Aside from the fact that I see markets pulling back in March, as noted here, I believe there is still time to be a stock picker. The question for this column is whether Take-Two Interactive (TTWO), which has had quite a run since the beginning of the year, is a stock with more upside for the rest of the year. It has risen from $11.11 on January 2, to $14.64 today -- an increase of almost 32%. It hasn't been alone. Electronic Arts (EA) and Activision (ATVI) have also been up a lot since then, as has the perennially hated GameStop (GME). So has this rise been based on stronger recent game sales, excitement over new console technology, or a healthier outlook for these companies, including Take-Two.
The first thing to realize when looking at the video game stocks is that the industry has evolved, likely due to increased competition and an increase in the average age of the game player ("gamer"), into a top heavy game market. What I mean by top heavy is, it's the top sellers that make or break a quarter and a year for these companies.
Why has the market become top heavy? Is it because the price of games has increased? No. The games themselves are actually cheaper than they were (adjusted for inflation) in the 1990's. According to EGM (Electronic Gaming Monthly), the price for an average Nintendo 64 game would be approximately $69.60 in today's dollars.
The rise of the tablet and smartphone-based games has presented competition to all but the highest production-value games. This has sucked some of the game play out of the consoles. Additionally, while a vast majority of gamers are still aged 6 to 25, the gamers from the 1980's and 1990's are now in their late twenties and thirties and now make up a significant portion of total gamers. Why does that matter? Older gamers work and have less time to game. Therefore, they are more likely to spend money on only two or three high quality games every year.
While it may be true that demographics and stiffer competition from mobile and tablet-based games are causing the gaming market to be top heavy, another trend is helping provide increased revenue and a boost to margins. Digital downloads, mostly the add-on expansion packs to games, do provide a method to extend the earnings life of a game. This can also help smooth out earnings to negate the effects of a subpar big game. They also have lower costs associated with their distribution, which means they boost margins.
Industry-wide challenges going forward include continued competition from mobile and tablet games and the new console transitions. The new console transition is interesting. On one hand, it has the potential to stir up new energy and buying in the industry -- specifically a boost to next Christmas' sales for consoles and the games for them. Some new blood is needed since it has been six years since a new console cycle came out.
On the other hand, recent game developer earnings calls mentioned the fact that there is traditionally a margin decline upon the introduction of a new console. This occurs because the new technology on the console requires the game companies to fund new research and development so that the game can take advantage of the console technology. This margin compression usually takes a few quarters to work through, too.
Take-Two has a core group of major titles, just like Activision and EA does (see table below).
The company just released an add-on pack for Borderlands 2. On March 5th, Major League Baseball 2K13 will come out for Xbox 360 and PlayStation 3. On March 26th, Bioshock Infinite will be released. Grand Theft Auto V is expected to be released on September 17th. And XCOM is expected to come out next year.
In January, Take-Two's NBA 2k13 was at #4 in video game sales.
|Boarderlands||FIFA||Call of Duty|
|Grand Theft Auto||Battlefields||Skylanders|
|MLB 2K||Tiger Woods PGA||Starcraft|
|XCOM||Mass Affect||Guitar Hero|
|WWE||Need for Speed|
Recent Quarter Results
Y/Y earnings were up 312% and revenue was up 76%. This beat analysts expected revenue by almost 11%. EPS was $.67, beating analyst expectations by almost 22%.
Gross margins increased by 1.3 percentage points, helped by higher priced new releases. This improvement in margins is also good to see because it indicates management is keeping costs down.
The company is relatively cheap compared to its peers. But Activision and EA have had better performance the past couple of years, which may give them a little benefit of the doubt in terms of earnings multiple.
Take-Two has a forward P/E of only 6.52, but again, it is tough to predict sales of these games a year out. You never know until they get into gamers hands and the reviews start coming in whether it will be a hit or not.
Take-Two also has a lower price-to-sales multiple than both Activision and EA, and a lower price-to-cash multiple than Activision and EA. Gross margins, while rising in recent quarters, is still well below those major competitors. Additionally, Take-Two has a substantial amount of debt, while Activision and EA do not. Take-Two does have enough cash to pay off this debt if it wants to, still leaving $100M in the bank.
In short, the company's financials are not quite up to either Activision's or EA's, but they are solid and getting better.
Compared to Peers
|Price to Sales||1.28||3.27||1.37|
|Price to Cash||3.02||3.63||3.64|
|LT Debt to Equity||.58||0||.28|
|Float Short (Ratio)||21.29%(9.03)||3.15%(1.39)||9.51%(5.07)|
The stock bounced out of the top of the channel for a bit, but I expect it to continue in the channel. It is likely going to approach the middle or bottom of the channel on a pullback (maybe this month?), so today's price may not be a good entry.
While I believe that Activision has the best current business model because it's MMOG (massively multi-player online games) lend themselves best to add-on sales, it's tough to predict out into the future. Activision also seems to have the best management, but Take-Two has made significant strides recently. I think you can look to buy any, or all, of the big three game makers on a pullback.
I think TTWO continues to rise this year. But I think with the new consoles likely out for next year, the game stocks will decline or churn sideways then due to margin compression. But after the margins rise again, I see the add-on digital sales and entrance into the mobile/tablet game market providing steady earnings, making all three of these long-term buys.