Game Over for Nintendo’s Risk-Reward Ratio

• Sell NTDOY around 71.15

Avid readers of SmartGuyStocks know that Nintendo (NTDOY.PK) has been one of our favorite stocks over the past year. NTDOY is the only stock I have recommended twice. The company has delivered two of the most exciting products in the world: Wii and DS. However, I believe price appreciation is limited for the following reasons: skyrocketing shipping costs, the weak dollar, and the current point in the console cycle.

First, let me preface my comments by saying NTDOY is still one of the best companies in one of the hottest sectors in the world. If the global economy was steamrolling, I would hang on to NTDOY through the coming holiday season. Unfortunately, my wish is not the economy’s command. Rather than fight reality and stubbornly hold my shares, I am willing to take my extraordinary gains and accept that my risk-reward ratio has diminished.

Although many shareholders will focus on the positives at Nintendo, headwinds are gaining strength. As oil costs levitate, shipping costs perform the same miracle. These costs eat into NTDOY margins for both manufacturing and distribution. Moreover, the dollar continues its celebrity makeover as toilet paper. This will continue to diminish the value of building in yen and selling in dollars.

Thus, the great irony of globalization (i.e., foreign production is cheaper) begins to mature. The forces in the global oil and currency markets are stronger than those in the growing video game space. And until something changes, these costs will limit upside in NTDOY.

Lastly, the easy money has been made in the current console cycle. Those who remain in shares are playing chicken with the inflection point of the cycle. Some time in the next 12-18 months I expect Microsoft (MSFT) and Sony (SNE) to start introducing exciting concepts for their next generation consoles. These glossy press releases will create signs that the current cycle is in the latter stages. Once that happens, analysts and investors will start to look ahead. And once that happens, doubt will arise as to whether NTDOY will repeat their success in the future. If you are still holding shares at that point, you will be very disappointed to see Nintendo the company still minting money while NTDOY the stock discounts for the great unknown of the next console cycle.

I do not aim to find the absolute high and low of a cycle. Rather, I seek to capture the easier money when companies are in stride during their climb or descent. That’s why I have not made many picks since the market has traded in a choppier manner. I prefer shorts and puts when things are falling hard, and buys and calls when they are rising in a healthy environment. Occasionally I will offer a short-term trade that contradicts the macro environment, but those who follow my picks will make most of their money in the sweet spot of each cycle. My one-year track record on SmartGuyStocks validates this strategy.

On a technical note, NTDOY peaked in the high 70’s and has not been able to push back. This is more evidence that the macro environment has great control over NTDOY shares. I held my shares during the decline from the peak because I believed the stock had a chance to bounce back and charge ahead for another leg up. Despite excellent growth and earnings, the stock has not made new highs. Therefore, I believe we may be witnessing the best price for NTDOY we will get as the hype for Mario Kart and Wii Fit bring optimistic buyers back to the trading floor.

Of course, the economy could improve later this year, but I do not take my economic analysis from the White House. From where I sit, it’s game over for Nintendo’s risk-reward ratio.

Activision Merger Brings Blizzard of Money

Last weekend, Activision (Nasdaq: ATVI) announced an exciting merger with Vivendi. The offspring, Activision Blizzard, will combine the two companies’ video game units and leave Vivendi with 68% of the outstanding shares. To initiate the deal, Vivendi will be tossing in $1.2 billion while Activision will make a cash tender offer for up to 146.5 million shares at $27.50.

SmartGuyStocks readers who bought the ATVI calls I recommended are getting an early holiday gift. The question now is whether to sell and take the gains, hold longer, or exercise the options closer to expiration.

If you scaled into your position and are sitting on gains of 100-300%, by all means, take some or all off the table. Otherwise, there is an arbitrage gap that will continue to approach $27.50 as we get closer to the merger date in mid 2008. The only way the stock will not ultimately reach $27.50 (and beyond) is if the deal falls apart. I think this is highly unlikely given the great benefits to both companies and the lack of antitrust issues. The only snag I envision would be shareholders demanding a higher price. However, given that the deal should close in approximately six months, it’s hard to prove ATVI would be trading higher in such a short period of time (especially given the recent run up).

If you are very bullish on the deal and expect Activision Blizzard to be the new guerrilla on the block, you may consider exercising your options (when your strike price reflects an underlying stock price as close to $27.50 as possible) and holding the new shares. The video game industry is growing faster than the S&P, so the shares should outperform. Moreover, Electronic Arts (Nasdaq: ERTS) may lose priority in fund managers’ portfolios, and rebalancing holdings in favor of ATVI may push Activision Blizzard higher. I will most likely call the shares to maximize the move to $27.50. But I will let you know closer to expiration.

No matter what you do with your ATVI calls, the windfall should make you hum the jingle bell rock on Christmas morning when your children or friends are jamming out to their new Guitar Hero III.

Disclosure: SmartGuyDH owns ATVI calls.

Let PETS purr its way into your portfolio

• Buy PETS around 12.55

Successful investing, especially for the long-term, is all about spotting societal trends. So it was with great interest that I looked at the recent bestselling business book, Microtrends, which seeks to highlight some of the biggest current cultural shifts. Not only is the book an interesting read, but it validates two major trends that we have highlighted at SmartGuyStocks: the growing demand for video games among adults (see SGS picks Nintendo and Activision), and the increasing popularity and importance of pets in our lives. It is this latter trend that I would like to revisit.

When I made PetMedExpress (NASDAQ: PETS) a SmartGuyStocks selection in June, I cited the fact that people are increasingly likely to think of their pet as a member of the family. They are thus more apt to not only put money into Fido’s health care expenses, but to think of those expenses as a necessity. I reasoned that PetMedExpress, the leading retailer of pet medications, stood to benefit. Recent press has re-affirmed that this trend is still strong: the American Pet Products Manufacturers Association (APPMA) reported that pet ownership has again reached a new high in 2007, and spending on pets overall and medications in particular are expected to rise in the high-single digits. In an article for the website Small Business Trends, the CEO of Embrace Pet Insurance predicted, “online veterinary pharmaceuticals will become more main stream. Pet lovers want, and are demanding, the same treatment options for their pets as they can get for themselves.”

Since my selection of PETS, the company certainly hasn’t disappointed. They’ve reported two stellar quarters of top and bottom-line growth, handily beating analyst expectations each time. As I recently noted, the company is successfully retaining its customers and actually reducing advertising as a % of sales, ensuring a sustainably profitable business. Most importantly in this time of credit turmoil, PETS is cash flow positive and has zero debt. In addition, they are actively buying back shares. Yet the stock has inexplicably dropped over 20% from its highs, much of that in recent weeks.

With the recent credit panic in the market, it appears that investors must be thinking of PETS as a consumer discretionary stock, lumping it in with Petsmart (NASDAQ: PETM) and other struggling retailers. Let me see if I can follow the logic: oil prices high, dollar low, consumer confidence suffers… Fido has to die of heartworm? I can see how penny-pinching consumers might not want to buy that expensive Coach (NYSE: COH) purse or even that newfangled birdhouse from Petsmart, but I highly doubt that they will deprive their beloved family pet of necessary medication.

In fact, if anything, PETS stands to benefit from any consumer thriftiness. With lower prices than vets, consumers are more likely to jump online and order from PETS if money is tight. This is not unlike Jim Cramer’s recent rationale for jumping on the bandwagon and recommending SGS pick McDonald’s (NYSE: MCD). If a recession hits, consumers will still have to purchase necessities like food or medication, but will be more likely to seek out the low-cost providers like MCD or PETS.

With impressive growth and financials and the tailwind of a strong macro trend, I recommend taking advantage of this recent market downturn to double-down on our long-term bet on PETS.

Disclosure: SmartGuyAB is long PETS.

Activate Activision

• Buy ATVI Jan ’08 17.50 calls around 6.10

Blue chip video game publisher Activision Inc. (Nasdaq: ATVI) will announce earnings this Monday, November 5^th. Given recent market turbulence, shares are trading lower than they should given Activision’s complete domination in the publishing space and their recent launch of blockbuster Guitar Hero III. Like Microsoft’s (Nasdaq: MSFT) stock pop following the successful launch of Halo 3, ATVI should experience a similar pop when they announce better-than-expected earnings, awesome initial sales numbers for GHIII, and exciting forecasts for other holiday blockbuster releases.

ATVI shares have also seen resistance as a result of Electronic Arts’ (Nasdaq: ERTS) distribution deal for a new music game called Rockband. Near-term concerns about Rockband are overdone for the following reasons:

1) ATVI beat EA to the punch by releasing GHIII much earlier than Rockband (release Nov. 20). I believe most gamers have been impatiently awaiting a new music game, and ATVI has captured such demand.

2) GHIII is more than 50% cheaper than the $199 Rockband. Given that parents already complain about video game prices like businesses complain about rising energy costs, I think Rockband has the wrong price point for mass sales. I think the more expensive game will appeal to music aficionados, while GHIII will maintain its phenomenal mass appeal.

3) GHIII is available on all three game consoles, while Rockband is not available on the most popular console, Nintendo’s (OTC: NTDOY.PK) Wii.

Although I think Rockband has potential to compete with GHIII in the long-term, I do not think the new competitor will hurt GHIII sales this holiday. That is why I am recommending the January ’08 call options for a short-term trade, and we will reevaluate ATVI sometime in late January once industry holiday sales are tallied. If you want to buy stocks in this sector, see my previous article about Nintendo at SmartGuyStocks.com.

Disclosure: SmartGuyDH owns Jan ’08 17.50 calls

Nintendo Update: Wii still sold-out

Nintendo (OTC: NTDOY.PK) net profit powered-up 143% yoy and sales boomed 135% yoy as Wii demand continues to outstrip supply and the handheld DS becomes ubiquitous. As I noted when first recommending NTDOY at SmartGuyStocks in June, the Wii is a revolutionary development in the gaming world that is doing what PS3 and Xbox360 will never do: going mainstream.

Goldman Sachs recently initiated coverage on NTDOY with a “Buy” rating. Besides the fact that Goldman (and most white shoe investment bankers) are late to the game, they bring a new wave of institutional and wealthy investors to the table. Seems like demand for shares of NTDOY may start following demand for the white-hot Wii and DS.

Although both Sony (NYSE: SNE) and Microsoft (Nasdaq: MSFT) have lowered prices for their consoles, the Wii and its games are still significantly cheaper. I was in Best Buy (NYSE: BBY) last weekend chatting with parents and teens in the video game aisles, and price conscious parents are much happier with the cheaper Wii console and Wii games. Parents know that the console is merely the first of many dollars sunk into interactive entertainment … games are constantly on every console owner’s “I Need” list. I also noticed that many people are happy that the third edition of Activision’s (Nasdaq: ATVI) pop hit Guitar Hero is available on the Wii.

People who want the stock to pull back so they can get in cheaper continue to focus on the undersupply of Wii’s. However, I do not have much of an issue knowing that NTDOY cannot even produce enough Wii’s to make the world happy. To me, that means sales will stay strong and grow gangbusters until at least the same time next year. Ho, ho, ho …

Disclosure: SmartGuyDH is long NTDOY

Sour Grapes: Snobs say Google losing indie sex appeal

An interesting phenomenon exists in the music industry. When an excellent new band forms and starts hitting the small venue scene, a certain crowd of independent music enthusiasts adopts the band as a new obsession. These fans pride themselves on knowing and supporting talent that remains unknown to the masses. They wear the rare t-shirts and talk about the band members as if they have been the best of friends since conception. Consequently, these fans self-righteously believe they are “cool” and “truly” know about cutting-edge new music, while the rest of us are brain dead squares who only know what the media power elite shovel into our ear holes. 

A similar phenomenon is unfolding with Google (Nasdaq: GOOG). Google was a classic garage startup (band?) founded by two engineers from Stanford. Tech geeks and college students quickly became groupies of Google’s golden search algorithm. Those who used Google were the Web’s avant garde, and those who did not were the brain dead squares who browsed the godhead of information through Microsoft’s (Nasdaq: MSFT) MSN, TimeWarners’s (NYSE: TWX) AOL, Yahoo! (Nasdaq: YHOO), or any other search engine your parents (or grandparents - gasp!) were using. Google.com was the feng shui zen bikini model, all others were content-cluttered faces with pimply banner ads and barely noticeable search bars.

At first, indie fans used the word ‘Google’ as sexy slang for searching the web. “Google like this … Google like that … Google with a baseball bat.” However, like Kleenex and Xerox, Google soon became synonymous with its product. More and more unhip adults began saying “Oh Mel, just Google your meds for a Canadian website that sells at a discount,” and “I Googled that video game and you cannot play because it has foul language.”

Once the uninitiated start liking your secret indie band or search engine, it’s time to wage a major PR campaign to smear the “evil corporate sellout.” I’m not a shrink, but it seems that when persons create part of their identity around something they perceive as special and unique, those persons quickly abolish any association as soon as their beloved identifier becomes commonplace - and Google is no exception.

Last week’s The Economist featured two commentaries (disguised as articles) throwing some very large stones at the great evil sinner: Google. In short, the articles raise a host of hypothetical issues that could bring Google to its knees. They pull out all the stops including Orwellian foreshadowing, interviews with disgruntled ex-employees, and overwhelming attention to expansion into lower margin revenue streams.

I don’t know about you, but the last time I checked, Warren Buffett recommended companies that are as close to monopolies as possible, with excellent returns on investment, high rates of growth, and powerful brand names. If you ignore all the fear mongering in The Economist, you would have a nice set of facts that meet Buffett’s framework. I believe this is a sign that we have officially entered the phase where emotional sour grapes will interfere with objective financial analysis of Google. As a result, buying opportunities will arise as negative propaganda affects GOOG.

Does Google face all the classic characteristics of a maturing company? Yes. Will growth slow as the size of the business grows? Yes. Does this make them any less able to make excellent acquisitions, invent new successful products, or continue to dominate one of the most profitable businesses in human history? No. Will Google stay on top forever? Probably not. However, things are still working well and the company continues to mint money. I recommend keeping it on your watch list.

So, don’t let the whining cool kids make you feel insecure about GOOG. The best thing a company (and investor) can hope for is its products to reach the masses and become “uncool” to the infinitesimal indie crowd. Thus, the indie kids can turn us on to the next big thing, but unless that thing goes mainstream, it remains psychological fanfare for the few and a very poor investment for the many.    

Wii Parties will keep Nintendo shareholders having fun

At the risk of turning Smart Guy Stocks into the Nintendo Fun Club, I bring you yet more evidence of the Wii’s success and potential to drive NTDOY’s stock price even higher.

In another case of Nintendo reaching well beyond the traditional gamer crowd, recent reports have touted the growing trend of “Wii Parties.” An article from the Pittsburgh Tribune-Review describes a “Wii and Wine” party. I’ve actually been invited to one of these myself, an occasion where professional adults who would never in a million years play “Halo,” are instantly returned to their youths as they giddily return tennis balls or race cows.

Nintendo has taken notice of this trend and appears intent to capitalize on it as a marketing opportunity. The company has already partnered with Norwegian Cruise Lines and Erickson Retirement Communities to add Wii parties to their activity schedules, and has been talking to libraries about using Wiis for community-building. Nintendo is also trying to tap into the classic Tupperware model- giving Wiis to people in target groups in exchange for them hosting Wii parties. Last month, Nintendo partnered with Evite to launch a dedicated Wii party-planning page.

All this means that not only has the Wii started a unique video gaming trend, but Nintendo appears ready and willing to capitalize. With the stock down 5% today apparently on news that the Wii is “only” outselling PS3 3-1 in Japan, this is another chance to buy in to NTDOY before the holiday season.

Disclosure: SmartGuyAB is long NTDOY

Gamers Won’t Stop: Bullish Growth in Video Games Continues

Last week the only pure play video game retailer GameStop Corp. (NYSE: GME) reported excellent earnings. In short, net profit increased 650% yoy to $21.8 million ($0.13/share) and beat estimates by $.04/share. Revenue was $1.34 billion, 12.6% higher than average analyst estimates of $1.19 billion. Same store sales increased 29%. GameStop also raised full-year guidance to between $1.45 and $1.48 (up from $1.42 to $1.46).

I am writing about GameStop because it is a bellwether for the video game industry. When the bells start ringing like they are, we know the flock will start following the leader. However, not all video game stocks are as sure a bet as the overall growth of the industry. In order to best understand the landscape and place some winning bets, we must first look at each component of the video game industry.

Console Manufacturers: A console is a device that reads a game and translates it to a usable experience (much like a hard drive for a computer). Three companies currently manufacture consoles: Nintendo (OTC: NTDOY.PK), Microsoft (NasdaqGS: MSFT), and Sony (NYSE: SNE). Of the three, only NTDOY has the ability to meaningfully reflect console sales in the share price. The other two are some of the largest companies on the face of the Earth, and an investment in them is an investment in more goods and services than I care to follow.

Video Game Publishers: Video game publishers make the games. The most visible publishers are Activision (NasdaqGS: ATVI), Electronic Arts (NasdaqGS: ERTS), THQ (NasdaqGS: THQI), Take Two (NasdaqGS: TTWO), Atari (NasdaqGM: ATAR), and Majesco (NasdaqCM: COOL). First, let me toss the garbage into the discard pile. If you are interested in gambling and throwing your money on the longest shots at a race track, here are a couple to waste time with: COOL and ATAR.

COOL is one of the worst run companies I have ever followed. This company is why Warren Buffet recommends, “It’s better to own a significant portion of the Hope diamond than 100 percent of a rhinestone.” The company has a lot of nepotism scattered through its ranks, and these people have less than a handful of brain cells between them. The company has been wrought with problems for years, and the climax was two years ago when the company’s then CEO Carl Yankowski pre-announced excellent earnings a few weeks before stunning shareholders with a massive miss (in laymen’s terms we call that “lying” and “misrepresentation”). If you bought a few months ago you could’ve made 50% on your money – but that’s only worth it if you enjoy staying awake at night wondering if the company will exist tomorrow.

ATAR is another fallen star. After years of nothing, this once famous company staged a major branding campaign to get back in the game. However, the company is poorly managed, its games are subpar, and if you invested, you would’ve watched shares nosedive from $60 to less than $2. Another piece of garbage for the renewable energy industry.

The next tier – one step from garbage – has only one member: TTWO. The company has been bought by a private equity fund that seems to be doing all the right things: slashing jobs, streamlining spending, and basically restructuring the entire company. TTWO has some excellent assets, franchises (including the famous Grand Theft Auto), and a nice balance sheet; however, the company has a long history of corrupt executives that cheat shareholders. The company recently announced a new game BioShock that is receiving top kudos from gaming experts and magazines, but some say it is too complicated to sell strong beyond the extreme gamer audience (i.e., the mainstream may not buy in). If you have the time to watch this stock like a pedophile at a kindergarten orientation, then you may be able to squeeze out some nice returns – otherwise, you may be better off upping your ante on your NFL Fantasy Football pool.

Stay tuned for my next installment where will I cover the best of breed game makers and continue to show why GME and NTDOY are currently the best bets in the video game industry.

Disclosure: SmartGuyDH is long NTDOY.PK

Wii Love Mr. Market’s Mood Swings

• Buy NTDOY.PK around 55 

Students of the stock market know Benjamin Graham is to stock investing what Moses is to Judeo-Christian ethics. Graham’s laser-beam insights and resulting pithy advice have made many (including Graham’s famed disciple Warren Buffett) a Wall Street fortune. Over the years I have found Graham’s parable of Mr. Market to be one of the most lucrative investing and trading strategies. As the market experiences wild mood swings, now is an excellent time to load up on my favorite holiday pick: Nintendo (OTC: NTDOY.PK).

For those unfamiliar, Mr. Market is the personified version of the stock market. As Graham noted, the price action on the stock exchange does not directly correlate to the value of the businesses underlying shares of stock. Thus, when the market (i.e., Mr. Market) sways with fear, an excellent business may see its stock price decrease. Conversely, when the market rages with greed, stock prices may become much more expensive than the value of the underlying business activities.

We are all aware that recent developments in the credit markets have adversely affected the stock market. However, many excellent companies and growth businesses continue to perform their alchemy turning goods and services into cash. Therefore, as Graham would say, Mr. Market is overly pessimistic and certain high quality companies are currently selling at a discount.

Since the Street begins their holiday stock fetish in September, I have found August a prime month to start snapping up shares of my favorite holiday picks (recall: when possible, always get ahead of the herd). This year my top holiday pick is Nintendo. (My previous holiday picks include Apple — NasdaqGS: AAPL — Activision NasdaqGS: ATVI — Sirius Satellite Radio — NasdaqGS: SIRI — and XM Satellite Radio – NasdaqGS: XMSR.) Since I believe the Nintendo Wii, the Nintendo DS, and Nintendo branded games will be on top of almost every holiday “must-have” list, I believe the stock will trade higher as these lists start hitting mainstream press and analyst notes.

This year, the added juice to my holiday trade is Mr. Market’s sale. I don’t know about you, but I am very confident that when Christmas, Hanukah, and all the other gift giving holidays arrive, the subprime mortgage and LBO credit issues will not work as a persuasive rationale in response to little Johnny and Lisa’s request for a $250 Wii or $50 Super Mario game (not to mention the employed young adult crowd who do not need an institutional mascot to justify a personal reward).

This is my third update on NTDOY, so I am not going to review the gangbusters numbers as I did in a previous review of Nintendo’s quarterly results. Although, I will note that Microsoft (NasdaqGS: MSFT) reduced by $50 the price of Xbox360. I think this is a nonevent because the Wii is still $100 cheaper and offers a revolutionary advance in gameplay that neither Xbox360 nor Sony’s (NYSE: SNE) PlayStation 3 offer.

So, although Mr. Market is a bit pissed at the moment, his current unhappiness is more reason NTDOY will deliver happy holidays.

Disclosure: SmartGuyDH is long NTDOY.PK

Akamai: Ride the Wave of Content Delivery

• Buy AKAM around 34.49

After witnessing the recent market volatility, I vowed to bide my time until my next pick and watch how everything would shake out. However, the market’s capricious whims have knocked down one of my favorite companies, Akamai (Nasdaq: AKAM), to relatively bargain levels. Two years ago I bought into the company at 13 and sold at 17, only to kick myself as I watched it soar to near 60. Although I expect the short-term swings to continue, I believe that the market is offering us another chance to jump on Akamai for the long-term.

Akamai provides a distributed computing platform for global internet content and application delivery. In other words, Akamai allows content providers like Apple and Yahoo! to seamlessly and quickly transmit audio, video, and graphics to internet users around the world. It’s obvious to any person with a modicum of technological literacy (and you qualify by reading this right now) that internet content delivery is a HUGE secular growth trend. Maybe the biggest. In order to distribute more content, companies need to increasingly leverage content delivery networks (CDNs). And as was stated in a recent Business 2.0 blog entry, Akamai is the Google of CDNs, controlling an estimated 54% of the market.

Earlier this year, the company was named Business 2.0’s #1 fastest growing tech company. Recent earnings indicated that the hypergrowth is set to continue, as Akamai announced full-year guidance that represents 44% YoY revenue growth and a 45% jump in profits. In return for meeting expectations and reaffirming this impressive guidance, the market rewarded Akamai’s shares with a 30% haircut.

Why? Minyanville has a great article breaking down Merrill Lynch’s (poor) reasons for issuing a dour view on the company following earnings. From what I can gather, the bottom line is that Wall Street is worried that others are catching on to Akamai’s game. Upstart competitors Limelight Networks, Internap, and EdgeCast have recently received glowing press and funding from big names. But I don’t look at the new entrants as a bad thing- it merely reinforces the fact that this is a remarkably high-growth industry. There will certainly be room for multiple players, but nobody has the experience or financial backing to go head-to-head with Akamai, the 800-pound gorilla. Akamai has spent hundreds of millions of dollars building out its world-class network and is currently engaged in a $60M capacity expansion. At its most basic, content distribution is about pure bandwidth power, and no competitors can come close to matching Akamai.

Trading at a 2008 PE of 21 on estimated growth of over 30%, I believe that Akamai shares have become too attractive to pass up. Regardless of the short-term gyrations, I think 12-24 months from now this will be one that we’ll be very glad we owned.

Disclosure: SmartGuyAB is long AKAM