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Pokemon Gone - why there's no profit in this craze

25 July 2016, 10:43Tim Culpan

Sydney - Nintendo's Pokemon Go profits are about as real as Pikachu.

The company's late Friday revelation that the global craze for chasing imaginary creatures with a smartphone won't be a huge earnings driver confirms what many had suspected, but which the stock had not yet reflected.

That changed on Monday with Nintendo falling by its 18% limit in early Tokyo trading. The plunge left the shares 73% higher than a month ago, before Pokemon Go was unleashed.

To put that move in context, the massive run-up leaves Nintendo only 42% higher for the year to date and just 15% up on 12 months ago. In other words, Pokemon Go may have driven the stock, but a lot of that gain has been recovering lost ground over the past year.

But there's an even more important issue to consider here. Why isn't a top app-store ranking, incessant media coverage and sponsorship deals with fast-food restaurants turning into a windfall for Nintendo?

The company itself outlined one of the reasons in its statement last week. Pokemon Go isn't developed or distributed by Nintendo, but by Niantic, a spinoff from Alphabet - Google's parent company. Pokemon itself is owned by The Pokemon Compant, of which Nintendo only owns 32%, and The Pokemon Company gets a licensing fee and "compensation for collaboration" in developing Pokemon Go.

So any earnings from Pokemon Go make their way to The Pokemon Company through a filtered process, details of which aren't public. Nintendo only gets to recognise its portion of those profits through the equity method of accounting.

Hence Nintendo's headline statement: “Because of this accounting scheme, the income reflected on the company’s consolidated business results is limited.”

It also means that movie rights, fast-food deals and any other spinoffs Pokemon Go inspires only get to Nintendo through The Pokemon Company.

All of this would have been taken into account when Nintendo laid out on April 27 its forecast for the 12 months to March 31, 2017. The fact that it said on Friday that it's "not modifying the consolidated financial forecast for now" indicates how underwhelming the upside is from the Pokemeon Go craze and why investors are right to finally start questioning it.

If The Pokemon Company has done a poor job of extracting more from the likes of McDonald's amid the Go craze, then there's not a lot Nintendo can do about it.

To further rain on Pokemon Go's parade, investors need also to understand that a hit game does not a windfall profit make. The app, and thus the game, are free and free is a very low barrier to getting users to download it to their smartphones - especially when every media outlet in the world is hyping it as a "phenomenon".

The revenue model is in-app purchases of items that could help players improve their scores. Pokemon Go's conversion rates, which track dollars per user or how many users buy items, aren't yet publicly available, and may never be made so. One estimate puts the conversion at about $1 per download so far, which is actually quite good but falls far short of justifying Nintendo's share-price run-up.

What Nintendo really needs is for Niantic to find a way to extract even more money per user, and for The Pokemon Company to get more cash out of the characters before the phenomenon dies down.

Choosing not to raise its outlook amid the craze indicates that Nintendo may have trouble doing either, and that's a bad omen for its hopes of repeating this hit.

We already know Pokemon Go's success is about as big as any augmented-reality and mobile-app spinoff is ever likely to get. In that light, don't bet on Mario, Luigi or Donkey Kong beating Pikachu to the profits.

* This column does not necessarily reflect the opinion of Bloomberg and its owners.

- Bloomberg


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