Q3:14 results reflected recent guidance cuts and included many significant year-over-year declines. It is clear to us that the Nintendo model of proprietary hardware supported by compelling proprietary software is broken. Nintendo recently slashed FY:14 Wii U hardware guidance to 2.8 million units from 9.0 million units and software guidance to 19 million units from 38 million units after hardware price cuts in the U.S. and Europe failed to provide a significant lift to sales, despite hurting profitability. The Wii U is under-powered relative to the PS4 and Xbox One, and is not competitively priced. We don’t think Nintendo should exit the console hardware business, but think it should consider getting out of the Wii U business and reconsider its strategy for its next console.
Nintendo also lowered unrealistic 3DS hardware guidance earlier this month. It had previously guided to full year 3DS hardware units growth of roughly 30 percent year-over-year despite cannibalization of handheld sales by gaming on smart devices
The recent guidance cut appears to have forced a reevaluation of Nintendo’s business. According to a Bloomberg article from earlier this month, Nintendo President Iwata announced that the company is “thinking about a new business structure” and “studying how smart devices can be used to grow the game-player business.” We have long believed Nintendo should license some older IP for smartphone and tablet game developers, and see it is a lucrative opportunity that could restore profitability. President Iwata is expected to discuss the company’s smart device strategy at the Corporate Management Policy Briefing tomorrow.
On Wednesday, Nintendo announced a share repurchase authorization for up to 10 million shares. We believe the share repurchases may be intended in part to assist the founding family with selling some of its own shares to pay for lofty inheritance taxes after the death of a former President who held an 11 percent stake. According to the company, the decision was partly in response to lower profits, which have limited dividend size. We estimate the repurchases will be accretive to annual EPS by up to 8.5 percent when fully executed.
We are maintaining our NEUTRAL rating and 12-month price target of 12,000 yen. Our PT reflects a 10x forward EV/adjusted EPS multiple, and is a premium to its 9,000 yen/share in cash and investments.
Michael Pachter is an analyst at Wedbush Securities.