Pokémon Go downloads exceeded 15 million in the first week making it the fastest adopted game in history. 
Nintendo’s share price shot up by 75 per cent as investors get sucked into the hype. Shares have been heavily shorted on the grounds that the Japanese retail investor is well known for loving a craze. 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.
At this stage we don’t know the terms of the spin out; we don’t know how much of Niantic is owned by Google, Nintendo and Pokémon; and we don’t know whether there is a Google license fee associated with the location technology. Everything is a bit of a rough educated guess.
There are some clues on the hype versus reality. 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.
In February 2016, there was a small series A round for external investors of $5m, rumoured to be based on a $150m valuation. This suggests that in the late 2015 funding round $20m would be unlikely to have purchased more than 20 per cent of the business.
We know that Nintendo owns 32 per cent of Pokémon Co, and yet they have tacked on $15bn of market cap versus a $150m valuation on the developer just five months ago.
The numbers behind the hype
Data tells us that revenue over the first eight days was $17.9m; a long way off the almost $300m estimated as monthly revenues by JP Morgan. Let’s assume that this number is correct as a forecast.
If we deduct 30 per cent by Google and Apple at the App store level, that leaves $210m. Assuming this is split in half by the major players, Pokémon and Niantic, that equates to $105m each (this could be seen as very generous to Pokémon that might more normally receive 15-20 per cent of revenues as royalty).
Nintendo’s 32 per cent stake in Pokémon gives it an economic benefit of $33.6m and with the probability that margins are high at around 90 per cent this would give an equity share of $30m or $360m annually.
$360m of annualized equity share would add only 5 per cent to revenues for the March 2018 year but it could add as much as 40 per cent to operating profits. We have seen accretion estimates at anything from about 20 per cent and up.
The shares are now up by 75 per cent or $15 billion 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.
What is the opportunity to invest?
It’s no secret that games are notoriously hit driven. Candy Crush reached $139m of monthly revenues at its peak; it currently drives just $32m of monthly revenues. This is why we have historically 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 average selling prices (ASPs) and this is a combination we like.
Hype or reality? Who knows at this point, but we think the excitement is far more indicative of the potential for augmented reality and location based advertising than for Pokémon Go.
The future of the game itself is far more likely to follow the time honoured path of hype followed by a long term tail off.
Mark Hawtin is an investment director at GAM. All the views expressed above are his own and shouldn’t be taken as investment advice.
