Zynga and King's failure could be Nintendo's opportunity

As a long term Nintendo shareholder and fan, I nearly fell out of my chair the other day when I saw the movement of the share price.  Up more than 4% on 8.18 on the Tokyo stock exchange (though it's subsequently down a bit today as folks take some profit).

The reason: speculation that Nintendo will finally enter the booming mobile games market through its affiliate, The Pokemon Company, by launching a Pokemon game made for Apple's iPad. Though there is no exact date set yet articles appeared in both the WSJ (for those of you who still pay for news) and Bloomberg related to Nintendo's plans.   The Pokemon game in question, a trading card game (TCG), works perfectly for this franchise (since Pokemon is not only a hit TV show but also based on a real world collectable card game in its own right).  More importantly, the TCG mechanic has been tried and proven in Asia by many of Nintendo's would be competitors on mobile like Mobage (part of DeNA), who arguably pioneered the genre with Rage of Bahamut, Blood Brothers and Marvel: War of Heroes in 2012- 2013. Rage of Bahamut was a top selling iOS and Android game for much of 2013 and continues to be among the top 100 here in the United States while Marvel: War of Heroes is ranked #59th on the Apple store currently according to Distimo, an app analytics company, and ranked #21st on Google play.

Nintendo needs a hit and it desperately needs to be on mobile.  To put things in perspective, there were 200 million tablet sold globally last year alone according to IDC.  Compare that to the most successful console of all time: the Playstation 2 which had lifetime unit sales of around 150M units - over 6 years! More importantly, tablets have become gaming machines in their own right.  To gamers who scoff about a tablets capabilities look no farther than games like Infinity Blade, Racing Rivals, Nova 3 to get an idea of what these machines are capable of.  Are they up to the likes of top console games?  Not yet but given the demographics of how people use tablets (11 min average gaming sessions for example) consumers don't expect a console-like experience yet but still happily will spend money for mobile games.  More importantly, companies like Nvidia (NVDA) are now unleashing a new generation of processors (like the K-1) that are even more powerful and consume less power than the chips actually used in the Xbox One or PS4.

The size of the stake is huge and has never been hotter.  The mobile gaming industry is estimated to bring in some $21.7 bln USD in 2014 and could generate as much as $35 bln by 2017 according to figures published by AppLift and Newzoo.

That said, the market has never been more competitive.  Though games like Puzzles and Dragons or Machine Zone's Age of War may bring in several million dollars per day in revenue, development costs, marketing costs and the overall cost of doing business are all on the rise (see the post I did on this recently here and the opportunity it presents for Google).  However, this is where I believe a company like Nintendo has a massive advantage over say a Zynga or a King.com:  They have the brands.  

Pokemon, Zelda, and Mario are all household brands and games that people all over the world of all ages have played and enjoyed.  The impact of brand is essentially reduced marketing costs, pricing power and the ability to extend the brand far beyond its base of users.  For all their early successes, there is a reason Zynga is where it is: nobody would ever care to watch Farmville on Nickleodeon and my kids aren't interested in brushing their teeth with Words with Friends toothpaste.  Though King.com is advertising Bubble Witch Saga heavily on TV, the stories, characters and themes of these games still feel superficial and shallow.  These are essentially casual games designed to reach a very broad user base quickly but with little depth.  The result is that they reach a large base but typically only 1-2% of users monetize and the ARPU (average revenue per user) is much lower compared to games that appeal to mid core or core gamers.  For example Candy Crush is estimated to generate a little over $1M / day from daily active users of more than 7M users which Clash of Clans does roughly the same revenue for 4M users.  

Nintendo is not breaking new ground here.  Activision, another successful gaming company that has been remarkably late to mobile, leveraged their World of Warcraft franchise recently and entered mobile gaming with there Hearthstone franchise.  The game, on iOS only, has done extremely well and is among the top 50 grossing games on the App store in the US.  Coincidentally, it is also a TCG which bodes well for Nintendo's efforts.  

So the three questions investors need to ask themselves when looking at Nintendo are:

1.  Can Nintendo learn mobile faster than Zynga, King and others learn how to build real brands / franchises?

2.  Can Nintendo develop a product roadmap of titles that complements rather than cannibalizes their existing hardware sales?

3.  Can mobile generate meaningful, profitable revenues?

The answer the first question isn't obvious.  For every company that has embraced mobile and succeeded many have not.  EA was successful after acquiring Jamdat, an early pioneer in mobile gaming back in 2006.  However, it still took EA quite a number of years to figure out and launch Free-2-play games (the dominant model of monetization on mobile today).  Like many large gaming companies, EA feared that giving away games for free would damage their franchises and devalue the brands that they stood for.  It wasn't until 2011 that EA embraced F2P in earnest with The Simsons: Tapped out, which proved to be enormously successful for them and still continues to do well in the charts.  Moving from paid games to F2P requires a culture change in most organizations that is often difficult to embrace.  Aside from monetization, there is the mobile form factor, user base and session length the consider.  Mobile screens are smaller and more limited which may explain why Nintendo is choosing to go on iPad first.  More importantly, gaming sessions are far shorter (11 minutes for a tablet session vs. north of 40 mins for a console gaming session).  This means consumers need to be able to "achieve" something that keeps them coming back for more.  Lastly, marketing on mobile is completely different than the traditional CPG model favored by console games publishers.  Acquiring users on mobile and retaining them is a science in itself and top game companies like Supercell, Zynga and others spend vast amounts of money and have large, dedicated teams whose sole purpose is to run and optimize campaigns across dozens of mobile advertising partners like Chartboost, Facebook (FB), Admob (GOOG), Fiksu and others. Running, optimizing and tracking mobile ad campaigns across 80+ different traffic sources requires unique skill sets and people which Nintendo would have to acquire/hire to fully leverage the mobile platform.  

The issue of a solid mobile roadmap seems less risky.  Given the form factor, user base and different consumption habits, I think Nintendo has enough resources and game design chops to come up with unique games that are made for mobile that provide a very different experience from what someone would experience on a DS or a Wii U.  Their experience making portable games for the DS here would be a tremendous asset though sessions on mobile devices are even shorter.  The key here is for them to hire and dedicate resources specifically for mobile.  The biggest problem traditional console game publishers face when moving to mobile is to simply "shoe-horn"  an existing console franchise onto the mobile platform.  A great example of how "not" to do this was Bioware's (a publishing division of EA) adaptation of Knights of the Old Republic (KOTOR) for iPad.  The games' size, controls, graphics and story were all simply copied or "ported" to iPad with little regard for the mobile user / experience.  The result was that though the game initially did nearly 60k in sales on it's first day, sales subsequently crashed once word got out among users that this was essentially an Xbox game from 2005 with little adaptation to mobile.  Other premium console franchises like Deus X and Final Fantasy committed similar mistakes as can be seen below.  

source: Distimo.com App Analytics firm owned by App Annie

Back in 2011, I wrote a piece entitled Could Nintendo Be the Next Nokia.  It doesn't have to be that way but clearly the company is at a crossroads.  It botched the launch of the 3DS (in terms of pricing, lack of titles and misjudging the amount of interest in 3D portable gaming) and subsequently botched the launch of the Wii U as well.  Though 3DS sales have recuperated, after sharp price reductions and the launch of new titlees, and the Wii U's slate of games shows signs of improvement (Super Mario Kart 8 has crossed 1M units sold) the company faces the strategic challenge of not being present on the PC nor on mobile; two key areas of growth (the former being particularly large in China).  Moving its beloved franchises to mobile without cannibalizing DS sales should be a priority.  Nintendo's rabid fan base would no doubt move en masse to mobile to play Zelda, Mario and Pokemon.  Now all Nintendo has to do is provide a great, made-for mobile experience.  

OK great.  But what about the numbers?  Well just bringing Pokemon to iPad won't turn Nintendo around.  Clash of Clans, one of the top grossing games on iOS globally, pulls in roughly $1.2M / day according to Thinkgaming.com  from a daily user base of around 4M players and this revenue is both from iPhone and iPad users.  So if Nintendo were to launch on both devices and also add an Android version (assume the Android game would monetize around 80% of the rate the iOS game does which is consistent with other top games) you might see yearly revenues of roughly $780M.  Less Apple and Google's take you're looking at around $550M (30% distribution costs) less development costs and marketing.  For just one game.  If you also factor in that marketing costs will be far lower than normal given Nintendo's brand strength and that development of a high quality game will likely not exceed $10-15M you're looking at something far more profitable than console equivalents.  Now also keep in mind that mobile development is faster and allows developers to make changes "on-the-fly" and resubmit to Apple and Google.  This means Nintendo could potentially be launching yearly sequels of their major titles and be continuously updating existing games with fresh content (characters, missions, events).  The importance of this is that it essentially de-risks development by turning Nintendo's games business into a games-as-a-service business where games can be improved constantly and always have new content.  This is exactly the model top developers like Zynga, Tencent, CJ&EM (a top korean developer), EA and others use.  

So in conclusion, investors should rejoice regarding the news that the Japanese publisher is finally dipping its toes into the water.  Now lets just see if they can embrace mobile and bring the joy of Mario, Luigi, Zelda and others to the teeming masses of users who have been waiting so long.  Myself included.