Nintendo Rakes It In...But For How Long?

Not even a slowing economy and an unfavorably strong Japanese yen could get in Nintendo’s way. For the fiscal year through March, the video game company reported on April 24 a mind-boggling 52.6% jump in operating earnings, as its Wii and DS portable gaming machines continued to rack up brisk sales.

Last year, Nintendo’s operating income more than doubled to $4.7 billion thanks to a whopping 73% jump in sales to $16.2 billion. And its profit margins edged up to 29%, from an already impressive 23% the previous year.

But not all is jolly in Nintendo-land. The company’s forecasts for this year are far less impressive, with single-digit gains expected for both revenues and operating profits in the current fiscal year.

This reflects a simple fact: Fewer consumers will be blowing their paychecks on video games if the economy turns south. And of the big three video game console makers, Nintendo is the one that stands to lose the most if a recession hits. That’s because it has wooed ordinary consumers who might not normally buy a video gaming machine but were drawn in by the DS’s easy-to-use touch screen and the Wii’s motion-sensing remote controller, which can be swung like a baseball bat or pointed at the screen and shot like a gun. During the good times, those consumers helped Nintendo put some distance between itself and Microsoft’s Xbox 360 and Sony’s PlayStation 3. But the diehards who make up most of Microsoft’s and Sony’s buyers are likely to continue adding to their gaming libraries even if the economy stalls, and that makes Nintendo’s rivals more resilient to a slowdown.

Some analysts had seen it coming. Before today’s earnings announcement, KBC Securities’ analyst Hiroshi Kamide had a “hold” recommendation on Nintendo’s shares. His “cautious outlook”, he said, stems from his view that “a U.S.-led recession will be negative on the casual gaming market.” Since January, the company’s shares have fallen 12%, along with the benchmark Nikkei 225 stock average, but in the past 12-month period its stock price is still up 60%.

Another concern: Slowing sales of the portable DS in Japan. The DS went on sale in 2004 and it’s starting to reach the peak of its life cycle.

A look at its forecast for DS sales this year is revealing. Last year, the company sold 30 million DS consoles, up 29% from the previous year, putting the cumulative total at 70.6 million units. But sales in Japan during that period fell 30% to 6.3 million machines from more than 9 million. (U.S. and European sales remained strong.) And this year's projected DS sales of 28 million units shows that falling sales in Japan could offset growth elsewhere for the first time.

The company’s saving grace will be software sales, which are still on the rise. Though only a fraction of the 342 new game titles for the DS and 184 for the Wii came out of Nintendo’s own studios last year, it earns from royalties from every game sold. How many was that? 185 million game packs for the DS and 119 for the Wii. Just two weeks ago, Goldman Sachs revised upward its software unit-sales projections for the next two years.

Many analysts think Nintendo has been ramping up Wii to shorten the wait for the machines overseas, where retailers are still selling out of the Wii as fast as they can restock their shelves. That should offset some of the recent losses from the yen’s appreciation in value against the dollar and euro. (As the yen goes up, the income Nintendo earns overseas shrinks when those funds are converted to yen.) And if the stellar debut of the new physical fitness game, Wii Fit, in Japan can be repeated in the U.S., where it goes on sale next month, and Europe months later, then Nintendo shouldn’t have too much to worry about. Still, some analysts think Sony’s PS3 will close the gap with the Wii this year, as it plays up its next-generation Blu-ray DVD player and two new features slated for launch later this year--a video download service and a new online 3-D social networking service. It will be interesting to see what creative new ways Nintendo thinks up to keep the momentum going.

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