Pokémon Go has gone viral over the last week as the game was launched in the US, Australia, New Zealand and Japan. This has created a huge move in the share price of Nintendo as investors get sucked into the hype surrounding the new game. Nintendo's market capitalisation has increased by 75% over the last week, rising by $15bn to $35bn at close on Wednesday. The shares were heavily shorted and the Japanese retail investor is well known for loving a craze - Pokémon Go is an easy win for retail enthusiasm. So what is the reality?
The making of Pokémon Go
Pokémon Go has been developed by Niantic, a games developer spun out of Google last year when they created the separate Alphabet grouping of companies. Niantic, that takes its name from a whaling vessel that came to San Francisco during the California gold rush, was Google's efforts in augmented reality and location based gaming. It is run by John Hanke, an early Googler who is considered the grandfather of Google Earth and has a background steeped in location based software development. It is not clear exactly why it was separated from Google but we believe that Google has maintained interest in the business. One credible theory is that Nintendo and Pokémon would not get involved and license the brand to a wholly owned Google subsidiary.
Since the spin out, Google, Nintendo and Pokémon have all contributed to a funding round of $20m, with the option to invest a further $10m. There is no information currently available on the shares taken by each company. In February 2016, there was a small series A round for external investors of $5m that has been rumoured to be based on a $150m valuation. This may act as some guide to the proportion of Niantic owned by Nintendo and Pokémon in the late 2015 funding round; it would suggest that $20m would be unlikely to have purchased more than 20% of the business. Here the hype versus reality starts to reveal itself. We know that Nintendo does not benefit from all the economics by any means and yet they have tacked on $15bn of market cap versus a $150m valuation on the developer just five months ago! The only fact we have to hand is that Nintendo owns 32% of Pokémon Co.
The numbers behind the hype
It is possible to get various data sources for game downloads and time spent playing Pokémon Go. We subscribe to a research service called AppAnnie for just this type of information. As an aside, this shows how the world of technology research is changing - we pay for this service rather than putting more into traditional investment banking research.
The data we have suggests that downloads have exceeded 15 million in the first week, making Pokémon Go the fastest adopted game in history. Based on iOS data, users spend an average of 33 minutes a day playing the game. This is actually behind Candy Crush Saga at 43 minutes but ahead of social network usage; Facebook at 22 minutes and Snapchat at 18 minutes. Surveymonkey data shows that on 11 July there were 21 million daily active users, well ahead of Candy Crush.
What is the opportunity to invest?
First we would point out that games are notoriously hit driven - Candy Crush reached $139m of monthly revenues at its peak following the hype phase of interest; it currently drives just $32m of monthly revenues. This is why we have resisted gaming names for investment. That view has started to change, however, as companies like EA have broad portfolios of games and move to take advantage of in game purchasing thus raising average selling prices (ASPs). More interesting than the Pokémon Go outlook itself is the new dynamic in gaming that it delivers: the use of augmented reality and location based context. This opens the way for not only a more immersive experience but also the opportunity for location based advertising. Some US based advertisers have already derived benefits from the location based opportunity - Tom Lattanzio, owner of L'Inzio Pizza Bar in Long Island City, told the New York Post that the pizza restaurant saw a 75% increase in business after buying a $10 in-game power-up that lured Pokémon to its location.
We have tried to put some numbers on the opportunity but it is an almost impossible task. We do not know how much of Niantic is owned by Google, Nintendo and Pokémon; we do not know whether there is a Google license fee associated with the location technology; we do not know the terms of the spin-out from Google last year. So everything is a very rough educated guess.
AppAnnie tells us that revenue over the first eight days was $17.9m; that is a long way from the almost $300m estimated as monthly revenues from JP Morgan's analyst Harauka Mori. Let's assume that this number is correct as a forecast (that is over 2x Candy Crush at its peak!) - then we deduct 30% take by Google and Apple at the App store level. That leaves $210m. How is this split? We assume that the major players take a half each - Pokémon and Niantic - so that is $105m to each company. Nintendo gets the economic benefit from its 32% stake in Pokémon so $33.6m. Margins are probably high, say 90%, giving an equity share of $30m or $360m annually. They also take some equity share from their stake in Niantic but we think that is low so for these purposes, add no value for that.
$360m of annualized equity share if the game is so successful would add only 5% to revenues for the March 2018 year but it could add as much as 40% to operating profits. We have seen accretion estimates at anything from about 20% and up. The numbers we have used above for the revenue for the game is the highest in the market and we deliberately use that to assess the hype versus reality aspect. The shares are now up 75% or $15bn of added market value. That puts a multiple of 42x pre-tax earnings on the added market cap to expected top end profit contribution before the game has been in existence for even a month. Hype or reality? Who knows at this point but we think the hype is far more indicative of the potential for augmented reality and location based marketing than for Pokémon Go. The game's future is far more likely to follow the time honoured path of hype followed by a long term tail off. This is why until recently we have resisted gaming names for investment. However, this view has started to change as companies like EA have become much more disciplined with their portfolios, using analytics to determine where and when to invest in their titles. The advent of in-game purchasing has also given them the opportunity to raise ASPs and this is a combination we like.