Nintendo must plot an exit from Switch’s uncharted territory

Investors have long hoped this would be the cycle that enabled the firm to break out of this volatile model. Many have suspected, prompted by what they see as hints from the company, that it would shift to a smoother upgrade model to keep customers locked in, something looks more similar to the iPhone’s generational upgrade cycle.

Now some are getting cold feet. A rumored “Switch Pro,” reported to be a more powerful version of the console, has failed to materialize; the company has denied in the strongest possible terms that such a device exists, beyond a vague 2020 reference to a “next gaming system” set to launch in “20XX.” Asked for comment, Nintendo said it was always considering future hardware, but had nothing specific to disclose. Amid the uncertainty, analysts are cutting their projections.

“We had thought the correlation between software, the real source of profits, and hardware would diminish with the Switch and had forecast Nintendo would transition to its next-generation console while maintaining a modest profit uptrend,” Citigroup Global Markets Japan Inc. analysts Junko Yamamura and Sachiho Uzaki wrote last month, joining others in cutting the stock to hold. “We prefer the sidelines and wait for a formal announcement.” Goldman Sachs Group Inc. is the latest to downgrade the stock this week, with now fewer than half of analysts rating it a buy, lower than before Pokemon Go became a smash hit in 2016.

This concern is logical. Demand for its franchises remains strong, but the company has repeatedly struggled to follow one hit product with another. An iPhone-like model makes sense on paper — eventually users are forced to upgrade while being pushed to stay in the ecosystem rather than jumping ship to an Android competitor. That prevents the kind of fall off seen between previous generations of Nintendo hardware, when there was little to stop users moving to a rival such as Sony Group Corp.’s PlayStation instead.

But is that the right model for a device just as often found in the schoolyard or under the TV — and if so, can the company execute it correctly? Recall that it followed up the iconic Wii with the confusing Wii U, which many dismissed incorrectly as an add-on rather than a replacement.

Some argue that this time it’s different. They say digital sales and smart use of its intellectual property, in the form of April’s Mario animated movie and the recently opened Super Nintendo World in Universal Studios Hollywood, will smooth any transition. Digital helps, but its mobile and IP segment make up less than 5 percent of revenue. The Switch accounts for fully 95 percent of sales; it’s become even more important as the firm has largely abandoned early attempts at mobile gaming.

The nervousness is compounded by the fact that, unlike previous generations, there’s no fallback. When the Wii U flopped, the 3DS handheld platform gradually took off, stabilising profits. But with the Switch, the company combined its portable and home-console devices — making for a steadier stream of first-party games, but also intensifying pressure to repeat the success. As it waits, optimism for a smooth landing seems to be fading.

The Mario maker is successful precisely because it so often flies in the face of common sense. Before the Switch, the consensus opinion was that it should abandon hardware entirely and focus on mobile — a strategy that not only would have eliminated its main competitive advantage, but also foregone more than $10 billion in profit made over the Switch’s lifetime.

But while surprises are good for gamers, they’re not necessarily the best for investors. Assurances that something is on the way, even if it’s too early for details, are needed. Consider that shares of Apple Inc., a company to which Nintendo is frequently compared, only really took off once it abandoned the shock and awe of its Steve Jobs-era “Jesus tablet”-style announcements, and switched to a more stable, predictable revenue stream under current head Tim Cook. As a result, the stock is finally valued at a level commensurate to its reach.

Bulls are right to suspect that Nintendo, with its global reach and timeless intellectual properties, is undervalued; Saudi Arabia’s sovereign wealth fund clearly agrees, having lifted its stake recently to 8.3 percent to become the largest single investor. But not all backers have such confidence. Uncharted territory makes them nervous. When lost in a sprawling video-game level, players’ most indispensable item is a map. Management should consider offering nervous investors something similar.

Gearoid Reidy is a Bloomberg Opinion columnist covering Japan and the Koreas. Views are personal and do not represent the stand of this publication. 

Credit: Bloomberg