Nintendo’s press release on Pokemon Go

Having the information from yesterday’s post, we can take a closer look at what Nintendo said in its press release from last Friday.  (In what follows, I’m assuming that the English version of the release from the Nintendo website is an accurate rendering of the Japanese.)

The heart of the release is this:

“The Company owns 32% of the voting power of The Pokémon Company. The Pokémon Company is the Company’s affiliated company, accounted for by using the equity method. Because of this accounting scheme, the income reflected on the Company’s consolidated business results is limited.

…Taking the current situation into consideration, the Company is not modifying the consolidated financial forecast for now.”

paragraph 1

True as far as it goes.  Because of equity accounting, Pokemon Company results will have, by definition, no impact on Nintendo’s consolidated gross, operating or pre-tax income.  But the paragraph actually says nothing.

In addition, significant information is left out. Nintendo benefits from Pokemon Go in two ways that don’t appear on the income statement at all.

–Nintendo owns about 10% of Creatures, one of its two 32% partners in controlling The Pokemon Company.  That interest, 3.2% of The Pokemon Company, is accounted for using the cost method, so the portion of Pokemon’s profits that this represents appears nowhere in Nintendo’s income statement

–Nintendo owns about 12% of Niantic, the developer and distributor of Pokemon Go.  If we figure that payments to The Pokemon Company represent 25% of Niantic’s profits, then that firm keeps 75%.  12% of that equals 9% of the total.  In other words, if these figures are approximately correct (I think they are), they indicate that Nintendo profits from Pokemon Go through its Niantic holding by about the same amount that it does through its The Pokemon Company interests.  The Niantic interest is accounted for by the cost method, so none of this appears on the Nintendo income statement.

–some analysts maintain that Niantic also makes direct payments to Nintendo for its use of Pokemon characters.  I’m not sure this is correct, particularly since this money would likely appear on Nintendo’s income statement–but is not mentioned in the press release.

paragraph 2

This is simply Nintendo saying, “we haven’t gotten any money in yet, so we’re not going to speculate.”

 

why nothing more elaborate   ….and potentially more useful in the press release?

Two reasons:

–the release is, I think, a report to the public of a formal reply to a stock exchange query, which was something like, “Given the sharp recent rise in your company’s stock, do you have any reason to raise your estimate of March 2017 consolidated profit results?”

Nintendo is simply answering the question, and in its mind avoiding possible future trouble by saying nothing more.

–many companies, and Nintendo is one of them, are intentionally closed-mouthed.  In conversation with someone they don’t know well, they may start out saying something anodyne, or even intentionally misleading.  They want to see if their interviewer has enough professional knowledge, and has studied their company in enough depth, to be able to challenge them.  Only after an analyst has passed one or more of these “tests” will the company begin to answer questions in a fuller way.  If the analyst flunks, the host is insulted and the analyst is written off as a waste of time.   The interview may still last, say, an hour but the conversation will remain on a superficial level.  This press release is part of the same mindset.

three ways to account for associated companies

This post is to lay the groundwork for understanding what Nintendo actually said about Pokemon Go last Friday.

There are three basic ways to account for companies that a firm owns an interest of less than 100% in another firm.

–the cost method.  This is used when the firm whose financial reports we’re talking about has neither influence nor control over the operations of the enterprise held.  A good rule of thumb is that this means a holding of less than 20% of the outstanding shares.

In this situation, the holding is listed on the balance sheet as a long-term investment at acquisition cost.

Under normal circumstances, the income statement contains no accounting of the holding’s financial results.

Two exceptions:  dividends paid are recorded as income; if the asset is impaired, the loss is shown on the income statement.

On the other hand, if the value of the holding increases, there’s no reflection of this in the owner’s financials.  Yes, accounting theory says the holding value should be adjusted periodically for changes in the investment’s fortunes, but as a practical matter this is rarely done.

equity interests.  This is where the holding firm is judged to have influence but not control over the entity held.  Typically, this applies to holdings that fall between 20% and 50% ownership of the investment.

If so, the owner records his share of the financial results of the holding on a single line toward the bottom of the income statement.  This line is called “Equity Interests” or something like that and is an after-tax aggregate of all such equity interests.

The holder also adjusts the balance sheet value for profits (up), losses (down) and dividends received (down).

consolidation.  This is the case where the holding firm exercises influence and control.  The rule of thumb here is that ownership of 50% or higher implies having both.

If the ownership is less than 100%, the consolidating company still reports results–revenues, costs etc.–from operations as if it owned 100%.  But it add correcting, after-tax entries, both in the income statement and on the balance sheet, typically labelled “Minority interests” that subtract out the portion of earnings and assets held by others.  Again, these are aggregate figures and not broken out holding-by-holding.  Minority interests are usually recorded toward the bottom of the income statement, somewhere near the consolidated net income line.

Tomorrow, how this applies to the Nintendo announcement

 

Nintendo (TYO:7974) and Pokemon Go

Nintendo in a nutshell

Nintendo is a non-establishment Japanese company that started out making playing cards but became a worldwide sensation early in the videogame era.  It’s the creator of the Nintendo console and Gameboy handheld machines, plus proprietary games and characters like Mario, Donkey Kong and Zelda.

When gaming shifted from consoles to mobile, Nintendo pretty much disappeared.   Its stock has languished since, despite the company’s extensive intellectual property.

That’s the main reason, I think, that the stock took such a huge leap–it came close to doubled in two weeks on 20x normal volume–when Pokemon Go was released.  Not only is that game a smash hit, but its success underlines the continuing relevance and therefore the still enormous profit potential from Nintendo’s extensive intellectual property.  Of course, this potential can most likely only be realized through mobile games, something Nintendo has, in a fashion bewildering to those not familiar with the company or with Japan, so far avoided as a matter of long-term corporate strategy.

 

Friday’s press release

After the close of business in Japan last Friday, Nintendo issued a short press release about Pokemon Go.

The release starts out with stuff anyone could have found out on Wikipedia. Pokemon Go was developed by Niantic, a spinoff from Google, not Nintendo.  Nintendo participates in the game’s success, however, through its 32% ownership in The Pokemon Company (PC).  PC will  receive a licensing fee from Niantic, as well as compensation for continuing collaboration in Pokemon Go’s development.  (Nintendo also owns an undisclosed (12%?) interest in Niantic, which might turn out to be much more valuable than any one game–but that’s not mentioned.)

brass tacks

The heart of the release is in the next-to-last sentence, which reads:

“Taking the current situation into consideration, the Company is not modifying the consolidated financial forecast for now.”

Monday trading

On Monday in Tokyo, short-term traders frightened by the press release quickly pushed Nintendo shares down by the maximum allowable daily amount (that percentage varies for each stock but in Nintendo’s case it’s 18%), where the stock stayed all day.  Today the stock rose slightly.

my thoughts

I don’t view Nintendo’s press release as containing much news at all.  I think it’s a response to an official inquiry from the stock exchange (Tokyo or Osaka) about whether there’s any reason for the unusual trading in Nintendo shares.  The inquiry will have been very specific:  whether Nintendo has any reason to revise up the earnings forecast for the fiscal year ending in March 2017 that it has on file with the exchange. (Note: publicly traded Japanese companies are required to revise their forecasts if/when they know earnings will be +/- 25% from what’s on file.)

Nintendo’s answer:  No, not at this time.

In my experience, this is a very Nintendo-like answer.  It’s also typical of mid-sized Japanese companies in general.  It responds narrowly to the question, and volunteers nothing more.  If a revision is warranted, it will most likely only come in February.  In this case, though, it probably is way too early to tell the significance of the new game.

More tomorrow.