Special Situation Investing

Tuesday, August 29, 2006

Going on Vacation..

I will be on vacation and won't be updating this blog for the next 2 weeks.

While I'm gone, the Sara Lee (SLE) spinoff of Hanesbrand (HBI) should take place. I believe this is set to occur September 5 or 6. This is not an automatic buy simply because it is a spinoff. There should be some financials released when it is spun-off providing better insight into it's debt structure, revenue, earnings and compensation of key executives. Make sure you look into these numbers prior to making your decision.

For those who care about such things, Cendant has announced a reverse 10 for 1 stock split and a new ticker symbol CAR. The theory behind the reverse split is that it will provide credibility to the company simply through a higher share price. I assume that the name change was partly to erase the Cendant legacy from the company. For analytical investors these should be treated as non-events.

Friday, August 25, 2006

Bally Total Fitness (BFT) -- Hedge Fund Activism

Bally Total Fitness (BFT) has entered a confidentiality agreement with Hedge fund Pardus Capital Management. According to the article:

Pardus said in a filing with the Securities and Exchange Commission on Thursday that Bally will give Pardus "certain nonpublic information about the company for the purpose of evaluating and negotiating a possible strategic transaction with the company."

Under the terms of the agreement, Pardus can nominate individuals for election to Bally's board of directors; bring business before a stockholders meeting; and conduct a proxy solicitation in support of director nominees, according to the filing.

This is just another chapter in a long battle to repair the heavily indebted company. A brief timeline of events follows:

August 24, James F. McAnally resigns after 10 years.

August 11 - the CEO resigns. Don Kornstein is appointed interim Chairman, Barry Elson is appointed as acting CEO. Side note, Don Korstein apparently worked in the investment banking department of Bear Stearns. Pardus and Liberation Investments is in support of the new management. While independant, Pardus and Liberation own approximately 25% of outstanding shares and have a vested interest in cooperating and driving change in the company.
- the company announces that plans for a sale or merger have fallen through
- operating income is forecast to drop by 10-20% year over year
- filing of the quarterly report is postponed

March 21 - The company received a temporary lift when it was announced that
Richard Branson's Virgin Group was interested in acquiring the company. It is now known that this deal fell through.

September 2005 - The company announced that it would sell it's Crunch Fitness Club to help pay down debt. This sale eventually went through.


Bally Total Fitness is faced with interest payments which generally exceed operating income. On top of this, operating income has begun to decline. Without large scale operational changes or capital restructuring the company faces bankruptcy.

However, with control shifting to the hedge funds, these types of changes are exactly what is in store. In the latest press release, Pardus has indicated that they are interested in strategic alternatives. On August 11th, Liberation increased their stake in the company and had this to say about their intentions:

It also wants to arrange or participate in talks with third parties about a potential purchase of Bally's assets, a reorganization or investment, according to the SEC filing.

Liberation also said it may hold talks with Bally stockholders, management or board to maximize the value of their investment. The moves could include the purchase of additional stock, the sale of its stake or private deals to transfer its shares to another group.


BTF is cheap. It is also near bankruptcy. A few comparison numbers with competitor Life Time Fitness (LTM) illustrate the point (all numbers 12 months ending March 31/06):


P/E: Effectively negative, the company realized a small gain after selling assets but is losing money each quarter.

P/Operating Income: 1.49

P/Sales: ~0.1

P/Tangible Book: -.07 This is better understood in absolute values, a market cap of $106.8 million over -$1.46 billlion tangible assets. However, much of this is Deferred Long Term Liability Charges. The company had $713 million in long-term liabilities, March 31.


P/E : 34.5

P/Operating Income: 18.3

P/Sales: 3.7

P/Tangible Book: 4.8


While I am not quite ready to pull the trigger, at present price the risk/reward ratio seems appealing. Any sort of improvement could lead to a large rally. Consider that the company is currently trading at $2.58, and has ranged from $2.33-$9.92 over the past 52 weeks. It is also worth noting that the market has reacted very mildly to the latest news of Pardus investigating strategic alternatives. Investors seem to have lost faith. That is usually a good time to buy.

Thursday, August 24, 2006

Private Equity IPO's

Are private equity IPO's special situations? Business week ran an article a few weeks ago on them. From the article:

The question is: Will the Hertz deal be good for public investors? If other recent IPOs are any indication, the answer is a resounding no. On average, the stocks of companies taken public by buyout firms this year have fallen 6%. In contrast, shares of companies that have gone public without any assistance from buyout firms have risen 0.7%.

Okay, fine, so they are not good investments this year, why investors even care about such short-term performance is beyond me. What I want to know is whether they are superior long-term investments. If I have to wait a few years that is fine. The article has this to say on long-term performance:

Soon-to-be-released research by professor Josh Lerner at the Harvard Business School will show that in the last two decades, companies taken public by buyout firms have outperformed other IPOs and the major market indexes. That's because buyout firms usually take three to 10 years to carry out the sort of operational improvements that could justify their huge payouts in IPOs.

Now I am not saying that all private equity IPO's are buys, many are over-burdened with debt and I would only purchase them on deep discounts. Then again as they lose credibility in the mainstream press you are more likely to see these discounts.

Wednesday, August 23, 2006

Weyerhaeuser (WY) to spinoff/split divisions to Domtar (DTC)

Forestry conglomerate Weyerhaeuser announced today that it is planning to spinoff or split-off it's fine paper division and merge the division with Domtar (DTC). A few points from the article cover pretty much all there is available right now:

The new company is expected to be the largest fine-paper company in North America.

...But as more and more documents -- such as legal rulings and financial reports -- have gone electronic, analyst Paul Latta with McAdams Wright Ragen said many have begun to think of it as a sector in decline.

...Weyerhaeuser shareholders will get a 55 percent stake in the new company and Weyerhaeuser will nominate a majority of its 13-member board

The companies said the deal is expected to generate about $200 million in annual "synergies" -- cost savings and extra revenue -- within the next two years, because the combined operation will be able to save money on things like transportation, logistics and purchasing.

Under the agreement, Weyerhaeuser will receive a $1.35 billion cash payment.

The deal has been approved by both companies' boards, and is expected to close early next year.

Another article has this to add:

Excluding overhead associated with the fine-paper business, Weyerhaeuser's operating earnings per share would have been $2.13 in the first quarter vs. the $1.78 actually reported, Rogel said.

This has the potential to be a good special situation. The stock will likely have a high debt load after the $1.35 billion special dividend, it is currently unprofitable and it is in a hated industry. Of course this is only appealing if it leads to large scale selling. It seems that the potential for economy of scale also exists. We will have to wait until more details emerge for a more conclusive analysis.

Gateway (GTW) Receives Offer for Retail Division

Computer hardware retailer Gateway (GTW) received a $450 million offer from a private investor for it's retail operations today. From the article:

The founder of eMachines Inc. has offered $450 million to acquire the retail business of Gateway Inc., in a bid that intensified speculation about a possible buyout of the long-struggling PC maker.

To put this into perspective, Gateway ended today with a market cap of $725 million and according to the article:

Gateway's retail operations accounted for $592 million, or 64 percent, of its revenue of $919 million in the second quarter.

Gateway was removed from the S&P500 on July 25, an event which can lead to price discrepancies as institutional investors sell.

So is gateway now a buy? Well let's break the numbers down. Gateway has a $450 million purchase offer for it's retail business divided by a market cap of $725 million. That gives a ratio of .62 or 62%. The retail operations acount for 64 percent of revenue so based purely on sales the company is just fairly valued assuming that the sale goes through.

Realistically, we should also look at earnings as it is possible this is an under-performing division. For that you need to look at the quarterly or annual reports, the quartely reports are accessible here.

The following numbers are from the 2nd quarter, 2006 report.

Retail - This is the unit on which the purchase offer was made

Sales : $592 million, a 21% year over year increase.
Segment Contribution : $17.2 million


Sales : $250 million, an 8% year over year decrease.
Segment Contribution : -$8.3 million

Direct Sales

Sales : $77 million, a 31% year over year decrease.
Segment Contribution : $9.3. million

So if you sum the segment contributions from the remaining 2 divisions you get $1 million. These numbers can swing either way quarter over quarter but I have a hard time believing that the remaining divisions are worth more than their relative proportion of revenues.

Although Gateway qualifies a a special situation due to it's delisting and potential purchase, it seems that at present it is fairly valued. I don't feel comfortable paying fair value. The computer hardware industry is very tough right now with even ultra-efficient Dell (dell) posting large earnings declines. It seems that this is a business where scale matters and Gateway, with $3.6 Billion in annual sales just doesn't stack up to Dell's $55 Billion. This is not to say that Gateway can't make it or that Hui won't purchase the whole company but at current prices I would prefer to remain on the sidelines.

Cendant (CD) Completes Travelport Sale

Cendant has completed the sale of Travelport for $4.3 Billion today. They announced this previously so I consider the sale itself a non-event. Cendant is planning to distribute $1.4 Billion of the proceeds to recently spun-off Realogy, $760 million to Wyndham and use the remainder to pay expenses and debt.

More interesting, Realogy announced that they will be using the majority of the funds to repurchase 19% of shares outstanding (48 million shares or $970 million worth at todays closing price of $20.23). The remaining funds will be used to repay debt. Realogy also lowered earnings expectations to $250-340 million in fiscal 2006 ($1.03 - $1.43 per share). The company still doesn't seem like a buy to me given the state of US real estate but the share buybacks are encouraging.

Other links on Cendant and the Wydham/Realogy spinoffs are available here, here and here.

Tuesday, August 22, 2006

Bausch & Lomb (BOL) Study Finds Recall Necessary

Preliminary findings on the Bausch & Lomb (BOL) contact lens recalls have been released. From the article:

Bausch & Lomb Inc.'s global recall of a popular contact lens solution in May appears to have stopped the spread of a serious eye infection but U.S. scientists still do not know what caused the outbreak, according to a study released on Tuesday.

The article also had some interesting statistics on the infection:

As of June 30, the researchers had identified 164 confirmed cases of the fungal infection fusarium keratitis. Of those, 94 percent, or 154 patients, wore soft contact lenses. Infected patients came from 33 states and one U.S. territory and about 34 percent of them required a corneal transplant.

According to the study, infected contact lens wearers were 20 times more likely to have used Bausch & Lomb's ReNu with MoistureLoc lens solution than another solution.

In terms of financial costs (for reference BOL has a market cap of $2.6 Billion):

In addition to the loss of a $100 million-a-year product, analysts have estimated Bausch & Lomb faces $500 million to $1 billion in potential liability from the infection.

Bausch & Lomb responded to the article shortly thereafter:

We think the report confirms that Bausch & Lomb took the right action in the interests of consumer health and safety by recalling the MoistureLoc product, and that Bausch & Lomb can continue to recommend its ReNu® MultiPlus® solution with confidence.

BOL's stock price has been hit hard as a result of the contact lens recall. In spite of this, there does not appear to be sufficient margin of safety in BOL to warrant investment. The company sells for ~5x tangible book value, 16x earnings (before the recalls) and ~1.2 x sales.

Previous post on BOL are available here and here.

Thursday, August 17, 2006

Pep Boys (PBY) Takes Itself Off the Market

In a recent report Pep Boys (PBY) has declared that it is taking itself off of the market. From the article:

The Philadelphia-based automotive parts and service chain also disclosed that in its search for a buyer or pursuit of strategic alternatives, it didn't find anyone interested in acquiring the entire business. Late Tuesday, Pep Boys said it was taking itself off the market and will focus on improving the business.

I mention this mainly as a word of warning about the potential sale of Cendant. To summarize that article, Cendant announced that it will consider selling itself (it is now a car rental company) to private investors. Despite the boom in private equity investment, buyers and sellers do not always agree on a suitable price and poorly performing businesses can be as unattractive to private investors as the general equity markets.

For value/turn-around investors, Pep Boys may be worth a look as it is selling right around tangible book value, near a 52-week low and is still eaking out a small profit.

Wednesday, August 16, 2006

Triple Crown Media (TCMI) Post Spinoff Analysis

In a somewhat complicated transaction, TCMI separated from it's parent company Gray Television, last december, and shortly thereafter merged with Bull Run corporation. The company operates a disparate collection of businesses: newspapers, collegiate marketing, collegiate production services, a management services company and a wireless provider. I really don't do it justice but there is a fairly exhaustive summary here for those interested.

Usually the pupose of a spinoff is to allow the parent or the child company to receive a "purer" valuation (that means higher) due to the simplicity of valuation. In this case, only Gray Television would have received the benefit. Personally, I don't consider this an issue, this company is still less complicated than say GE, which still garners a very healthy valuation.

TCMI is interesting from a special situations perspective for a number of reasons:

1) It has a massive debt load for it's size. To put it into numbers, at current prices, TCMI has a market cap of $38 million, and long-term debt of $118 million. In total, TCMI, as of March 30, listed $168 Million in assets and $158 million in liabilities. Much of the assets are in the form of goodwill or intangibles. As such, the company has tangible assets of $-93 million. So the company is highly leveraged but this is counterbalanced by a very depressed stock price. Obviously not something you want to sink your whole portfolio into but that same reaction is probably keeping many fund managers away.

2) TCMI is small. Again, it has a market cap of $38 million. Most mutual funds cannot gain a meaningful piece of it, I doubt most would even look at it.

3) The whole TCMI situation is somewhat complicated. Long-term financials are not readily available, it was a complicated spinoff and their are several different types of businesses bundled as TCMI.

4) The company has incredible price appreciation potential. In the last quarterly results, the company listed $34 million in revenue ($136 million annualized) and $4.6 million operating income ($18.4 million annualized). To put this into perspective, Gannet Company, a large newspaper publisher and admittedly not a perfect comparison, is doing about $8 billion in revenue per year and has a market cap of $13 billion. To be fair though, Gannet does make a healthy profit.

5) The shares were originally tendered at ~$15 / share last December. Currently the company is sitting around $7.50. Management clearly thinks higher of the company than the market does.

6) Management has considerable interests in stock price appreciation. In a series of SEC filings on April 27, 3 senior executives received rights to large stock option blocks:

Cornwell Steven, Exec. VP Operations, 20000 shares, expire 2016, exercisable at $5.43 / share
Meikle Mark, Exec. V.P. & CFO, 25000 shares, exercisable at $5.43 / share
Tom Stultz, CEO, 100000 shares, expire 2016, exercisable at $5.43 / share

Company Outlook

This is all fairly meaningless of course, if the company does not survive. There is tremendous risk with the high debt the company carries. There appears to be little synergies between the businesses it manages (that is more speculation on my part than analysis). In spite of this, I think TCMI will survive. My reasons include the following:

1) In spite of it's huge debt load, despite recently merging Bull Run, and despite just recently spinning off as an independant company, Bull Run made a small profit of $464K in the quarter ended March 31, 2006. If you disclude amortization of intangibles (this is a paper expense only), they profit would have been closer to $1 million.

2) I anticipate that the company will be able to cut costs over the next couple years as recently merged companies tend to have at least some overlap.

3) I am repeating myself, but management has a strong interest in the company NOT going under.

Do your own research, and it would be very helpful if I could get some comments on the idea.

Tuesday, August 15, 2006

Cendant (CD) and Take Two Interactive (TTWO) - Carl Icahn reveals ownership

In a recent report (this version of the analysis is more readable) it has come to light that Carl Icahn has ownership in Cendant and Take Two Interactive. The filing was current as of June 31.

If he held his position, he would now have ownership of Cendant, Wyndham and Realogy as a result of the spinoff. He is listed as having 6.1 million shares of Cendant out of some 1 billion shares outstanding. As such he has little direct control over management. It seems likely that he picked Cendant more because current management shares his style of extracting value from troubled businesses.

His stake in TTWO is again likely meaningless as far as influence over management. He owns 800,000 shares out of ~72.5 million shares giving little influence other than psychological. I remember reading, but cannot find the post, something about him financing a video game startup so perhaps this has given him some insight into the software company.

More on Take Two Interactive here and Cendant here and here.

Monday, August 14, 2006

HealthSouth (HLSH.OB) Potential Spinoff

HealthSouth has announced plans to divest it's surgery and outpatient rehab centers. The outpatient division is quite small in comparison to the parent, from the article:

In the three-month period ended June 30, HealthSouth said that among its four primary operating divisions, surgery accounted for 24.5% of revenue and 18.1% of operating earnings; its outpatient division contributed 11% of revenue and 6.8 % of operating earnings

Another article provides comments on the form that the divestiture might take:

Chief executive Jay Grinney said HealthSouth is considered alternatives including a spinoff or sale of its underperforming divisions.

The company has clearly stated that they will use the proceeds to pay off debt. In the case of a spinoff this would likely mean the spun-off division would take on a large debt load and pay it back to the company in the form of a tax-free dividend. High-debt can exacerbate institutional selling in the case of a spinoff. On the flip-side, HealthSouth is relatively small at $1.8 Billion and is not part of the S&P 500 which will limit the amount of selling when and if a spinoff occurs. In spite of this, the story is worth watching.

Sunday, August 13, 2006

Tyco (TYC) Share Repurchases

Tyco released it's third quarter results last week. To summarize the financial numbers, revenue was up 5.1%, and net income fell from $.56 per share to $.42 per share of which 6 cents was attributed to 1-time charges. Tyco is made up of four divisions, all but the fire and security division saw operating income decreases despite generally posting higher revenue. Overall I thought that the numbers were somewhat concerning given their trend but their is too little data at this point to make a case that the company is in long-term decline. However the valuation still seems reasonable at ~$25.50 per share, and an estimated forward P/E of 12.38.

The company is undertaking large scale share buybacks as seen in their 10-Q. During the past 9 months Tyco has repurchased 71 million shares for $1.9 Billion, or about 3.5% of outstanding shares. They also state in the report their intention to continue to repurchase shares and have $1.3 Billion remaining in their current share repurchase program. In spite of the capital allocated for share repurchases, Net Tangible Assets have increased by $1.9 billion over the past 9 months.

I originally posted about the Tyco (TYC) split up here.

Take Two Interactive (TTWO) update

The July video game sales numbers just came out and they are fairly encouraging. Aggregate industry sales are up 22%. Take Two Interactive (TTWO) saw even larger gains as described in the article:

Meanwhile, Take-Two Interactive Software Inc.'s shares dropped 2 cents to $10.62 on the Nasdaq. The company saw sales rise 34 percent, helped by easy year-ago comparisons and gained one percentage point of market share to 8 percent.

Note the casual reference to the market share increase of 1%. When you break it down, going from 7% to 8%, this translates into a 14% gain in market share.

I wrote a post earlier this week on TTWO as a value play, it is accessible here.

Thursday, August 10, 2006

Advanced Data Processing (ADP) spinoff

Advanced Data Processing (ADP) announced it's intention last week to spin off it's Brokerage Services and Securities Clearing companies into an independant company. It is aiming to finalize the spinoff by the end of fiscal 2007 (June 2007). According to the Motley Fool, the Brokerage Segment represent about 20% of revenue. Unfortunately the new entity will not be small enough to warrant large scale institutional selling but it is worth keeping an eye on what the new management will look like, how much skin they have in the game (shares & options) and how tightly coupled it will be to ADP.

It seems the primary motivation for the spinoff may be it's low growth relative to the rest of ADP, as described in the Red Herring:

The company has typically only seen single-digit growth in the brokerage services business and is aiming for double-digit growth in its payroll-processing and back-office businesses.

The article also describes the standard spinoff motivation of a simplifying analyisis of the parent company. This often leads to a higher price.

Mark Marcon and Jeffrey Meuler, analysts with Robert W. Baird & Co., view the spin-off as a positive move for ADP. “The unit has been a drag on ADP’s margin improvement and we believe that the concerns regarding secular trends in the division have held back ADP’s multiple,” they wrote in a research note.

Cendant (CD) Up for Sale?

Cendant announced today in a conference call that it will consider selling itself, or either of it's 2
recently spun-off companies, Realogy (H) and Wyndham (WYN), if the right price came their way. This should come as no surprise, Cendant is in the process of finalizing it's sale of it's Travelport business to private investors.

For general information on the Cendant spin-off click here and here.

What makes the company interesting from a special situations perspective is that the company's executives have substantial equity interests in the various Cendant
entities. For instance, the CEO is listed as owning 9.3 million shares pre-spinoff (at current prices, the 3 divisions are worth about ~$12.50 a share, which puts his piece of the pie at $116 million) and seem intent on maximizing their value through whatever means available. While I applaud the approach, their numbers would make me question the inherent quality of the
underlying businesses. Just be aware that if a sale does not go through it could take
some time to realize the underlying value discount and results could deteriorate while you are waiting.

Cendant closed down at $1.89 on the news.

Wednesday, August 09, 2006

Sara Lee (SLE) Spinoff

Sara Lee will be spinning off it's Hanes brand company in September. This is part of a long-term restructuring effort at Sara, as they have spun-off or sold a number of companies over the past few years including Coach.

Hanes, with $4.7 billion in sales, will be taking on $2.6 billion in debt when it is spun off. The unit had earnings of $263 million in the past 39 weeks.

Cendant (CD) Spinoff

Cendant completed the spinoffs of it's real estate division (Realogy R) and hospitality division (Wyndhan WYN) about a week ago. It has also announced the sale of it's Travelport business for $4.3 Billion has received antitrust approval.

Post spin-off analysis:

CD was originally selling for $15-19 billion in the 52 weeks pre-spinoff. Currently, the sum of the parts goes for about $12.30 billion, divided as follows:

CD - ~1 billion shares * $1.99 = $1.91 billion

WYN - 200 million shares * $26.07 = $5.21 billion

H - 250 million shares * $20.72 = $5.18 billion

= $12.3 billion

For spinoff junkies this might be worth looking at.

Cendant also announced it's latest and final quartely results with all divisions included. From this point onwards, "Cendant" is really Avis/Budget rent-a-car. The results were less than expected, revenue up 2% and EPS from continuing operations of $.17 or $170 million including restructuring costs.

Now I am not advocating Cendant but you might want to keep an eye on it. In it's new form (as a car rental company) it is selling for $1.99 billion with expected revenue of $5.6 billion. Earnings are likely to be weak as EBITDA is predicted to be $260-295 million. Digging through some statements it looks like actual earnings will be less than $100 million for a steep P/E of 19+. However there are restructuring results included in those numbers and they are getting hit hard by the increase in interest rates. Consider that Dollar Thrifty (DTG) has revenue of ~$1.55 billion and a market cap of $1.02 billion for a P/S of .66 compared to Cendants P/S of .34. There is similar debt levels between the 2 companies.

Take Two Interactive value play (TTWO)

Take Two Interactive (TTWO)

Take Two Interactive is a developer of software games for personal computers, video game consoles, and handheld platforms. I am not writing to tout the growth prospects of the video game industry so mach as to show an excellent turn-around situation. So let's quickly move on to the dirt.


Grand Theft Auto, TTWO's most successful product, was pulled off shelves last year due to a scene containing sexual materials. However, the company is still selling modified version of the product with a different adivsory rating. This years sales are going to be impacted adversely. Nevertheless, this is not a significant long-term event. The advisory rating on this version does not dictate the advisory rating on future releases nor does it impact other products by the company. Also, the target audiences do not look at this in a negative light, perhaps the opposite. This situation reminds me of criticism over Abercombie and Fitch's racy catalogues several years ago. The stock has soared since then.

Perhaps more significant is a options backdating investigation by the SEC. However, the company is under investigation for options backdating in 2003. While this is certainly a concern, there is a new CEO (albeit the president at the time of the scandal) installed in 2005. I view this as a serious issue, the present management cannot fully be trusted, and the stock price should reflect it. Having said that, this is hardly the only instance of options backdating and the stock is oversold on the news. Consider that the SEC is investigating 80 companies for improprieties in backdating options. This includes 2 of Take Two's competitors, THQ & Activision, both of which trade at substantial premiums to TTWO and to both of which I would apply the same comments about upper management. This is business, companies bend the rules, what is important is that you as an investor are sufficiently compensated in the form of a reasonable stock price for these unknowns. In TTWO's case, you are more than sufficiently compensated.

3) In general, the video game industry has not been very hot in 2006. Industry sales were down through the early part of this year


1) In spite of everything, the last version of Grand Theft Auto was the best selling video game of 2006. There have been multiple versions of it released and, as media companies have done with successful movies, TTWO can continue to generate revenue by releasing tangential and enhanced versions of the product. In fact, this would appear easier to do in the video game industry as upgrades to hardware render older games obsolete motivating consumers to purchase the "new" version.

2) TTWO has numerous other software programs, including rights to the Civilization series, which was HUGE in the 90's and could certainly be exploited further.

3) Video game sales may already be turning with industry-wide sales in July up 25%.

4) I said I wasn't writing to tout the video game industry but even without any significant growth this stock has upside potential. A boom in the video game industry would just be gravy: Next generation Nintendo and Sony consoles are expected to be launched in fall, while the XBOX 360 has already came out. The new sony console is notable in that it contains 8 processors (as opposed to 1 for the previous console) and is considered to be years ahead in it's graphics capabilities. This is the first large scale console release since 2002. Many industry analysts expect an upturn in sales due to the excitement generated by the devices as well as the luring of larger demographic segments. As well, the new devices include internet connectivity which provides new revenue streams, such as online gaming and advertising, for the game providers.


In recent quarters TTWO has seen a slowdown in revenue and a drop in earnings. Due to the problems with Grand Theft Auto, the critical christmas quarter was much weaker than in the past and TTWO suffered a lost this past christmas. It should be noted that many video game publishers make the majority of their profits in the fourth quarter. As such TTWO does not seem cheap based on past 12 months earnings and I would rather focus on future earnings and past revenue numbers for this company and their competitors. All of the following companies are video game developers and while they appeal to different niches a general comparison should be appropriate:

For an apples to apples comparison I am including both the Fiscal 2005 revenue (to show what the stock had done in the past when thing went ok) and the past 12 months from April (for a better comparison with it's rivals)

TTWO Revenue 2005 (Ending Oct 31/05) - $1.2 Billion
Revenue 2005 (Ending Apr 30/06) - $1.0 Billion
Market Cap $770 million
P/S (Oct 31/05) 0.64
P/S (Apr 30/06) 0.77

ERTS Revenue 2005 (Ending Mar 31/06) - $2.95 Billion
Market Cap $15.22 Billion
P/S 5.15

ATVI Revenue 2005 (Ending Mar 31/06) - $1.47 Billion
Market Cap $3.56 Billion
P/S 2.42

THQI Revenue 2005 (Ending Mar 31/06) - $.86 Billion
Market Cap $1.6 Billion
P/S 1.86

Earnings for the year ending Oct 06 are expected to come in at -.67 per share or $-48.7million. However, I will note again that the majority of earnings are generated in the christmas quarter ending January.

This year is going to be a write off but with net tangible assets of $375 million, this company can afford to soldier on while it gets it's problems behind it.

Factors that Could lead to price improvement

1) Significant management change

2) Buyout by rival firm

3) Improvements in video game sector as new consoles are deployed

4) Market memory of these incidents, especially sex scandal, will fade over time if not repeated

5) New range of products should lead to improvements in revenue and return to profitability