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Will the Wii U Push Nintendo Back Into Profitability?

Nintendo Wii U Console Demo
Chris Morris for CNBC
Nintendo Wii U Console Demo

When Nintendo reported a $533 million annual loss in late April, it was the first time in the company's 30-year history as a publicly traded company that it had fallen into the red.

Even though the loss was expected at that point, it was a mark of shame for Nintendo — and investors battered the stock. Now, as the company'snext generation console system prepares to launch later this year and the handheld 3DS device starts to get its legs under it, it's hoping to get back to black. But not everyone's convinced it will manage to do so.

Officially, Nintendo is projecting revenues of $10.1 billion and profits of $246.4 million for the fiscal year ending March 31, 2013.

"Our intention is to return to profitability after just one year of losing money," says global president Satoru Iwata. "I cannot say that it's a good thing for Nintendo to record an annual loss for two or more years in a row. The reason we had the annual loss this past year is due to the 3DS hardware sales. We were selling hardware below the [manufacturing] cost, so this year we are already recovering or improving the profitability of the 3DS. That's why we are focusing to return to a profit this year."

Nintendo 3DS
Source: Nintendo
Nintendo 3DS

The 3DS is still being sold at a loss, though. Iwata says that will change "in the very near future," but analysts remain skeptical.

"I have them losing a little bit this year and next, primarily because of handheld weakness as smart phones continue to erode their market share," says Wedbush analyst Michael Pachter. "They have a lot of cash, so risk is low, but they are not likely to make much money if their console doesn't resonate with gamers and sales are weak, especially when next generation consoles come from the competition."

The key to profitability for Nintendo comes down to a couple factors: Will gamers be interested in a dedicated handheld gaming system amid competition from a new iPhone from Apple ? And will the Wii U be able to capture the same zeitgeist as the Wii?

The answers aren't easy. The Wii U has so far failed to excite gamers and the mass market doesn't seem to grasp what the tablet controller will do to significantly differentiate the system from its predecessor. Iwata himself said he was "not 100 percent satisfied" with the company's performance at E3 this year.

The company does have some things working in its favor, though. The current console generation is long in the tooth – and consumers are ready for new hardware. Nintendo will be the only company offering it this year.

Most gaming hardware companies operate on a razor and razor blade model — sell the razor (in this case, the gaming system) at a loss, then make up those losses on high profits from the razors (the games). Nintendo, though, has never been a believer in that strategy.

Some analysts, though, argue it might be time for the company to reconsider that strategy — even if it means another fiscal loss — since selling the Wii U at a loss would result in a lower retail price. That, they say, would ensure a notable installed base of systems, giving them a solid market share when Microsoft and Sony roll out their new consoles (which is expected to occur next year).

After all, they note, the 3DS didn't gain a foothold with consumers until the company lowered the price of that system.

"I think the price point of the Wii U will be very important for them to regain consumer mindshare," says Colin Sebastian of R.W. Baird. "I wouldn't be surprised if in the near term they forego some profitability to gain market share. … [Nintendo] might be leaving more money on the table long term if they don't sell more units now."

The fate of the 3DS is even more uncertain. Smartphones and tablets, with their low-priced software, continue to eat away at the dedicated handheld gaming market. (Sony's PS Vita is struggling at retail as well.)

For the past several years, Nintendo's handheld division has been a cash cow — and if the company can't find a way to regain that momentum, it could have dire financial effects.

"[The] 3DS is trying to replace their bread and butter DS business, and has competition from smart phones/iPods at the low end and from PS Vita at the high end," says Pachter. "I think that their handheld revenues will be cut in half from 2008 levels by 2014, and that means that they lose a ton of profitability."

Sebastian agrees, noting that while Nintendo should do fine in the home console market, it needs to find a new secondary market to focus on.

"I think the reality is, whether Nintendo admits it or not, the handheld market is disappearing," he says. "They have the tablet integration with the [Wii U] console and they should focus their resources there."

email: tech@cnbc.com

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