Special Situation Investing

Wednesday, August 09, 2006

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


  • Good Work!

    Bioshock is getting a lot of buzz since E3. This should be a positive catalyst when it release. Now I just need to work on the model.....

    By Anonymous Anonymous, at 1:31 PM  

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