The Horse Race Between Sony and Nintendo for #10 in Japan

Members of the financial press have been tripping over themselves to see who would be the first to chronicle that Nintendo has surpassed Sony in market capitalization to become the 10th largest company in Japan. This imaginary horse race has captured the attention of numerous observers and been blown out of proportion.

Well, On Friday, June 29, 2007 The Asahi Shimbun announced that “Nintendo Co. on Thursday (June 28) exceeded Sony Corp. in terms of market capitalization, ranking it among the nation's 10 largest companies in aggregate market value. Nintendo finished the day at 45,050 yen per share, which valued the company at 6.38 trillion yen, above archrival Sony's 6.24 trillion yen. Sony closed at 6,220 yen per share on Thursday.”

Unfortunately, this declaration was wrong for two reasons. First, Nintendo’s stock price at the close of trading on the Tokyo Stock Exchange (TSE) was 44,950 not 45,050. Second, and more importantly, Asahi Shimbun in its rush to declare Nintendo the winner failed to use the proper number of shares of stock.

The market capitalization (MarketCap) of a stock is defined as the share price times the number of shares outstanding. It is not the share price times the number of shares issued nor is it the share price times the number of shares authorized. Nintendo has reported that on March 31, 2007 it had 127,903,013 shares of common stock outstanding, while Sony has reported that it had 1,002,062,405 shares outstanding on that same date.

A correct calculation of market capitalizations using the June 29, 2007 Tokyo Stock Exchange closing prices of 44,900 yen for Nintendo and 6,330 yen for Sony shows that the MarketCap of Sony is 6,232,828,159,000 yen or $50.603 billion U.S. (123.17 yen=$1), while the MarketCap of Nintendo is 5,749,240,434,000 yen or $46.677 billion. For comparative purposes, Disney has a market cap of $69 billion, Apple $110 billion, IBM $159 billion, and Microsoft $288 billion.

While the MarketCaps of Sony and Nintendo are close, the companies are vastly different. Nintendo is highly acclaimed worldwide as a video game company that has a proven track record of producing breakthrough hardware systems and immensely popular, propriety games. It current focus is on growing the gaming market so it can sell more game products, since almost 100% of its revenue comes from the video game industry. Its sales increased 89% in fiscal 2007 and its net income rose 77%.

By contrast, the video game segment of Sony’s business accounted for only 12.3% of its total revenue in 2007. Its video game sales increased 6.1% and the game segment of Sony’s business produced an operating loss of $1.97 billion.

Nintendo Upward Guidance A Certainty

Nintendo management has a penchant for significantly understating future sales, income and dividends. This characteristic is admirable and indicative of its innately conservative corporate culture that has thus far benefited Nintendo stockholders. The pattern of Nintendo lowballing its likely financial results is clear and strongly suggests that the fiscal 2008 forecasted sales and net income per share included in its April 26, 2007 press release are artificially low.

The fact is that the 2007 fiscal year financial results released on April 26, 2007 dwarfed the guidance given by Nintendo on May 25, 2006, July 24, 2006, October 3, 2006, and January 10, 2007. Its May 25th forecast stated it expected 2007 net sales of 600 billion yen, net income of 65 billion yen, and earnings per share of 508.15 yen. Nintendo actually reported 966.5 billion yen in net sales, 174.29 billion yen in net income, and earnings per share of 1,363 yen. The actual results for fiscal 2007, which ended March 31, 2007, therefore, far exceeded the forecast made 10 months earlier. In fact, net sales were 61.1% above guidance, while earnings per share and net income were 168% above Nintendo management’s forecast.

Similarly, actual 2007 net sales exceeded the July 24th upward revised forecast by 55.7, while earnings per share were 110% above forecast. Nintendo revised its guidance upward once again on October 3rd but those revised net sales and earnings were exceeded by 30.6% and 74.5%, respectively. On January 10, 2007 Nintendo again revised its guidance upward but it still exceeded its upward revisions in net sales by 7.4% and earnings per share by 45.3%.

It is readily apparent that Nintendo management’s forecasts are consistently too low. Accordingly, investors can expect that Nintendo’s actual financial results for its fiscal year ending March 31, 2008 will far exceed its guidance of 1.14 trillion yen in net sales and earnings per share of 1,368 yen. Furthermore, investors can expect to see at least three significant upward revisions in net sales and earnings per share by Nintendo management during the next eight months. Those revisions will likely be announced in July, October, and January.

Nintendo’s Share Price Expected To Skyrocket

A few hours after this blog forecast that Nintendo would release an upward revision of its fiscal 2007 results it did exactly that. Nintendo’s April 5, 2007 announcement that it exceeded its own January 10, 2007 upward revisions was well received by shareholders.

The price of its shares rose 900 yen on the Tokyo Stock Exchange immediately following the Thursday mid-day press release and closed the day up 550 or 1.62%. The next day, Friday, April 6th, Nintendo rose an additional 800 yen or 2.33% to close at 35,100 yen, which put the intrinsic value of the NTDOY shares at $36.95.

The official April 5th release stated that the company intends to accelerate its financial closing process so that it will release its March 31, 2007 fiscal year results on April 26, 2007. That is a full month earlier than comparable releases in 2005 and 2006 and indicative of a company management that is anxious to report its good news

Nintendo whetted the appetite of shareholders when it stated that it exceeded its forecasts of sales, consolidated operating income, consolidated income before income taxes and extraordinary items, and consolidated net income. In particular it noted that sales were 66 billion yen greater and that foreign exchange would yield about a 30 billion yen boost. Nintendo also stated that it would likely pay its year-end dividend based on its 50% of net income.

These statements strongly suggest that Nintendo will report fiscal 2007 net income of about 159 billion yen or 1,240 yen per share up 62.6% from 2006. Furthermore, it will likely pay a year-end dividend of 550 yen, which is in addition to its regular 70 yen, interim dividend. Its expected total fiscal 2007 dividends of 620 yen would represent a 59% increase above its fiscal 2006 dividends of 390 yen.

An examination of quarterly results shows that Nintendo’s sales are in a dramatic uptrend. Its sales for the quarters ended June, September, and December were up 85%, 59%, and 75%, respectively over prior year comparable quarterly sales. Even more remarkable is the fact that its sales for the quarter ended March 2007 at 253 billion yen are expected to be about 160% above the comparable March 2006 quarter.

On April 5, 2007 Nintendo was selling at a price earnings (PE) ratio of 27.7 based on estimated fiscal 2007 earnings and it provided a healthy 1.8% dividend yield. Nintendo’s PE multiple is much too low considering its sales and income growth rates, its abundant cash position ($6.7 billion), its debt-free balance sheet, and comparable PE multiples of other publicly held gaming companies. For example, the PE multiple of Gamestop is 33, THQ is 45, Activision is 72, and Electronic Arts is 190. By the way, none of these companies pay a dividend.

Nintendo shareholders should expect generous total returns going forward from a combination of dramatic growth in earnings per share, further dividend increases , and a higher PE multiple. Furthermore, favorable financial coverage of Nintendo will surely call it to the attention of the investing public who remain largely unaware of how to buy stock in Nintendo.

Nintendo Expected to Announce Upward Revision of Fiscal 2007 Net Income

During the past two years Nintendo has established a pattern of announcing upward revisions of its forecasted fiscal year-end income and dividends during the first week in April. On April 6, 2005 it announced that it had exceeded its forecasted net income by 17.1% for its March 31, 2005 fiscal year. A year later on April 4, 2006 it announced that it had exceeded its forecasted net income for its March 31, 2006 fiscal year by 26.7%.

Within the next few days, shareholders should expect Nintendo to once again announce that it exceeded its forecasted net income for its latest fiscal year ended March 31, 2007. The forthcoming upward revision will be partially due to the fact that Nintendo’s earlier 2007 forecast assumed a weaker dollar and Euro versus the yen.

As of March 31, 2007 the U.S. dollar was trading at 118.05 yen and Euro was trading at 157.33 yen. Nintendo’s financial forecast modifications of January 10, 2007 assumed exchange rates of 115 yen to the U.S. dollar and 143 yen to the Euro. These differing exchange rates benefit Nintendo’s net income because it has deposits and receivables denominated in dollars as well as Euros. For example, as of December 31, 2006 Nintendo had about $3.9 billion in cash, deposits, and receivables denominated in U.S. dollars and $1.5 billion denominated in Euros.

A comparison of amounts denominated in other currencies along with the forecast versus actual exchange rates prevailing on March 31, 2007, Nintendo’s fiscal year-end, suggests that it will announce an increase in net income of about 5% above its January 10, 2007 forecast.

Stockholder Suggests Nintendo Make Shareownership Affordable for Individuals in Japan

The Tokyo Stock Exchange (TSE) classifies listed stocks into TOPIX categories that rank TSE first section stocks according to market capitalization and liquidity. The TOPIX Core 30 includes the 30 most liquid and highly capitalized shares. The TOPIX Large 70 includes the next 70 most liquid and highly capitalized shares. The TOPIX 100 includes all stocks in the Core 30 and Large 70 categories.

On February 28, 2007 Nintendo was ranked #16 on the TOPIX 30. With 127.9 million shares outstanding and a market price on that date of 31,400 yen, the total market value (market capitalization) of Nintendo was 4 trillion yen or $33.5 billion.

The minimum number of shares of Nintendo that can be purchased on the TSE is 100. Accordingly, at the end of February 2007 a purchaser would have had to pay 3.14 million yen or $26,167 to become a Nintendo shareholder. Only 4 other companies in the TOPIX 100 have a higher entry price to become a shareholder. How many individuals in Japan can afford to place such a stock order?

The entry price to become a shareholder in Nintendo is clearly too high in Japan. It simply does not sync with Nintendo’s recent public statement that it wants to widen its shareholder base and encourage shareholding by individual investors. Nintendo has stated that it has experienced a growing interest by individuals in owning Nintendo stock, which it attributes to the growing popularity of its DS handheld player and Wii console. Given these expressions of individual interest in owning Nintendo stock, it is time for Nintendo management to take positive action to promote such ownership.

The simplest and most meaningful way for Nintendo to achieve its stated objective of encouraging individual ownership is to lower the minimum number of shares of Nintendo that can be purchased on the Tokyo Stock Exchange to one (1) from the current 100 share minimum. There are currently 8 companies in the TOPIX 30 and 14 companies in the TOPIX 100 who already allow the purchase of a single share of their stock. Interestingly, this action would allow individuals to purchase a share of Nintendo stock at essentially the same price as a Wii console.

Going forward, the share price of Nintendo should rise dramatically during the next few years as production and sales of Wii consoles, DS handhelds, and related games expand. It will, therefore, become necessary for Nintendo to keep the entry price of ownership within the reach of the average individual by declaring either stock splits or stock dividends.

It would be a good idea for Nintendo to always keep the minimum price of stockownership close to the selling price of its Wii console. Millions of Nintendo fans could then enjoy their games, while participating in the profits they generate for the company. Such profits could then allow them to buy more games, thereby, further adding to Nintendo’s financial success.

Nintendo Secondary Offering Price of 30,478 Yen Should Provide Support

The secondary offering of the 1.987 million shares of Nintendo stock owned by the Banks' Shareholdings Purchase Corp was priced at 30,478 yen on Tuesday, March 6th after the Tokyo Stock Exchange closed. The offering price represented a 2.47% discount from the Tuesday's closing price of Nintendo which was 31,250 yen. Brokerage firms in the syndicate selling these shares include Nomura Securities, Nikko Citigroup, Shinko Securities, Mitsubishi UFJ Securities and Daiwa Securities SMBC.

Given the large number of non-Nintendo shares that must be liquidated going forward by the Banks Shareholdings Purchase Corp, there is considerable pressure on member firms in the selling group to make this offering a success. A successful offering will go a long way toward insuring that these brokerage firms will be included in future sales.

It would be embarrassing to the Japanese government if the price of Nintendo dropped below the offering price. In that event, a wave of public criticism would surely be leveled at government officials for allowing the Banks entity to dump shares on unwitting purchasers.

Accordingly, the pressure on brokerage firms and the Banks Shareholdings entity for a successful sale strongly suggests that the Nintendo secondary will be over-subscribed, the price will rise above the offering price, and 30,478 will become a floor under which Nintendo will not trade in the immediate future.

Intrinsic Value of NTDOY

On Wednesday, May 2nd Nintendo closed at 38,650 yen on the Tokyo Stock Exchange. That was down 150 yen or 0.38% from the previous close. As of 8 AM New York time, the U.S. dollar was trading at 120.185 yen. Accordingly, the intrinsic value of NTDOY at the start of Wednesday's trading in New York is $40.20. The Tokyo Stock Exchange will be closed on May 3 and May 4.