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Coverage Initiation: Konami Corporation (KNM)
Value Line recently initiated coverage of Konami (KNM) in The Value Line Investment Survey. In the United States, it is best known as a video game company, with titles such as Silent Hill, Birds of Steel, and Metal Gear, though it also has such well known “vintage” game properties as Frogger. However, like many Japanese companies, it does a lot more than people realize.
Management breaks its products into four main business groups: Digital Entertainment; Gaming and Systems; Pachinko and Pachinko Slot Machines; and Health and Fitness. The first group, Digital Entertainment, is the one that most domestic consumers would recognize. The other three would be much more difficult to identify, let alone understand (Pachinko is huge in some markets and completely unknown in others).
Konami was founded by Kagemasa Kozuki in 1969 with the goal of producing amusement arcade games. The company began to create microcomputer-equipped video game machines in 1978, video game software for personal computers in 1982, software for video game systems in 1985, and software for LCDs for Pachinko machines in 1992. The company started its health and fitness segment in 2001. The shares were listed in Japan in 1984 and have subsequently been listed on other exchanges, including the New York Stock Exchange in 2002.
As noted above, the Digital Entertainment segment primarily makes video games. It has a collection of titles, some more successful than others, and distributes worldwide. Its games are made for multiple platforms, including some of the most popular today, like the Nintendo Wii, Microsoft (MSFT - Free Microsoft Stock Report) Xbox, and Sony (SNE) Playstation. It also creates products for portable game machines like the Nintendo DS. This segment also includes arcade style games, specifically the well-known Dance Dance Revolution line, that would be located in arcade/game room facilities. In addition, the segment produces playing card games (Yu-Gi-Oh!), and toys and videos related to its intellectual properties. This segment accounted for about 50% of the company’s revenues in 2011.
The Gaming and Systems segment creates gaming machines (i.e. video poker) for casinos, as well as systems that control and monitor gaming machines. This group represented about 8% of the top line in 2011.
Both of these segments are heavily dependent on creating products that resonate with consumers. This can be an expensive process with little to no guarantee of success. Employee input into the games is also a vital component of success, so the loss of key personnel or the inability to hire qualified employees could hamper results. Complicating these issues for the Digital Entertainment group is the need to tailor programs to the game systems on which a title will be sold. As new game systems are introduced, games must be updated. Moreover, if games are created for a game system that does not sell well, the costs of tailoring games to that console will have been wasted. Economic headwinds would likely affect both segments, as gambling and discretionary purchases usually decline when economic times are tough.
Up to this point, Konami has operations that make complete sense together and wouldn’t raise an eyebrow. The next two business segments, Pachinko and Health and Fitness are a little more difficult to explain.
On the surface, Pachinko appears to be a game that involves shooting metal balls into an array of metal posts, watching them fall through the posts, and, eventually, into receptacles of varying point values. The game is popular in Asia and is, basically, a form of gambling. Modern Pachinko machines incorporate video screens and elaborate video presentations. This segment is subject to many of the same issues as the Digital Entertainment and Gaming and Systems segments. Although the game of Pachinko may be foreign to many, if not most, Americans, this business line fits in with the other two, which are both related to games and gaming. The Pachinko segment was around 7% of the top line in 2011.
The Health and Fitness segment, however, is the odd man out. As of December 2011, Konami owned or operated over 350 gyms and sports facilities in Japan. These are exactly what one would expect, noting that there is little synergy between the other businesses and this one. Maintaining desirable facilities is an important component of running health and fitness clubs, which can be costly and labor intensive. In addition, the company is open to lawsuits brought by customers, as there is material potential for customers to injure themselves in a company owned or run facility. As a discretionary purchase, economic weakness can hamper the performance of this group. Health and Fitness contributed about 33% to the top line in 2011, making it the second most important operating group for the company. Although this segment does not particularly fit well with the other three, it falls within the company’s broad mandate of creating “valuable time.”
While one can argue about what “valuable time” is, it is clear that Konami owns a collection of important digital properties and has a material gym business in Japan. With health consciousness generally on the rise and video games becoming an ever more important part of daily life, the company has at least the foundation for solid long-term performance.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.