Pokemon Go is not enough to keep banks from telling investors to abandon Nintendo stock

The free-to-play game Pokemon Go, which uses augmented reality on your smartphone to catch cartoon animals, has become an overnight success and is already set valued in the multi-billions of dollars due to in-app purchases.

However, bank analysts are warning investors that there is one key reason why people should either abandon or be cautious about Nintendo stock- it is not the company that will be making heaps off the gaming phenomenon.

Basically, Nintendo was the original creator of Pokemon video games and holds some licensing rights to Pokemon Go, but as analysts at CLSA and Macquarie Research point out, Nintendo is not the main beneficiary of how well Pokemon Go does because it didn't develop the actual game.

Who will benefit? Game developer Niantic and tech giant Apple, which takes a cut of in-app purchases on iPhone.

Jay Defibaugh at CLSA says (emphasis ours):

"Nintendo's Pokémon Go app climbed to the top ranks in terms of downloads and revenue soon after release. Although the core gameplay mechanic is tailor-made for mobile monetisation, we think that the economic benefit to Nintendo from the title is unclear. The title is not associated with Nintendo and DeNA's partnership in-app games, so the success of Pokémon Go has no direct positive read-through for DeNA.

"We have not directly incorporated revenue from Pokémon Go in our model. We rate Nintendo a SELL."

"The economic benefit to Nintendo from Pokémon Go is rather unclear. In our past conversations with Nintendo management in the context of Pokémon games for Nintendo handhelds and consoles, management has indicated that Nintendo receives royalties for Pokémon titles but surprisingly little direct profit, benefiting instead from the impact of Pokémon titles on hardware sales and penetration.

CLSA points out in its stark note that Pokemon Go was created by The Pokemon Company and Niantic, a spin-off from Google's location-based technology group:

"Pokémon Company is an equity affiliate of Nintendo. Nintendo owns 32% of the company, with the other portion owned by two companies, Game Freak and Creatures, associated with the originator of the Pokémon concept. The ownership is further complicated by Nintendo's part-ownership (10% when we last checked) of Creatures, and the fact that Nintendo, Pokémon Company, and Google participated in a US$30m capital raising by Niantic in September 2015. Pokémon Company published Pokémon Go, but the typical handheld or console game developed by Pokémon Company is manufactured, distributed, published and marketed by Nintendo."

In other words, while people may associate Pokemon products to Nintendo due to brand recognition, the Japanese company does not directly reap huge amounts of the profits from the Pokemon Go game because the ownership structure is super complicated. On top of that, because Pokemon Go uses smartphones and not a console, Nintendo doesn't benefit as much.

As my colleague Kif Leswig pointed out recently, Apple is more likely to make more money than Nintendo from the game.

Meanwhile, David Gibson and Aya Haruyama at Macquarie Research said that action over Nintendo's equities is under review.

They are super-bullish on how popular Pokemon Go is going to be, estimating that it will generate $4 billion annually, "which we estimate would add ¥3.5k to our ¥21.3k valuation. But the core smartphone business could do better now which we believe would push valuations to ¥29k-¥36k."

However Macquarie also points out: "We think it's too early to include Pokemon Go in our forecasts for Nintendo for now."

Investors have been ignoring these warnings over the last few days, as you can see from Nintendo's share price:

Shares in Nintendo jumped as much as 16% on Thursday due to the popularity of Pokemon Go and have added over $7.5 billion to the group's value within the first two days of Pokemon Go going live.

Within just 7 days of Pokemon Go's launch, more than 65 million people are playing the game in the US. And even though it is not available in the UK yet, people are finding ways of getting Pokemon Go on their phones by using a loophole.