Nintendo's Big Rally on China Prospects Hasn't Scared Off Shorts

(Bloomberg) -- Nintendo Co. shares have surged this year thanks to a stellar games lineup and potential entry into China. But the hedge funds betting against the company aren’t going away.

Nintendo’s stock has rallied 30 percent this year, the best start since 2015. Still, short sales, or bets the stock will fall, are more than double their level a year ago. Hedge funds even added to those positions last Friday -- the day Nintendo shares rallied 15 percent as China gave a nod to Switch game sales in the country.

The clash raises the stakes for Thursday, when rookie President Shuntaro Furukawa will unveil financial results for the last fiscal year and guidance for the coming one. With short sellers betting against him and analysts expecting more growth, Furukawa faces pressure to meet estimates while avoiding last year’s mistake of overselling his prospects.

Nintendo's Big Rally on China Prospects Hasn't Scared Off Shorts

“Nintendo understands better than anyone how critical it is to maintain the current momentum,” said Takao Suzuki, an analyst at Daiwa Securities Group Inc. “Although there’s uncertainty over the new hardware and the China launch, we should expect guidance for Switch shipments to keep growing. An outlook for negative growth would be a disaster."

Short interest rose to 1.8 percent of outstanding shares on Friday, from 1.7 percent the prior day, according to IHS Markit. That compares with 0.7 percent a year ago, before hedge funds including Melvin Capital Management began aggressively shorting the stock. The figure was 1.8 percent on Monday, the latest data available.

“The people who are short are disappointed the platform didn’t do better last year, when it was supposed to put up some really big numbers,” said Amir Anvarzadeh, a market strategist at Asymmetric Advisors Pte, which advises hedge funds. “Nintendo will continue to release beautiful quirky games like Labo VR, but we just don’t think the Switch will expand Nintendo’s market share in gaming.”

Nintendo's Big Rally on China Prospects Hasn't Scared Off Shorts

Analysts estimate Nintendo shipped 17.5 million Switch units in the fiscal year that ended in March and that will rise to 18.5 million this fiscal year, according to the average of 12 estimates compiled by Bloomberg.

Growth in the current period will get a boost from the launch of a new, cheaper version of the Switch, according to two people familiar with the matter who requested anonymity to discuss private plans. The new device will likely be launched by the end of June, according to one of the people. The existing Switch will receive a modest upgrade this year, though a more powerful version is not in the works, the people said.

Nintendo has yet to acknowledge the new hardware, but will likely include it in its guidance, leading to a lot of guesswork and reverse-engineering of the figures, analysts said. Any potential revenue from China will most likely not be reflected in the numbers, according to Daiwa’s Suzuki.

Nintendo has publicly acknowledged it is working with Tencent Holdings Ltd. to start selling Switches in China, but said that last week’s approval is just one piece of the puzzle. The company must still receive the country’s China Compulsory Certificate approval, and each software title will need approval from the State Administration of Press, Publication, Radio, Film and Television, according to Niko Partners analyst Daniel Ahmad.

That agency is still working through a backlog of game approvals and has only cleared applications from last July, he said. Despite the hurdles, Ahmad expects the Switch to launch in China by the end of the year. Other analysts privately echoed the optimism, although none included potential China sales in Switch shipment forecasts provided to Bloomberg.

What’s more certain is the Switch’s software lineup for 2019, which is decidedly stronger than last year. The Pokemon franchise, perennially popular, will formally migrate to the Switch from the 3DS later this year. New entries in the Animal Crossing and Luigi’s Mansion series are also slated to hit by the end of the year, and analysts expect more big titles to be announced at the Electronic Entertainment Expo in June.

That is projected to drive operating profit to 352 billion yen ($3.2 billion) in the fiscal year through March 2019, with software sales of 161 million games, according to estimates compiled by Bloomberg. That compares with estimates for the last fiscal year of 260 billion yen and 121 million units.

Then there’s Mario Kart Tour, the company’s most anticipated mobile game since 2016’s Super Mario Run. Slated for a "summer" release, analysts say the title based on the popular racing franchise is the company’s best chance to create billion-dollar-grossing app. Releasing Nintendo’s smartphone games in China, the world’s largest market, could be a bigger opportunity than selling the Switch itself, since consumers there historically haven’t bought many consoles.

“We see significant potential for growth should Nintendo expand into the Chinese mobile games market using jointly-developed titles that leverage its compelling IP,” Hirotoshi Murakami, an analyst at Mitsubishi UFJ Morgan Stanley Securities Co., wrote in a report.

Still, management has to demonstrate it can deliver on its promises. Nintendo cut its forecast in January, stumbled in executing its online strategy and backtracked on plans to release at least two mobile titles a year.

“The past year was dominated by a focus on short-term numbers,” said Daiwa’s Suzuki. “But this year will be about whether long-term shareholders believe what management says it will do.”

©2019 Bloomberg L.P.