Seeking Alpha
Deep value, special situations, long-term horizon, banks
Profile| Send Message|
( followers)  

Summary

  • Take-Two Interactive is extremely cheap.
  • The company has tons of cash to allocate after a successful GTA 5 launch.
  • Shares are worth $30-$36.

With stocks rallying sharply over the past year, finding screaming bargains has become much more of a challenge. Thus, I have concentrated my search to smaller companies. With this new approach, I stumbled across a name every gamer has known for years, Take-Two Interactive (NASDAQ:TTWO). Although I began purchasing shares in the $18-range, shares continue to look like a screaming bargain.

Quick Background

For those not particularly fond of spending hours playing video games, let us take a quick look at what exactly the company does. Take-Two produces video games for consoles including Sony's (NYSE:SNE) PlayStation 4 and PS3, Microsoft's (NASDAQ:MSFT) Xbox One and Xbox 360, Nintendo's Wii and Wii U, and the personal computer. The company, thus, owns two primary studios that are responsible for game production including Rockstar Games and 2K.

Rockstar is responsible for a myriad of popular titles, including Grand Theft Auto, Red Dead, LA Noir, Max Payne, Manhunt, and Midnight Club. Many of these games require years of development and investment but generate blockbuster revenues that justify both the time and money invested. In fact, GTA 5, the latest iteration of the studio's crown gem Grand Theft Auto franchise, is on its way to becoming the best selling video game of all time. The feat is even more impressive when considering the game is not available for sale on the newest generation of consoles.

As for 2K, the studio also has some blockbuster franchises on its hands like Borderlands, BioShock, and The Elder Scrolls. These games are similar to those under Rockstar in the sense that they require long lead times, high production costs, and elite talent to develop. Additionally, 2K creates NBA 2K and WWE titles. NBA 2K is almost like an annuity. While the company continues to please fans, save a poor showing on the newest generation of consoles (not out of the ordinary for the first release on a new platform), NBA 2K continues to sell upwards of 5 million copies annually. Sports games require lower incremental investment costs and, unlike blockbuster games, can be released every year. WWE 2K came to Take-Two after rival studio THQ was liquidated. The first iteration on the 2K platform received positive reviews, and I think an even better game could be released for the '15 version. 2K also recently shuddered its money-losing MLB franchise, which should be positive overall for earnings.

Recent Positive Events

Far and away, the most positive recent events have come in the form of the blockbuster success of GTA 5. As I said before, the game will likely become the best-selling video game ever, and it has translated to fantastic financial results for Take-Two. The firm generated $1.8 billion in sales during its most recent quarter, which lead to EPS of $4.69. Both figures were several times larger than the year ago period. The sales have resulted in over $700 million in free cash flow year-to-date, and nearly $1 billion in cash on the firm's balance sheet versus $450 million in long-term debt.

This robust cash balance gives Take-Two financial flexibility. Though the firm already repurchased shares from Carl Icahn earlier in the year, I think the company could return a nice chunk of cash to shareholders via an additional buyback program or a special dividend. Take-Two does not need such a robust cash balance to operate, even if its earnings can be cyclical.

While it does not impact the performance of the business, it is also relevant to note that hedge fund manger David Einhorn's Greenlight Capital purchased 4.2 million shares, good for 3.4% of the company. Einhorn is a successful value investor, and his presence in the stock after Icahn sold his position signals some confidence in Take-Two's return profile.

Some Negative News

As I mentioned previously, Take-Two owns a fantastic franchise in BioShock. However, the head of the studio that produced the game, Irrational Games, decided it was time to move on to other projects. Thankfully 2K will retain ownership of the BioShock franchise, but it also means that there will not be a new game from the franchise released any time soon. Also a slight positive, Irrational Games head Ken Levine will stay on at Take-Two to develop new narrative games. Ultimately, this news is only mildly negative, but it will eliminate near-term revenue streams.

Additionally, rumors competitor EA's (NASDAQ:EA) exclusive licensing contract with the NFL was ending appear to be untrue. Gamers remain largely dissatisfied with the Madden franchise's complacency and only modest generational improvements, and there was some hope that 2K, which has done incredibly well with the NBA, would be able to create a competitor to Madden. Only EA and the NFL know the status of the contract for certain, but it seems safe to say an NFL 2K15 is not in the cards.

Why is Take-Two Undervalued?

With the most positive potential catalyst, GTA 5, mostly behind it, you may be curious as to why Take-Two looks cheap. On a relative basis, it's a no-brainer. Take-Two trades at roughly 5x FY14 earnings (ends in March) and 20x FY15 earnings. Even more impressive, Take-Two announced it would be profitable going forward, and it will not experience the cyclical losses of years past. Competitor EA trades at 22x FY14 earnings and 19x FY15 earnings. More troubling, one of its recent blockbusters, Battlefields 4, received underwhelming reviews, whereas BioShock Infinite received incredible critical praise, and GTA 5 is considered one of the best games ever.

Another competitor, Activision Blizzard (NASDAQ:ATVI), trades at 15x FY14 earnings (ends December) and 14x FY15 earnings. Activision's Call of Duty: Ghosts received solid critical reception, but I think the franchise is stagnating with consumers. The game can be found for over 50%, which is considerably lower than popular games released around the same time. I worry that Call of Duty has lost some of its luster, so Activision's earnings estimates may even be too high.

Clearly, relative to its peers, Take-Two looks pretty cheap, especially considering that the firm is putting out the best video games in the industry at the moment. Plus, FY15 may be stronger than anticipated thanks to continued monetization of GTA 5's online experience and a yet-unknown title releasing in CY14. President Karl Slatoff would not make a concrete announcement, but he did note that there is another large title coming.

What's Take-Two Worth?

In my humble opinion, Take-Two currently possesses the best intellectual property of any video game maker, as well as the most talented development team. Further, Take-Two continues to build incredibly valuable brands that could be worth much more in the hands of Disney (NYSE:DIS), Microsoft, or Sony. Any of these companies could monetize Take-Two's brand portfolio in various ways. Additionally, Microsoft or Sony could acquire the company to create exclusive titles for its 8th generation consoles.

At the moment, Take-Two sports an enterprise value of only $1.16 billion. In my view, the GTA franchise alone is worth at least $2 billion. Further, the dominant NBA 2K is probably worth a few hundred million dollars on a standalone basis. Conservatively, the company could be valued at $3 billion, or roughly $27 per share on a fully diluted basis. However, in my view, the company could be worth closer to $4 billion based on both intellectual property and its improved earnings potential. Such a valuation would yield a share price of $36 per share, or upside of nearly 80%. EA, Activision, and the aforementioned companies could all be viewed as potential acquirers.

Even if Take-Two is not sold, I think the company's share price will soar on the announcement of a new title, and when the company proves its ability to earn a profit every year. Because of the year-to-year volatility in earnings, it is probably wrong to value the firm on a PE ratio, and more appropriate to think of the firm from a DCF perspective. From this angle, I believe shares are worth (conservatively) $30 per share. Thus, I think investors can expect upside of 50-80%. This is the sort of asymmetrical return that I find highly attractive, with the primary downside risk being that the firm is unable to execute on creating hits in the future. Even after a fantastic 27% gain in the past 3 months, shares are cheap.

Source: Take-Two Is Poised To Rise 50%