Take-Two Aspirin and Call EA in the Morning

Take-Two Interactive Software (TTWO) is the subject of a hostile bid from fellow video game maker, Electronic Arts (ERTS). Take-Two has the hottest video game franchise in the Grand Theft Auto titles, which since 1997 have sold more than 70 million copies. EA is trying to acquire this lucrative family of games as soon as possible in order to get the revenue boost during the holiday game buying season. EA offered the hostile bid to shareholders on February 25^th of this year because Take-Two would not negotiate until after the release of the latest edition of the famed and controversial game. Take-Two put a lot of stake in the release of “GTA4” going well, and the gamble is paying off as the game has shattered sales records in its first week.

Take-Two had been trading within the $16-$18 range prior to Electronic Arts bid of about $26 per share, or $2 billion total. Management at Take-Two knew that they had a monster hit about to go to market and wisely pleaded with shareholders to be patient. With $500 million in sales in the first week, “monster hit” could be an understatement. In comparison, the highly anticipated release of Halo 3 sold $10 million less in its first week than GTA4 sold on opening day, April 29^th. Most analysts had expected GTA4 to sell 5 million copies in the first 2 weeks; however, the game actually sold 6 million in just one week.

The growth of the gaming industry is astounding, and even as economic difficulties permeate many sectors of the economy, gaming has never been stronger. Gamers are willing to pay $60 prices for these games and a few hundred for an Xbox 360 (MSFT) or PS3 (SNE) gaming platform, even as they contend with high gas and food prices. It seems hard to imagine but the gaming industry is now generating more revenue than the movie business and interactive entertainment is growing much faster as well. Video games revenues grew by more than 34% in 2007, compared to box office revenues up 4% mostly due to increased ticket prices and home movie sales fell 3.2%, according to the Wall Street Journal.

Take-Two will undoubtedly be asking a much higher price before they would consider a takeover bid for EA. EA is likely trying to put a deal together right now, as time is of the essence in order to subsume the holiday sales revenue. The odds of this deal going through are diminishing by the day as the value to EA lessens as more revenue is lost. At Ockham Research, we have thought that Take-Two has been undervalued for quite some time. The revenue growth is obviously impressive as we have already covered, but cash flow has improved markedly as well. Take Two has commonly traded with price-to-cash flow in the range of 24.13 to 42.78 and at current price levels its only 7.75. It will be very interesting to see if the smash hit release of GTA4 has driven Take-Two out of EA’s price range, but with the value that we see underlying TTWO, it would not be surprising if other suitors knock down their door.

Disclosure: none