Will Take Two’s Shareholders Have the Chutzpa to Wait Out the EA Battle?

“The offer is inadequate and not in the best interests of the shareholders.”

That was the tagline when Take Two (TTWO) initially responded to EA’s (ERTS) public tender offer to acquire the company. Wednesday, the sentiment echoed anew from the boardroom and two brokerages when Take Two formerly rejected the offer.

Supporting the decision legally, the company filed a heavy load of documents with the SEC stating their case, along with supporting (albeit disclaimer laden) fairness opinion letters from Bear Sterns and Lehman Brothers.

It took some time to digest all the paper and put together this detailed review, but the general argument put forth against the deal continues to hinge on its timing. Take Two believes the full commercial potential of their Grand Theft Auto game, and by relation its impact on the company, won’t be "evident until after its release." From their standpoint, the company says why should they trust projections when the actual data is just a month away. (Game releases April 29th). There’s a certain logic to that claim but little is simple in a battle like this one.

EA counters that the premium they offered, which was substantial compared to the closing price on the day of the offer and the stock’s 200 day moving average, more than accounts for high-estimate results. (The offer was also a more than $600m premium to Take Two’s enterprise value according to Wedbush Morgan’s analyst Michael Pachter).

EA further hints, albeit indirectly, that the run up of the stock toward the offer price in anticipation of their takeover, coupled with opportunistic trading speculation about the game title once it releases (if the deal remains pending but open), could drive a temporarily higher stock value that is not fundamentally supported by the company (and then may drop after); either case, EA doesn’t want to trust market volatility to carry more weight than financial analysis. There’s a certain logic and history in that claim too.

This desire of one side to wait, and the urgency of the other to prevent volatility swings (pro or con), has turned this into a high stakes poker game with both sides betting aggressively from opposite tracts: Take Two stalling and EA trying to rush the decision. The battle also seems to be getting somewhat personal as the two sides maneuver to push and prod each other’s management into a mistake.

Already, EA has made compensation for Take Two’s management with an ultimatum in the deal. Take Two countered by rescheduling their annual meeting by a week, thereby pushing the date of the shareholder gathering until after the expiration of EA’s tender. Take Two also implemented a short term shareholder rights agreement, or “poison pill”, that makes any uninvited share purchases beyond 20% trigger what amounts simplistically to very expensive, and dilutive, stock based dividends. Additionally, a move possibly but not necessarily unrelated, Take Two adjusted the salaries and employment agreements (severance packages) of a few key executives to higher levels. (Specific details on all these various moves can be found in documents searchable at the SEC’s website for those brave enough to get buried in the legalese).

Institutional investors own a substantial portion of Take Two’s stock. Based on a quick look at Yahoo finance (which may be slightly off), the current percentage (Institutions and Mutual Funds) is a massive majority of 97%. Given the general unease about the present state of the economy and the added uncertainty of a significant stock pullback if the deal falls through, one has to wonder how risk tolerant these investors are.

Are they willing to sacrifice short term gains for a longer term result? Are they willing to trust a capable but untested management team (the current team has only been on board since being brought in by the shareholders around June, 2007)? It’s an issue of “a bird in the hand” as the saying goes.

Handicapping it isn’t easy, especially in light of significant sell offs by the company’s two largest shareholders. That move could’ve been viewed as a sign that the funds were in disagreement with their peers and avoiding a fight that they anticipated. Just as viable is an argument that they believed the price, even a slightly lower price (which they took in selling), was more than enough to hedge the risks.

Ultimately, Take Two says they’ll begin considering alternatives and negotiating on April 30th. As part of the standard language, that announcement included statements that they’ll look for alternate deals, or approaches to find the best value for the company. Even with so called “indications of interest,” there have been no substantive discussions in the month since this deal began. Questions have to be raised as to whether there are other buyers. Only a short list could afford the $2b plus price:

• Activision (ATVI), which might have been a contender, is not going to jump in given their in-process merger with Vivendi/Blizzard. That also rules out Vivendi Games.

• Microsoft (MSFT), which does have gaming aspirations, is locked in their battle for Yahoo (YHOO). Even more appropriately, though, they have made moves to get out of some studio businesses including their flagship Bungie, which was set free in October. Either of those pieces of evidence is enough to count them out.

• Another possibility, Disney (DIS), is not likely given audience demographics; despite the strengths and growth opportunities of Disney’s gaming, Rock Star’s more mature fare (Grand Theft Auto as one example) is not a good fit. Maybe, the rest of Take Two could be in a separation deal….but that to is too complicated to be realistic at this time.

• Viacom (VIA.B) remains one of the few companies capable and potentially willing. The MTV Networks demographics, and existing tie-ins for Nick games, would make for some overlap. On the other hand, the operational costs associated with Take Two’s more than 13,000 person staff and 16 studios makes that seem, like many other prospects, too complex to happen now; even if Viacom proves interested.

Back to that majority of institutional shareholders – will they really have the confidence, or chutzpa, to wait this out? It’s a tough call. The conflicting arguments from the companies lobbying for them to choose a side makes it even more complex.

It’s true, for example, EA’s offer is unquestionably opportunistic in its timing. But does that mean it’s automatically inadequate?

Arguments that Take Two’s shareholders will fail to benefit from some of the value that lies in a combined company (so called “synergies”) are interesting, maybe even accurate, but they’re just as opportunistic in reverse.

As an analogy: if a developer comes along and offers to buy your house at a substantial premium to the local real estate market, do you take it? Assume you know they have the resources to knock the house down and build a mansion, or a strip mall – something of far higher value – but something you could never do on your own. Is it realistic to believe you’re entitled to a pro-rated share of that future value, even considering you won’t bare its risks or costs? Not to mention, those costs can’t be accurately projected – which is exactly the argument Take Two has used to try and stall the deal over GTA IV.

The other big argument from Take Two’s management - that their efforts to turn around the company, and progress made already, aren’t reflected in the price - seems similarly interesting but even more tenuous. The team has been onboard for less than a year. While they have made a significant improvement, they’re still a long way from realizing their long term plans. Many risks and challenges remain. At a $600m premium (mentioned above), it could be argued those contributions are more than included.

To a similar point: in an analyst briefing, Chairman Strauss Zelnick made a point of emphasizing the company’s pipeline. He noted that since 2004, the company has seen the launch of at least one million unit selling game per year. The trouble with that data is, it mostly happened under a prior management team that proved to some extent incompetent in the view of shareholders (they were replaced after SEC investigations, among other things). Using them as an example overlooks the troubled financial performance that came at the same time; and that’s something EA could argue might be in the company’s future despite the new management’s better credentials and skill set. The argument could go, "it’s not management, it’s the core of the business."

Broken down – this has all the makings of a complex, hostile, and aggressive battle. (Even more so than patent suits looming against games like Guitar Hero and Rockband). Shareholders are going to come back to the one question: do they want to gamble on a growing industry and a company in turnaround or take a hefty premium to the recent market value and accept profits while they’re there?

I wouldn’t want to peg odds…. This could go either way. On a limb, I’d bet for more than 50% tendering shares and the deal going through but it might be extremely close.

Comments

[steveballmer]

Now that Bungie is gone we may very well look up these guys!

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