched the world’s economy. Hence, we have decided to
compute Nintendo’s future growth rate by taking into
consideration the expert forecasts from IMF (International
Monetary Fund), and additional sources on the world
economy for the next 3 years. Based on these expert
analyses regarding the performances of the worldwide
economy, we have attempted to extract a general trend in
order to be accurate and realist in our calculation. For the
next 3 years, our forecasts for the world GDP real growth
rate will be around 3.10% for 2011, 4.00% for 2012 and
lastly 4.50% for the year 2013.
Figure 9 highlights the impressive correlation and puts
into perspective the performances of Nintendo in relation
with the global economy for the upcoming years:
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20130%
1%
2%
3%
4%
5%
6%
-100%
-50%
0%
50%
100%
150%
200%
World GDP Real Growth Rate (%) Net Income Growth rate Net Sales Growth Rate
NDS 2Wii 2
Xbox Natal
Wii
Xbox 360/PS 3/
PSP
NDS
Figure 9
c) Success of Nintendo’s launch of new console
According to various sources and concordent with
Nintendo’s product innovation cycle, the video-game firm
would release an update of the successful Wii beginning
of 2011. The “Wii 2” would offer both better graphics by
providing an HD resolution and more sensitivity in its
captors. The release would is predicted to bump
Nintendo’s performance as it would respond to the critisim
and complaints of many of its users. Moreover, the launch
of a new Nintendo DS would also be in the pipeline for
2011.
The juxtaposition of both events would have a direct
positive impact on the firm’s revenue. However, because
those two events represents simple update of existing
products, their impact on Nintendo’s growth rate would
not be as significant as the one experienced in 2005
(163.35%).
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d) Impact of competitors on Nintendo’s historical and
projected financial performances
The release of competing products have always somewhat
affected Nintendo’s trend to a certain extent. In the last 4
years (since the release of the “Wii “), the impact of
Nintendo’s competitor’s products on its performances has
been rather low, as Nintendo has succeeded in positioning
its product on a different level of entertainment and
therefore conquering a quite different target market.
However, prior to the “Wii” success, Nintendo’s main
competitor, Sony, was dominating the market with the
PlayStation 2, which impacted Nintendo’s finances in the
years 2003, 2004. Therefore based on past experiences, we
can assume that the future launch of Microsoft’s “Project
Natal” will have a negative impact on Nintendo’s financial
statements.
Figure 9 emphasizes both the historical trends and the
forecast for the next three years in terms of new product
releases.
e) Growth rate figures from 2011 to 2013
Based on the four above factors and on their high
correlation with Nintendo’s financial performances we
have computed the forecasted rate of growth for the three
upcoming years. While the first figure of 2011 resembles
results of the raw calculation of the growth rate formula
(Expected Growth Rate for 2011 = Equity Reinvestment
Rate 2010 * Return on Equity 2010) 8.14% vs. 6.29%, we
observe some disparities in the computations for the two
remaining years. These latter differences can be explained
through the constant aspect of the Return on Equity
figures (around 18.5% for the three years). Therefore, we
have decided to base our computations on the factors
explained above, as they tend to be in precise concord
with the market reality. The results of our estimation give
us a rate of growth of 8.14% for 2011, around 20.00%
for 2012, and close to 30% for the year 2013. The 3
mentioned rates fall under a fair evaluation of the four
factors’ evolution over the next 3 years and are on top of
that in perfect accordance with the projected growth
pattern of the firm.
4. Discount Rate for Nintendo
To determine the value of Nintendo using the FCFE
model, the discount rate for future cash flows is an
important factor. We would examine Nintendo’s costs of
capital the cost of equity, since there we use FCFE and
there is no debt in Nintendo’s books. To figure out the cost
of equity, three major input factors have to be determined:
the risk-free rate, the market risk premium for Nintendo’s
home market Japan, and the respective beta. The risk free
rate for Japan can be derived from the yield of a 30-year
treasury bond.
According to Bloomberg the currently 2.34% are a good
estimate:
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Figure 10
http://www.bloomberg.com/markets/rates/japan.html
The market risk premium is rather difficult to define.
According to Prof. Damodaran from New York
University’s Stern School of Business, 5.40% are a good
estimate as of January 2010. To come up with that
number, he started with Japan’s country rating (from
Moody's: www.moodys.com), and estimated the default
spread for its rating (based upon traded government
bonds) over a default free government bond rate. This
became a measure of the added country risk premium for
Japan. He added this default spread to the historical risk
premium for a mature equity market (estimated from US
historical data) to estimate the total risk premium.
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/
ctryprem.html
Lastly, we extracted Nintendo’s beta from Bloomberg at
0.93. Comparing it with other sources like Financial Times
and Reuters we believe that this is a reasonable estimate.
Plugging those three numbers in the following equation,
we derive a cost of equity for Nintendo of 7.35%.
Cost of Equity=R f +β∗Rmrp
5. Adjustments
5.1. Research & Development Expenses
As a major player in the console video game industry, the
bulk of Nintendo’s annual reinvestment budget goes into
research and development on research and development to
continue innovating new products for the rapidly changing
technological market with shorter product life cycles. Due
to the conservative accounting measures that require R&D
expenses to be expensed in the same period of occurrence,
the value of the assets created by research does not show
up on the balance sheet, resulting in understating the
amount of assets that Nintendo actually has. To provide a
more accurate view of Nintendo, we have capitalized the
research assets, and adjusted the balance sheets and
income statements accordingly.
Due to the lack of financial information available, we are
only able to perform adjustments to the years 2007-2009.
The assumption made about the time taken for Nintendo’s
research and development to be converted into
commercial products is 5 years, the average time for
Nintendo to come up with a new product line. Thus, 5
years is the amortizable life of the research assets. The
respective adjustments and the adjusted financial
statements could be viewed in the appendix. The graphs
below show the effect of the adjustments on the net
income and return on equity for the years 2007-2009.
Net Income Adjustments 2007-2009:
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2007 2008 20090 ¥
100,000 ¥
200,000 ¥
300,000 ¥
400,000 ¥
500,000 ¥
174,290.00
257,342.00279,089.00
162,685.80
367,896.20
430,096.80
Original Adjusted
Figure 11
Return on Equity 2007-2009:
2007 2008 20090.00%
5.00%
10.00%
15.00%
20.00%
25.00%
11.22%
14.20%15.14%
9.86%
19.27%
22.00%
Original Adjusted
Figure 12
5.2. Forecasting Financial Statements
The adjusted earnings growth for 2008 and 2009 are
126.14% and 9.5% respectively, mainly due to the sales of
the Nintendo Wii doubling from 2007 to 2008. Though
earnings growth rates is believed to slow down to 5%
according to the recent economic growth forecast of 5%,
Nintendo’s continuous expansion plan allows the investors
to believe in the optimistic growth momentum. Hence, the
forecast for the Nintendo’s earnings growth for 2010-2013
years is adjusted to 13.5% due to the forecasted release of
the 2nd generation Nintendo Wii, featuring high definition
resolution. The forecasted financial statements are
attached in the appendix. The forecast financial statements
are also adjusted to capitalize on their research and
development expenses.
Forecasted Items AssumptionsForecast
Ratios
Income Statement
Revenue3-Stage Growth
Model
As per
assumptions in
model
Operating
ExpenseProportion to Sales 72.00%
Depreciation/
Amortization
Proportion to Other
Assets30.00%
Tax Rate Marginal Rate 44.79%
Balance Sheet
Current Assets Proportion to Sales 101%
Current Liabilities Proportion to Sales 31.00%
Research Asset Proportion to Sales 8.00%
Common Equity Remain Constant $21,700.00
Treasury Stock Remain Constant $(155,400.00)
Minority Interest Remain Constant $25.00
Cash & ST Inv. Plug Figure
6. Equity Reinvestment Rate:
In the past few years, Nintendo’s Equity Reinvestment
Rate closely followed an explicit pattern, reaching high
reinvestment rates in high growth periods, up to more than
a 100% for example in 2007. In contrast, requirements for
capital reinvestment have been rather small during years
of moderate growth like 2009 amounting to only 9,56%.
As a closer look to the figures unveils, Nintendo has a
distinct need for massive increases in working capital in
high-growth years – change in working capital for instance
ballooned by 380% from ‘06 to ‘07 – leading to a
relatively low Free Cash Flow to Equity compared to Net
Income. Excluding additional adjustments for
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amortizations and depreciations from the FCFE
calculation, the picture gets even clearer: Capital
expenditures increased considerably in boom years like
2007 to 2009 as well.
As mentioned earlier, we anticipate a strong boost in sales
and revenues for Nintendo from 2011 to 2013. Due to
2009 and 2010 being exceptional years for the global
economy in general, forecasting the Equity Reinvestment
Rate by simply putting last years’ ROE and growth rate in
relation is not an appropriate, realistic assumption.
Instead, to achieve the predicted increase in sales and new
product introductions, large capital expenditures and a
sharp increase in working capital will be inevitable. To
reflect that, we apply the average of the last 5 years’
Equity Reinvestment Rate as an estimated input figure for
the upcoming extraordinary growth periods, because these
years best match the capital needs Nintendo will
experience.
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”:
2010 (forecast)
20092008200720062005-100,000 ¥
0 ¥
100,000 ¥
200,000 ¥
300,000 ¥
400,000 ¥
500,000 ¥
-30%
-10%
10%
30%
50%
70%
90%
110%
130%
150%
11.51%
49.36%
131.52%
40.91%
9.56%
48.57%
Net Income = FCFE Equity reinvestment rate
Figure 13
7. Stable Growth Inputs:
In the long run, we do not expect Nintendo to maintain
either extraordinary growth rates or exceptional Returns
on Equity figures. Long-term ROE – based on a smoothed
out average of past boom and baisse years since 1999 – is
therefore estimated to amount to 11.58 % as soon as
Nintendo reaches its stable growth period. This number
reflects Nintendo’s unique position as one of Asia’s most
prominent companies, taking into account that typical
ROE figures for the sector, and the industry average,
fluctuates around 10 percent, a benchmark for Nintendo.
Having no negative earnings and a relatively stable size of
the company in the past, this supports the approach of
applying the historic 10-year average ROE as an
estimation of stable return on equity.
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As Nintendo is operating globally and expanding to
emerging markets of late, its long-term growth rate will be
determined by the growth rate of the world economy. In
accordance with IMF forecasts and historical figures from
the last 10 years, we assume the GDP of 1st world
countries and emerging markets – Nintendo’s main sales-
regions – to grow with 4.50 percent per year on average.
Since Nintendo’s business is highly exposed to
traditionally low-growth markets such as Japan, its growth
rate will stabilize slightly below world economy growth at
4.00 percent from 2017 onwards.
Figure 14 illustrates the exposure of Nintendo to the world markets:
2006 2007 2008 20090%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Japan Americas Europe Other
Figure 14
As a consequence of the growth and ROE figures
explained above, a constant Equity Reinvestment Rate to
Equity of 30.76 percent will be necessary in the stable
growth period according to the standard growth formula:
Growth g=ROE∗Equity Reinvestment Rate
→ ERR= gROE
= 4.00 %11.58 %
=30.76 %
Regarding prospective, long-term discount rates and risk-
premiums, the current worldwide national debt problems
are a major factor from our point of view.
Please refer to figure 15 for a detailed illustration of
recent developments in terms of national debt in the US
and Europe:
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 (est.)
2011 (est.)
0 $
2,000 $
4,000 $
6,000 $
8,000 $
10,000 $
12,000 $
14,000 $
16,000 $
18,000 $
0%
20%
40%
60%
80%
100%
120%
US Gross Debt in Billions undeflated European Union (27 countries, in Billion EUR) as % of US GDP
as % of EURO GDP
Figure 15
The urgent debt problems in the USA, Europe and Japan
are likely to cause rising inflation in the upcoming years
on a worldwide level. Since Federal Reserve (FED) in the
US, as well as the European Central Bank (ECB), is
predicted to take measures to oppose inflationary
tendencies, higher risk-free rates are the logical
consequence. As a side effect of increased inflation and
debt troubles, we expect the country risk premium for
Japan as well as the equity risk premium to increase
slightly.
Scenario Analysis
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To account for the dynamic nature of the current economic
environment, we have formulated scenario analyses to
account for extreme conditions on either sides of our base
valuation of Nintendo.
Bear Bull
Years of Extraordinary Growth 1 5
ROE (Extraordinary) 3.27% 32.33%
ROE (Stable) 11.57% 11.57%
Risk Free Rate 6.00% 5.00%
Growth Rate (Extraordinary) 0.93% 18.93%
Growth Rate (Stable) 3.50% 4.50%
1. Valuation in the Bear Scenario
Nintendo’s growth will be adversely affected if the world
economy fails to sustain its recovery. Credit conditions are
still tight in major developed economies, where the
rebound in domestic demand seems more tentative than
self-sustaining. Moreover, the widely debated prophecy of
a world economic crisis in 2012 is anticipated, with China
being speculated as the next greatest bubble to burst with
massive misallocation of wealth. Taking into account
these factors, we have reduced growth rates to 0.93% for 1
year of extraordinary growth stage and 3.50% for the
stable stage. Risk free rate is at 6.00% due to world debt
crisis and inflation causing increased level of interest
rates.
2. Valuation in the Bull Scenario
Global production and trade have bounced back and
confidence rebounded strongly on the financial and real
fronts with immense policy support. There has been
stabilization of both money and equity markets, with
tightening of bank lending standards. If policymakers are
able to make astute policy decisions to sustain recovery,
the world economy can well be on the mend. The
spectacular growth prior to 2007 could be seen again, with
Nintendo enjoying 5 years of extraordinary growth of
18.93% and a stable growth rate of 4.50%. Risk free rate is
at 5.00% considering a stable boom scenario.
Taking into account our current stock price of ¥31,900.00,
this represents a -15.89%% downside for the bear scenario
and an impressive 39.11%% upside for the bull case.
Recommendation and Summary
In hindsight, Nintendo has endured a tough time in the
past two years of worldwide meltdown. As a consumer
discretionary company running operating globally,
Nintendo has been affected by reduced consumer
confidence, unemployment and wage-cuts. Still, Nintendo
has maintained a strong overall position. As the world
continues to show signals of economic recovery, optimism
and a stabilizing equity markets, prospects are nothing but
glorious for Nintendo.
Despite sales of Nintendo’s blockbuster console “Wii” are
clearly slowing down and growth rate even has turned
negative since March 2009, the outlook for Nintendo is
generally positive. In relative to its rivals, Nintendo
maintains a valuable competitive edge by dominating the
rapidly growing video game market for aged and female
players. In addition, Nintendo has several promising
product innovations coming up such as the 3D handheld
console “3DS” and furthermore in the pipeline. Besides
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that, existing products are performing on a surprisingly
stable level.
Looking forward, the results of our estimation give us a
rate of growth of 8.14% for 2011, around 20.00% for
2012, and close to 30% for the year 2013.
As a fully equity financed company, Nintendo is currently
in a stable and healthy economic condition eliminating or
lowering risk factors such as default risk or the probability
of bankruptcy. On the other hand this policy of totally
avoiding leverage limits Nintendo’s Return on Equity and
increases cost of capital. However, since Nintendo is a
highly regarded, low-beta company, fund raising has never
been a problem.
Taking all major factors into consideration – growth,
margins, R&D and discount rates – our target price for
Nintendo is ¥40,824.67. We therefore recommend a
“strong buy” position for Nintendo. With a current share
price of ¥ 31.900 it is significantly undervalued by 21.86
%.
Furthermore Nintendo’s shares have been trading at a
Forward P/E of 14.98x as of 10th of March 2010, which
clearly emphasizes our assessment of Nintendo. Holding
slightly optimistic assumptions, a share price ranging
between ¥35.000 and ¥45.000 is most likely according to
Relative Valuation.
Analyzing the bear scenario – dominated by a negligible
worldwide recovery and exploding debt and inflation
problems – Nintendo’s downside risk appears to be limited
with a projected value of ¥27,527.04 and 15.89 %
overvaluation. On the opposite end of expectations, the
bull scenario shows splendid prospects for the company,
dangling a 39.11 % upside at an anticipated stock price of
¥52,397.02. Overall, the scenario analysis apparently
reinforces our recommended “strong buy” position for
Nintendo Company Ltd.
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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
Basis for financial analysis
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.
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Appendix I - Adjustments
Adjusted Income Statement
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 (EBIT)
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
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 Div
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
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
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Adjusted Balance Sheet
Year-ended 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Assets
Cash And ST Investments 1.220.060,00 1.414.491,00 1.408.634,00 1.483.567,53 1.629.851,43 1.796.526,21 1.986.433,20 2.229.910,57 2.504.816,31 2.807.572,01 3.132.652,11
Receivables (Net) 87.780,00 145.611,00 135.149,00 121.571,39 138.511,61 157.812,33 179.802,49 200.391,28 218.360,74 232.518,36 241.819,09
Total Inventories 88.609,00 104.842,00 144.752,00 112.723,26 128.430,54 146.326,53 166.716,22 185.806,53 202.468,14 215.595,36 224.219,17
Other Current Assets 140.116,00 144.060,00 148.676,00 150.866,56 171.888,86 195.840,50 223.129,65 248.679,73 270.979,31 288.548,50 300.090,44
Current Assets - Total 1.536.565,00 1.809.004,00 1.837.211,00 1.868.728,74 2.068.682,45 2.296.505,58 2.556.081,56 2.864.788,10 3.196.624,50 3.544.234,23 3.898.780,82
Other Assets 16.498,00 3.209,00 6.687,00 7.253,93 8.264,72 9.416,35 10.728,46 11.956,96 13.029,16 13.873,92 14.428,87
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 Assets 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
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' Equity
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
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Appendix II – FCFE Input figures
Adjusted Equity Reinvestment Rate
2010 (forecast) 2009 2008 2007 2006 2005
Net Income ¥232.751,41 ¥430.096,80 ¥367.896,20 ¥162.685,80 ¥98.378,00 ¥87.416,00
Current Assets ¥1.837.211,00 ¥1.809.004,00 ¥1.536.565,00 ¥1.018.730,00 ¥993.891,00
Current Liabilities ¥538.984,00 ¥565.374,00 ¥466.657,00 ¥182.274,00 ¥205.449,00
- Change in Working Capital ¥54.597,00 ¥173.722,00 ¥233.452,00 ¥48.014,00 ¥10.928,00
- CAPEX ¥22.956,00 ¥7.992,00 ¥6.144,00 ¥4.139,00 ¥2.061,00
- Acquisitions ¥0,00 ¥0,00 ¥0,00 ¥0,00 ¥0,00
+ Amortization Depreciation ¥36.434,20 ¥31.214,80 ¥25.633,20 ¥3.591,00 ¥2.931,00
- Net capital expenditure -¥13.478,20 -¥23.222,80 -¥19.489,20 ¥548,00 -¥870,00
= FCFE ¥119.701,25 ¥388.978,00 ¥217.397,00 -¥51.277,00 ¥49.816,00 ¥77.358,00
Dividend Pay-outs ¥227.458,00 ¥97.110,00 ¥49.857,00 ¥34.943,00 ¥18.455,00
Cash to stockholder to FCFE ratio 58,48% 44,67% -97,23% 70,14% 23,86%
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.
Equity reinvestment rate = 9,56% 40,91% 131,52% 49,36% 11,51%
(Net Income - FCFE)/Net Income
Average Equity reinvestment rate 48,57%
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Growth Rate 09 to 10 – Quarterly Sales, Net- and Operating Income Figures
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
Net Sales (accumulated per year) 340439 694803 1316434 1672423 423380 836879 1526348 1838622 253498 548058 1182177 1450785,46
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%
Average share of income in 4th quarter 20,83%Average Net Sales in 4th quarter 18,51% Expected sales growth rate 2009 to 2010
Average Operating Income 4th quarter 11,42% -21,09%
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Forecast of Growth Rates 2011 to 2013
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%
Compound Annual Growth Rate CAGR (2010-13):
13,93% CAGR Nintendo: 13,93% 13,93% 13,93%
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Stable Growth Input Figures
Expected terminal growth 4,00%
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%
Arithmetic Average ROE (as Proxy for future) 12,98%
Geometric Average ROE (as Proxy for future) 11,57%
Reinvestment Rate to Equity: 30,81%
(Terminal growth/ROE)
Note:
Historic Average growth applicable since there were no negative earnings and relatively stable size of the company in the past
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Appendix III – Valuation
FCFE Valuation (1/2)
History
Extraordinary Growth Transition
Stable Growth
(¥ in millions except for per share data) 2010 2011 to 2013 2014 2015 2016
2017 Onwards
3 2 1
Company Data:
Historical beta 0,89 0,92 0,95 0,97 1
Adjusted beta 0,93 0,95 0,96 0,98 1,00Value of cash (including short term investments and marketable securities) ¥1.408.634,00
Share price (11 March 2010) ¥31.900,00
Shares outstanding (in millions) 127,885
Value of equity ¥4.079.522,60
Discount Rate calculation:
Beta of operating assets 0,93 0,96 0,98 0,99 1,00
Risk-free rate 2,34% 5,00%
Japan Country Premium 0,90% 1,00%
Additional risk premium 4,50% 5,00%
Cost of equity 7,34% 8,26% 9,17% 10,09% 11,00%
Cash Flow calculation:
Duration (years) 3 1 1 1 (Expected Compound Annual) Growth Rate for period -16,60% 13,93% 11,45% 8,97% 6,48% 4,00%
Return on Equity 18,56% 28,69% 28,85% 24,41% 19,20% 11,57%
Reinvestment rate 48,57% 48,57% 39,69% 36,73% 33,77% 30,81%
Cost of equity 7,34% 8,3% 9,17% 10,09% 11,00%
Tax rate 37,74% 39% 40% 40% 40,69%Adjusted Net income in previous year ¥430.096,80 ¥232.751,41
¥344.236,27 ¥383.654,01 ¥418.056,98 ¥445.162,09
Adjusted Net Income in current year ¥232.751,41 ¥265.183,86
¥383.654,01 ¥418.056,98 ¥445.162,09 ¥462.968,57
FCFE in current year (based on Adj Net Income and Reinvestment rate) ¥119.701,25 ¥136.380,86
¥231.376,81 ¥264.499,18 ¥294.824,91 ¥320.321,65
PV of future Free Cash Flows to Equity ¥461.468,95
¥172.793,14 ¥223.796,38 ¥245.313,14
Net income in first year of stable growth ¥462.968,57Terminal value (no change in tax rate) ¥4.576.023,61
Terminal value (change in tax rate) ¥4.359.343,06
PV of cash flows in stable growth ¥2.708.846,31
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FCFE Valuation (2/2)
Value of operating assets ¥3.812.217,92Value of cash and ST marketable securities ¥1.408.634,00
Value of equity ¥5.220.851,92
Shares outstanding (in millions) 127,885
Share price ¥40.824,67
Over/undervalued by 21,86%
Recommendation strong buy
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Relative Valuation (1/3)
Dataset obtained on 10th of March 2010
Name of Company Forward P/E P/E P/S P/B Beta NINTEDO 14,94 12,46 2,40 2,27 0,89
Pee
r-G
roup
(E
nter
tain
men
t-E
lect
roni
cs a
nd V
ideo
Gam
es)
Sony Corporation 35,13 -81,32 0,44 1,04 1,44
Microsoft 13,48 14,75 4,34 5,77 0,98Sega Sammy 19,01 - 0,75 1,18 0,87Mattel 12,87 13,99 1,48 1,49 1,15HappiNet Corporation 9,42 10,48 11,67 0,64 0,45Nihon 32,81 77,31 1,78 1,35 0,71Apple 16,57 18,98 4,43 5,79 1,57LeapFrog 13,18 21,57 1,23 2,42 2,17Konami 14,21 18,29 0,84 1,23 1,10
Electronic Arts Inc. 29,81 54,25 1,56 2,12 1,30
THQ 20,68 52,15 0,47 1,23 2,26
Take-Two Interactive 7,35 -20,65 0,81 1,53 1,24Activision Blizzard 14,45 16,38 3,24 1,29 0,64Navarre Corporation 6,44 6,37 - - 1,75Nokia 12,56 14,66 0,90 2,82 1,42GameStop 8,13 9,34 0,32 1,09 0,96
Minimum 6,44 -81,32 0,32 0,64 0,45 Median 14,21 14,71 1,35 1,42 1,15 Maximum 35,13 77,31 11,67 5,79 2,26 Mean 16,53 14,94 2,29 2,08 1,23 Std. Deviation 858,71% 3421,28% 282,34% 155,51% 50,29% 90th percentile 31,00989501 53,2 4,385 4,295 1,918 (¥ in millions of YEN) Forecast Earnings 2010 ¥232.751,41 Forecast Sales 2010 ¥1.450.785,46 Current Book Value ¥1.535.048,08 Common Stock Outstanding ¥127,88 Forecast Earnings per share ¥1.820,08 Forecast Sales per share ¥11.344,90 Forecast Book Value per share ¥12.003,82 Current Share Price ¥27.200,00
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Relative Valuation (2/3)
Market Price Estimates
Relative Valuation Based OnPessimistic
(assume median)Base
Optimistic (assume 90th percentile)
Forward P/E ¥25.863,29 ¥30.089,88 ¥56.440,39
P/S ¥15.365,23 ¥25.991,04 ¥49.747,37
P/B ¥17.063,30 ¥24.953,70 ¥51.556,39
P/E ¥26.764,23 ¥27.188,27 ¥96.828,08
Forward P/E
P/S
P/B
0.00 ¥ 10,000.00 ¥ 20,000.00 ¥ 30,000.00 ¥ 40,000.00 ¥ 50,000.00 ¥ 60,000.00 ¥
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Relative Valuation (3/3)
Name of CompanyPEG
(Cur. PE/1 year forward Growth)
Forward P/EProjected Growth
(10-11)EPS Next
FYP/E
EPS Cur. FY
NINTEDO 0,86 14,98 14,69% 2087,33 12,68 1819,99
Microsoft 1,56 13,48 9,45% 2,20 14,75 2,01
Mattel 1,66 12,87 8,43% 1,80 13,99 1,66
Konami 0,63 14,21 28,97% 1,38 18,29 1,07
Electronic Arts Inc. 0,66 29,81 82,35% 0,62 54,25 0,34
THQ 0,37 20,68 141,67% 0,29 52,15 0,12
Activision Blizzard 1,18 14,45 13,89% 0,82 16,38 0,72
Navarre Corporation - 6,44 0,00% 0,32 6,37 0,32
Nokia 0,89 12,56 16,50% 1,20 14,66 1,03
LeapFrog 0,35 13,18 62,07% 0,47 21,57 0,29
Apple 1,31 16,57 14,52% 13,41 18,98 11,71
GameStop 0,62 8,13 15,04% 2,60 9,34 2,26
0.00 10.00 20.00 30.00 40.00 50.00 60.000.00%
25.00%
50.00%
75.00%
100.00%
125.00%
150.00%
PEG (Cur. PE/1 year forward Growth) Linear (PEG (Cur. PE/1 year forward Growth))
Current P/E
On
e-y
ear
fo
rwar
d g
row
th
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Appendix IV – Diagrams
Figure 1
Figure 1 underlines the abrupt halt in software as well as hardware sales in 2009:
2004 2005 2006 2007 2008 20090
10
20
30
40
50
60
70
-10%
0%
10%
20%
30%
40%
50%
10 12.5 17 24 28.5 30.519.5 20
21.5
2836.5 35.5
Video Games Value Sales Performance by Type
video games harware retail value RSP video games software retail value RSP
Hardware y-o-y value growth (%) Software y-o-y value growth (%)
Bil
l. U
S $
Figure 16
Figure 2
Figure 2 displays the most important markets in regards to consumption per capita:
UKUSA
France
Austra
lia
Canada
Italy
Japan
Spain
Germany
China0
20406080
100120140160180
Per Capita Toy Consumption in 10 Largest Markets2009
US
$ p
er
cap
ita
Figure 17
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Figure 3
Figure 3: Current P/E (x-axis) to one-year Forward Growth (y-axis)
0.00 10.00 20.00 30.00 40.00 50.00 60.000%
25%
50%
75%
100%
125%
150%
PEG (Cur. PE/1 year forward Growth)Linear (PEG (Cur. PE/1 year forward Growth))
Current P/E
On
e-y
ea
r fo
rwa
rd g
row
th
Figure 18
Figure 4
Figure 4: Displays the expected range of fair prices for Nintendo according to possible scenarios (grey: pessimistic, red: optimistic)
Forward P/E
P/S
P/B
0.00 ¥ 20,000.00 ¥ 40,000.00 ¥ 60,000.00 ¥
Figure 19
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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.
20062007
20082009
20102011
20122013
20142015
20162017
20182019
20202021
-20%
0%
20%
40%
60%
80%
Historical Growth Rate Extraordinary Growth Rate
Transition 2 Stable Growth Rate
Figure 21
Nintendo Co. Ltd Page 8
Nintendo‘s Road-Map to ValuationSales
Growth Forecast (%)
Operating Margin (%)
Equity Reinvestment Rate (%)
Tax Rate (%) &
Interest Expenses
Adjustments
EBIT
Net Income
FCFE
Cost of Equity (%)
Equity Value of Operating
Assets
+ Value of Cash and ST
Securities
= Value of Equity
Number of Shares
Fair Value per Share
Main Value DriversValue Determinants Cash Flow Figures Value of Equity
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Figure 7
Figure 7: Illustration of smoothed out growth rate for 2011 to 2013
2011 2012 20130%
5%
10%
15%
20%
25%
30%
35%
Net Income Growth rate Av. Growth Nint.: CAGR Nintendo:
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:
1st 03
3rd 0
3
1st 04
3rd 0
4
1st 05
3rd 0
5
1st 06
3rd 0
6
1st 07
3rd 0
7
1st 08
3rd 0
8
1st 09
3rd 0
90 ¥
100,000 ¥
200,000 ¥
300,000 ¥
400,000 ¥
500,000 ¥
600,000 ¥
700,000 ¥
0%
10%
20%
30%
40%
50%
60%
Proportion of Net Sales Net Income Net Sales Operating Income
Figure 23
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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:
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20130%
1%
2%
3%
4%
5%
6%
-100%
-50%
0%
50%
100%
150%
200%
World GDP Real Growth Rate (%) Net Income Growth rateNet Sales Growth Rate
NDS 2Wii 2
Xbox Natal
Wii
Xbox 360/PS 3/
PSP
NDS
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
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Figure 11
Net Income Adjustments 2007-2009:
2007 2008 20090 ¥
100,000 ¥
200,000 ¥
300,000 ¥
400,000 ¥
500,000 ¥
174,290.00
257,342.00279,089.00
162,685.80
367,896.20
430,096.80
Original Adjusted
Figure 26
Figure 12
Return on Equity 2007-2009:
2007 2008 20090.00%
5.00%
10.00%
15.00%
20.00%
25.00%
11.22%
14.20% 15.14%
9.86%
19.27%
22.00%
Original Adjusted
Figure 27
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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”:
2010 (forecast)
20092008200720062005-100,000 ¥
0 ¥
100,000 ¥
200,000 ¥
300,000 ¥
400,000 ¥
500,000 ¥
-30%
-10%
10%
30%
50%
70%
90%
110%
130%
150%
11.51%
49.36%
131.52%
40.91%
9.56%
48.57%
Net Income = FCFE Equity reinvestment rate
Figure 28
Figure 14
Figure 14 illustrates the exposure of Nintendo to the world markets:
2006 2007 2008 20090%
10%20%30%40%50%60%70%80%90%
100%
Japan Americas Europe Other
Figure 29
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Figure 15
Please refer to figure 15 for a detailed illustration of recent developments in terms of national debt in the
US and Europe:
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 (est.)
2011 (est.)
0 $2,000 $4,000 $6,000 $8,000 $
10,000 $12,000 $14,000 $16,000 $18,000 $
0%
20%
40%
60%
80%
100%
120%
US Gross Debt in Billions undeflated European Union (27 countries, in Billion EUR)
as % of US GDP as % of EURO GDP
Nintendo Co. Ltd Page 13