Wall Street Strategies'  Instablog

The videogame console cycle for investors in the big three independently traded software publishers (Electronic Arts, Activision Blizzard, THQ) has almost been a complete bust. I say almost as the merger between Activision and Blizzard (division of Vivendi at the time) in 2008 was a seminal moment for the industry, not only creating an industry titan but also marrying two different spectrums of the gaming industry (console and online).  That said, I have an inkling that the fortunes (i.e. financial numbers) of the publishing sector are about to be reignited, and it could actually start to be borne this holiday season.

Price cuts have begun for current generation consoles, initially for the Xbox 360 and recently the Playstation 3.  The lower comparatively priced Nintendo Wii should also receive a price cut long before not as the phenomena of motion sensor gaming dies and some other way to drive units is needed to move Nintendo's first-party software (Mario Brothers, for example).  Collectively, by my estimation, there have been 108.0 million units of the Xbox 360, Playstation 3, and Nintendo Wii sold since 2005.  By comparison, the Playstation 2 has sold about 138.0 million units from its launch in 2000.  With price reductions now in scope, it's not unreasonable to project the base of current generation consoles doubling by say 2012/2013 assuming the hardware is not upstaged by new technologies (aka a new console cycle commences). Given a higher installed console base, it's commonsense that more software will be sold no matter of the economic conditions.  One way to invest in such expected growth is through Take-Two Interactive (TTWO).  Though the maker of the Grand Theft Auto franchise has a spotty track record when it comes to delivering titles on time and contending with public outcry regarding in-game violence, the fact is that it has some of the most lucrative assets from which to monetize during the 3-4 year time horizon I just suggested for a material increase in the installed base of consoles.

The third fiscal quarter was rather unkind to Take-Two as it grappled with cautious order patterns by retailers and tough margin comparisons to the year ago launch of Grand Theft Auto IV.  The non-GAAP LPS result did marginally surpass guidance set on July 13, when management dropped a bombshell by announcing the push out of Bioshock 2 into FY10 to garner more development time.  We attribute the upside on the bottom line to continued cost containment efforts by the Zelnick-led management team and catalog sales that were not as soft as one would have anticipated given commentary by Electronic Arts (ERTS) and THQ (THQI) in early August.

Pre-holidays Take-Two will have Grand Theft Auto content available, so there is potential for 4Q09 and 1Q10 numbers to surprise.  On balance, however, holiday 2009 will not be strong for Take-Two unless it releases either Bioshock 2, Mafia II, Max Payne 3, or Red Dead Redemption.  We do not project these titles hitting the market for the holidays as Take-Two appears dead set on getting the gameplay and firm shipment dates in order; a more likely scenario is that these key titles will launch in 2Q10/3Q10.  We believe these titles have considerable potential as they are released into a market we foresee experiencing renewed hardware uptake from the aforementioned price cuts as well as less caution on the part of retailers.  In tandem with potential commentary on the next iteration of Grand Theft Auto, there are certainly catalysts in place to drive the stock higher.  Net debt has trended lower in recent quarters and barring a complete failure on the FY10 launch slate, which we are not envisioning, tapping the capital markets for added liquidity should be off the table.  

Brian S. Sozzi is an equity research analyst with Wall Street Strategies Inc. (www.wstreet.com). Mr. Sozzi actively covers the retail sector for a client base consisting of buy-side and sell-side firms as well as individual investors.  For more information about Mr. Sozzi, refer to the company's website, wstreet.com.