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Can Nintendo Play Hard Through a Recession?

The game maker expects strong holiday sales, as more consumers opt for home entertainment

Video games are recession-proof. That has been the conventional wisdom among gaming industry executives for years. But faced with the worst financial crisis in decades and the prospect of a global slowdown, will consumers see games as a frivolous expense?

Nintendo (NTDOY) CEO Satoru Iwata doesn't think so. On Oct. 31, Iwata predicted that this holiday season would help the Japanese company pull off its third straight year of record-high earnings. "In the near term, we don't expect the gaming business to be affected by economic trends," he told journalists and analysts in Tokyo.

Nintendo's latest update offers some evidence to back Iwata's claim. In its second-quarter earnings announcement a day earlier, Nintendo raised its sales forecast for the Wii living-room console to 27.5 million units for the year through next March, up from the previous projection of 26.5 million. "At the Nintendo store in New York, people are still lining up in the morning before it opens," Iwata said. Last year the company sold 18.6 million Wii machines. Nintendo kept its target for the DS portable console at 30.5 million units. Last year it sold 30.3 million.

Easier to Use, Less Expensive

Just as important, though, are the games themselves. Hundreds of other game makers develop software for Nintendo's consoles, but Nintendo games account for 15 of the 36 Wii titles and 30 of the 69 DS titles that have sold more than 1 million units, the industry benchmark for a hit title. In November, Nintendo will release in Japan a new slimmed-down version of its DS that's packed with features such as a camera, music player, and internal memory.

Nintendo's strategy has been to go after ordinary consumers with a console that's easier to use and less expensive than Microsoft's (MSFT) Xbox 360 and Sony's (SNE) PlayStation 3. Analysts credit Nintendo for helping to expand the global gaming market, which consultancy PricewaterhouseCoopers says was worth $41.9 billion last year. By 2012 that figure could reach $68.3 billion.

But not everyone believes the market will grow this year—or that Nintendo will sail through unscathed. Nintendo makes 90% of its revenues overseas. Yet while other major Japanese exporters, such as Sony and Honda (HMC), have warned of lower annual earnings because of the yen's sharp rise against the dollar and euro, Nintendo's revision was small. The company lowered its operating profit forecast by just 3%, to $6.5 billion, from its August prediction. Net profit will likely be $3.55 billion, 16% less than the earlier forecast.

Analysts fret about the effect increased currency volatility might have on Nintendo's results. In a recent report, Credit Suisse (CS) analyst Jay Defibaugh said that a strong yen could "severely undermine" Nintendo's growth potential next fiscal year. Goldman Sachs (GS) (which maintains a "buy" recommendation on Nintendo) estimates that a one-yen rise against the dollar erases $41 million from Nintendo's operating profits, and a one-yen gain against the euro results in $62 billion less profit.

Less Promising Lineup

That might help explain why Nintendo's stock has been hit harder than others in the market plunge, losing 29%, compared with 25% for the benchmark Nikkei 225 index. This week, KBC Securities' analyst Hiroshi Kamide downgraded Nintendo's stock to a "sell" recommendation, from "hold".

Must-have games can give console sales a boost. But Kamide thinks Nintendo's game lineup this holiday season, which includes Wii Music and Animal Crossing, isn't as promising as last year's, when consumers flocked to get Wii Fit and Super Mario Galaxy. Indeed, from July to September, unit sales of both Wii and DS machines and games declined in some regions.

If the global economy hits the skids, Nintendo's Iwata envisions consumers spending less time away from home. Games would be an inexpensive way to have fun without going out. That has been the case with die-hard gamers whose game purchases tend not to fluctuate with the economic cycle. But games might be the first thing a not-so-serious gamer would scratch off the shopping list during hard times. Nintendo executives "see it as a strength that they have expanded the market by targeting casual gamers," says Kamide. "It was a master stroke. The problem in this recessionary environment is it could backfire."

Other major gaming companies appear to be cautiously optimistic. On Oct. 30, U.S. video game maker Electronic Arts (ERTS), which makes the Madden football series and other sports games, said that it's too early to tell if an expected slowdown will affect game sales this year, but noted some early signs of slowing retail sales.

Hall is BusinessWeek's technology correspondent in Tokyo.

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