Take-Two Should Be a Bigger Acquisition Target

I will forever remember the easiest and quickest 20% return I ever made in my life. It only happened a few weeks ago. The wave of selling was just indiscriminate. I looked at Anheuser-Busch's (BUD) stock price and saw a $57 stock with a $70 approved buyout offer from a major foreign company, which implied there should have been a major risk to its deal. But I searched and searched and found little risk at all. Each company kept insisting everything was fine as they were already announcing managers who would be in charge of the newly combined company. And yet, much of the market was not interested in listening. They were just trying to survive. Anybody who bought into that company's stock had a positive return while the rest of the market dealt with a storm.

Beer and video games is my thing, so naturally I also follow video game stocks. Again, all I see is indiscriminate carnage. The one that strikes me the most is Take-Two Interactive Software, Inc. (TTWO). It's trading as if a $26 buy-out offer from industry leader Electronic Arts (ERTS), which Take-Two rejected – and which was pulled a little over a month ago – never happened at all. The stock currently trades at around $11 while it has $4.40 in cash as of July. Not only that, they appear to have more cash building up as they dumped a lot of properties into the market in their recently completed quarter. On Thursday, they even significantly beat analyst expectations for the month of October 2008 – of all months.

Meanwhile, Activision (ATVI) and Electronic Arts, the industry's third party publishing leaders, seem to be putting up mediocre numbers. Consumers slowed down their purchases of the expensive Guitar Hero and Rock Band items, suggesting that perhaps the recession has touched the game industry a bit – at least when it comes to expensive $100+ video games.

Yet, consoles and software overall saw a dramatic year over year rise in sales and even beat expectations in a time when all other retail is struggling. Take Two appears to be a part of that crowd weathering the storm. But there is a storm, no doubt.

What I don't understand, however, is how the market can now ignore the fact that Electronic Arts made a very public offer to buy out Take-Two. The market seems to discount the possibility of any other offer. The offer was an immediate signal to me that Electronic Arts was looking to acquire the company to benefit from the synergies of reduced expenses (like they said would happen with the acquisition), and thus add considerable earnings for Electronic Arts for a relatively low price. The offer was, in fact, made before Take-Two had hundreds of millions in cash and when there was a question mark over how its megahit game, Grant Theft Auto 4, would perform.

With Electronic Arts and Activision having issues and cash rich Take-Two trading at less than half of the buyout offer made in February of this year, wouldn't that just make Take-Two a more high profile acquisition target? You would think so. But while the market now ignores this company in the mayhem, I see a stock that is not only doing fine as a stand-alone company, but is still a major target for industry consolidation. Activision and Electronic Arts both have the cash for it and both stand to gain much more through this acquisition than a stock buyback. They also have increasingly fewer options. And what better time to twist Take Two management's arm than when its shares trade at $11.

If the market is going to continue to ignore legitimate buyout offers of cash rich companies, I think it opens up a major opportunity to profit. You can't tell me a company is worth 850 million today in an industry that is weathering this storm at retail when nine months ago it was using a line of credit, had 300 million less cash and was actually offered 2 billion dollars cash by an industry leader. There's a lot of insanity in the market right now, but with recent legitimate cash buyout offers, I think the opportunity is lower risk.

Stock position: Long TTWO.

Comments

[homersby:]

I totally agree with everything you wrote, but isn't the market discounting another offer since TTWO rejected 26/25.74? Zelnick probably still thinks it is worth more than that and he may well be correct, but that would mean an offer well over 100% premium to current price. Rare numbers even in the best of times. The market, in general, no matter how hard we try to inform others, still sees TTWO as a one hit wonder. I know that's not true and so does any reasonably informed person, but the market is not always reasonably informed of things like this. Just my thoughts.

2008 Nov 25 10:45 AM

[User 306691:]

Activision is far from having issues, Guitar hero still sold moderately well, I don't see why anyone would expect a 100 dollar game to sell really good in this economy. however COD World at war outsold COD4 by 200% in the first week and their other recent release, WOW-Wrath of the lich king broke the single day record with 2.8million copies being sold. They also have a LOAD of cash piled up... so yea something tells me Activision is doing just fine. I don't even have to mention the other two huge titles they're working on.

2008 Nov 25 02:03 PM

[Gaucho420:]

TTWO is where Activision was 5 years ago, except they have a killer franchise.

I made some good returns buying early on at $13, selling during the takeover battle and I would advise anyone to buy shares now for a long term hold.

Given the current recessionary environment, the lack of confidence in anything as well as the living fro news to news market action, in the short term all of these stocks could still go further down and by short term I mean six months to a year.

2008 Nov 25 04:27 PM

[Muzie:]

I too am puzzled how breaking the record for most ever sales in one day on a PC game makes Activision's numbers "mediocre".... hmmmm...

ERTS underperformed TTWO by quite a bit in the last month so they are in less of a position to do the buyout now. It's anyone's guess if ATVI would be interested.

2008 Nov 25 07:42 PM

[mrottersman:]

Following up on the pro Activision comments: in addition to the points made above, Guitar Hero isn't selling poorly, it's selling out but there's insufficient supply. If you don't believe me, check out Amazon, Gamestop, etc. People are selling the band kit on ebay above retail. Demand is there, and the Christmas numbers are going to surprise a lot of people.

2008 Nov 25 07:54 PM