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Flipping the Switch: What's next for Nintendo?

Investors are keen for the next hit console, but some are losing patience

Nintendo's red-capped hero rides again on the Switch.

TOKYO -- The Nintendo Switch is only 2 years old, but investors are already growing impatient for Nintendo to come out with its next blockbuster gaming console.

Global sales of the Switch, which was released in March 2017, have already surpassed 30 million units, while overall software sales have hit 163 million units.

The success of the Switch -- which can be used either as a handheld device or connected to a television -- helped Nintendo to double its revenue in fiscal 2017 and has provided a stable foundation for growth. Hit games such as Nintendo's original title "Super Smash Bros. Ultimate" and third-party titles like "Pokemon: Let's Go, Pikachu!" have added to the popularity of the console.

Now, however, sales of the Switch seem to be losing steam.

At the end of January, the company announced that it has slashed its full-year forecast for the console, forecasting sales of 17 million units in the year ending March from the previous estimate of 20 million. Heightened investor wariness over the company's future earnings led to a sharp sell-off, with the stock price dropping 9% the next day.

Shares have fallen dramatically from a year ago, with both short- and long-term investors choosing to let go of their holdings. The stock price has plummeted nearly 40% since hitting a near 10-year high of 49,980 yen in January 2018.

Kazuharu Konishi, chief fund manager at Mitsubishi UFJ Kokusai Asset Management, says he sold Nintendo stocks late last year. "I invested in its shares right before it came out with the Switch. It seemed like the stock rose to its limit and I had gained enough returns," he said. "Concerns about a stronger yen also led me to sell." A considerable amount of Nintendo's sales come from overseas, meaning exchange rates can have a huge effect on its earnings.

Foreign investors are also growing wary. The percentage of shares held by foreign investors was 45.5% as of last September, down from 47.9% in March 2018. One reason could be the sharp sell-off that hit the game sector last year when U.S. game company Epic Games' multiplayer online survival game "Fortnite" became a massive hit. While interest around the game surged, investors sold off other gaming-related stocks, including those of U.S. rivals like Activision Blizzard and Take-Two Interactive Software, as well as Nintendo.

According to analysts, however, Nintendo shares, currently trading at around 30,000 yen, may have a big upside potential.

Goldman Sachs Securities puts the 12-month target price at 46,000 yen while JP Morgan Securities puts theirs at 42,000 yen, an upside of about 30-50% from the current share price. Mizuho Securities senior analyst Takeshi Koyama, in a report dated Feb. 14, said "The lineup of original titles intended for the Switch console in fiscal 2019 is plenty and will support the sales momentum of the hardware." He puts the target price at 57,000 yen.

"Nintendo has mentioned about a new hardware, possibly a new version of Switch, coming out in fiscal 2019," Hideki Yasuda, senior analyst at Ace Research Institute, pointed out. Nikkei has reported that this will be a miniature Switch, which could mean that it will be missing some of the functions of the previous console.

"It will lower production costs and if there is a synergy between the old and new consoles, it could also boost Switch sales once again," Yasuda said. In 2006, the game company released the Nintendo DS Lite, a smaller and lighter version of the Nintendo DS. This strategy worked well, with the success of the redesigned DS lifting sales of the older version.

Not everyone, however, is so optimistic.

Satoshi Kurihara, an analyst at Tokai Tokyo Research Institute, said, "It's about time for the next catalyst after the Switch." Aside from its hardware business, Nintendo has been trying to expand its smartphone game business, while President Shuntaro Furukawa, who took the helm in June 2018, has also suggested that the company may be looking into creating a successor to its Nintendo 3DS.

Over 90% of Nintendo sales are generated from of its video game platform business, of which about 60% are hardware sales. With consoles remaining a pillar of the company's earnings, investors are hungry for a new announcement on this front. Given the success of the Switch, expectations are high.

Nintendo is known for staying mum on its strategies, an approach that helps to protect its ideas from competitors as well as avoid a potentially bad reaction from consumers. Though it eventually went on to become a success, the Switch faced widespread criticism and doubt before its official release.

Some investors say they are waiting patiently. Yasuo Sakuma, chief investment officer at Libra Investments, is holding on to his Nintendo shares. "I understand that the game business has volatile changes in profitability. But Nintendo is cash rich and free of debt. The stock is discounted a lot," he said. The company has over 900 billion yen in cash reserves.

Investors will likely have to keep waiting for any update on the company's strategy, meaning those who are hesitant to buy on the dip may find themselves sitting on the sidelines for sometime.

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