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It is no secret that the video game industry is surprisingly cyclical for many players. Look no further than GameStop (GME), which has seen shares soar after a multi-year lull in games now appears to be over with the launch of Microsoft's Xbox One (MSFT) and Sony's PlayStation 4 (SNE).

The game-developing business is probably even more cyclical, but it has little to do with broader economic conditions. Rather, development is somewhat similar to biotechnology in the sense that developers may spend years developing a game before finally launching and recouping costs with extraordinarily high marginal profits.

That story is playing out at Take-Two Interactive

Take-Two Interactive (TTWO) is a game developer that owns infamous studios like Rockstar Games and 2K Sports, maker of the dominant basketball franchise NBA 2K. Shares of the developer languished in 2012 and throughout most of 2013 as Take-Two struggled to bring its latest Grand Theft Auto (GTA) to market.

These concerns were valid, until Grand Theft Auto V came to market. In just 3 days, the game registered over $1 billion in sales. From the company's press release:

"We believe this marks the fastest that any entertainment property, including video games* and feature films**, has reached this significant milestone."

Even more impressive, Take-Two's current market capitalization is only $1.6-$1.7 billion. With additional game sales going forward, as well as additional revenue generated from the game's robust online gaming community, the game looks poised to be an incredible revenue and profit driver. News leaked that the game will allow micro-transactions, so users fully immersed in the digital world can spend real life money to access digital capital. Given the relatively low amount spent on capital expenditures, this revenue could translate into hundreds of millions of dollars in free cash flow.

GTA 5 is it…or is it?

Many skeptics believe that Take-Two is highly dependent on GTA 5 to drive revenue. While any game that adds more than $1 billion in sales in just a few days is going to materially sway results, Take-Two has several other valuable franchises including Max Payne and LA Noire, though they aren't nearly as important as GTA.

We're also very bullish about sales prospects for NBA 2K14. NBA MVP and consecutive champion LeBron James will grace the cover in this year's edition, and we think the NBA in general has a very compelling storyline this year. All-star center Dwight Howard changed teams, the Miami Heat will look to "three-peat," the last NBA MVP not named LeBron returned when Derrick Rose hit the court this preseason, and the Brooklyn Nets made some blockbuster moves to become a competitor (these events impact the league's biggest star and all four of its largest media markets). These factors combined with the release of next generation consoles will ignite strong sales of NBA 2K14 past the 5 million units achieved during the past three years.

Valuentum's Take

Take-Two has a very interesting product suite, and we've seen the stock receive a fairly mundane response to blockbuster sales numbers. The company, as we said earlier, is highly cyclical, so even if GTA V sets all sorts of sales and profit records, the focus remains on what's next. This uncertainty is why we assign the company a wide fair value range; however, we think the Street is underestimating how accretive GTA V sales will be to earnings (assuming the high end of our fair value range becomes a more likely fundamental outcome).

With results soaring and Take-Two proving it can develop hits (GTA V, Borderlands 2), a larger acquirer such as EA could be interested, especially as we've seen a ripe appetite for M&A while interest rates remain low. We're watching Take-Two very closely, and we could look to add shares to our Best Ideas Newsletter portfolio if we find an attractive entry point.

Source: Grand Theft Auto 5 Will Drive Results At Take-Two

Additional disclosure: MSFT is included in the portfolio of our Dividend Growth Newsletter.