Augmented reality has arrived

Unless you live under a rock, you surely have heard of something called “Pokemon GO”. It is a new mobile game that was released by Niantic Labs on Apple and Android phones in the US, Australia and New Zealand just one week ago.

Reports from SimilarWeb emerged this week that Pokemon GO had already overtaken Tinder in Android app downloads and was expected to soon overtake Twitter (NYSE: TWTR) in daily active users. More spectacularly, users are spending more time in the game than on Snapchat, Instagram and WhatsApp.

We will leave readers to do their own research into the actual game of Pokemon GO. And it is interesting, at the very least, to experience how this game incorporates virtual game playing into the real world – a.k.a. “augmented reality”. (Your author admits he has downloaded the game and spent time playing). Instead, we will focus on an interesting financial observation that has resulted from this craze.

Now, publisher Niantic Labs was spun out of Google in 2015 and Nintendo (Tokyo: 7974) and The Pokemon Company invested in Niantic in October 2015. The size of their shareholdings is unknown, although, as of end FY2015, Niantic was not a Nintendo equity-method affiliate (meaning the stake is less than 20%); though we know Nintendo has 32% of the voting shares of The Pokemon Company.

Why is Nintendo interesting? Because over the last week, the company’s shares have surged by more than 75%! (Unfortunately, Montaka does not own any shares in Nintendo). So how should one interpret such a large appreciation in Nintendo’s stock price? Well, let’s consider the following:

• The share price appreciation of Nintendo equates to a US$14 billion increase in the company’s value.
• This level of incremental value requires approximately US$2 billion in additional incremental operating income – every year for the rest of time – to justify (or maintain this new share price level).
• For context, Nintendo’s operating income has been averaging approximately US$250 million per annum for the last two years. So Nintendo’s share in Pokemon GO needs to effectively increase the earnings power of the entire business by a factor of 8x!
• Let’s assume that Nintendo owns, say, 20% of Niantic Labs. Then this would effectively imply that Niantic would need to generate US$10 billion per annum of operating income for the rest of time. For context, Facebook (NASDAQ: FB), a US$300 billion company that owns Facebook, Instagram, WhatsApp and boasts over 1 billion daily active users, did not even generate US$10 billion in operating income last year.
• (And if Nintendo owns less than 20% of Niantic Labs, then the required earnings to justify Nintendo’s share price increases even further by the inverse proportion).

Readers of this blog will know that we view stock prices as numerical representations of future expectations of earnings. So when Nintendo’s stock price rises by 75%, we immediately ask ourselves how much Nintendo needs to earn now to justify the incremental value. Based on our calculations above, the required additional earnings are astronomical. And that’s just to break-even on an investment at the current share price.

On this basis, Montaka will unlikely be buying the shares of Nintendo any time soon.

Andrew Macken is a Portfolio Manager with Montgomery Global Investment Management. To learn more about Montaka, please call +612 7202 0100.