Take-Two: A Compelling Value With 2 Asymmetric Options

| About: Take-Two Interactive (TTWO)
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The traditional bear case on Take-Two (NASDAQ:TTWO) has been it is a one-trick pony with poor management. Traditionally what investors have done is buy into every "Grand Theft Auto" release and then sell afterwards.

This time however this point of view doesn't match reality. Take-Two has a different management team, which hasn't done any silly deals like the Major League Baseball exclusive, which cost the company tens of millions of annual losses last cycle.

Instead the company along with "Grand Theft Auto" has a list of ever-green franchises, which include "Red Dead Redemption" (sold 13 million units), "Bioshock," "NBA 2K," "Civilization," and an attractive publishing deal with "Borderlands" ("Borderlands" 2 sold 7.5 million units). The company now has 9 different franchises that have sold over 5 million units.

Another fear for investors was that the power of the "Grand Theft Auto" brand was on the wane. This could not be further from the truth. With over 29 million units sold in, "Grand Theft Auto V" turned out to be an intellectual property on the rise. It already has sold more than "Grand Theft Auto IV" and is on track to be the best-selling console game of this generation. Pre-launch analysts were expecting 15-20 million units sold during the first fiscal year, but now the game is on track to do DOUBLE that number.

And even though 29 million units of "Grand Theft Auto V" have sold-in, the CEO of Take-Two expects continued re-orders in the December and coming quarters.

"And in terms of our expectations going forward, yes, we fully expect to keep selling lots and lots of this game and I think the fact that we've sold in more than 29 million units to date in 6 weeks is pretty extraordinary.

So demand remains very, very strong Indeed. I think it's a fair question, because I think some people have asked us to put a finer point than you did on your question is thus just a reflection of all the demand being pulled current, but there is just no evidence that that's the case at all" - CEO of Take-Two Source.

To support this thesis of continued strong demand for "Grand Theft Auto V" into the holiday season, I've been tracking the best-seller lists on Amazon (NASDAQ:AMZN) on a daily basis. "Grand Theft Auto V" has been out-selling EA's "Battlefield 4" even 1 day after "Battlefield 4" was launched in the past week. On most days it's the second best selling game on current generation consoles only following "Call of Duty Ghost" pre-orders, which releases this week.

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Due to the success of "Grand Theft Auto V," the company within months will have over $1 billion of net cash on the books. In the September quarter the company reported, the balance sheet showed over $1 billion of accounts receivable, which according to the 10-Q/10-K filings should turn to cash on 30-60 day terms.

With continued strong sales and using the high-end of management earnings guidance for FY2014 (March) of $3.75 and my estimate of net cash per share of $7.76 within a couple of quarters, Take-Two is currently trading at a P/E of 2.7.

Option 1: Free-to-play "Grand Theft Auto" Online

"Grand Theft Auto" Online is a free-to-play game that comes built-in to every copy of "Grand Theft Auto V." It is a completely separate game and experience with a separate mission structure (over 500 missions) and narrative to the single player game.

I think it is likely "Grand Theft Auto V" will sell 40 million units over its lifetime on current generation consoles. According to Eurogamer, their sources say the PC version of "Grand Theft Auto V" will come out in Q1 of 2014, which should add millions if not tens of millions to the "Grand Theft Auto Online" player base.

I believe the market is giving little to no value to the large upside potential of "Grand Theft Auto Online."

Merrill's analyst said "Call of Duty" did $260 million of digital add-on sales in 2012. League of Legends is the most popular free-to-play game on PC and makes hundreds of millions a year off its 32 million player base. "World of Tanks" is probably the 2nd most popular free-to-play game on the PC with 20 million players and makes hundreds of millions a year too. King.com, the maker of free-to-play "Candy Crush Saga," is preparing a reported $5 billion market cap IPO.

Take-Two has already committed to doing micro-transactions on "Grand Theft Auto Online." With a player base of 50 million+ (console and PC) in the coming year, the upside could be hundreds of millions in profits on an annual basis. I hear the margin on selling in-game cash to players, so they can buy themselves an F-16 or a Ferrari are very, very high.

Option 2: Strategic Take-out Value

Due to the success of "Grand Theft Auto V," the intellectual property value of GTA has gone up. Consequently Take-Two is a very attractive acquisition candidate for many suitors. It has a long list of intellectual property brands as discussed, large upside due to "GTA Online," and most importantly the best developers in the business at Rockstar and 2K studios.

Using my assumption of $1 billion in net cash within a couple of quarters, at current prices Take-Two has a comically low enterprise value of $1.3 billion. I believe over a 4-5 year cycle, proven by the success of FCF generation by "Grand Theft Auto V" and "Red Dead Redemption" even without the upside of GTA Online, Take-Two can generate $1 billion FCF in 4-5 years. So basically you get the company for free in a few years, not even counting the intellectual property value of their franchise brands.

Compare this low valuation to Activision (NASDAQ:ATVI), which trades at 19Xs earnings and is facing competitive threats to all their core franchises. "World of Warcraft" subscribers are on the decline, the next "Call of Duty" will be down y/y not up huge like GTA and "Skylanders" are facing the Disney (NYSE:DIS) Infinity threat. This is likely a peak earnings year for Activision. Wouldn't it be very attractive for Activision to use their stock trading at 19Xs earnings to buy single-digit P/E Take-Two?

The same goes for Electronic Arts (NASDAQ:EA), which is trading at 20Xs earnings and has a huge hole in their first person shooter lineup next year with no "Battlefield" or "Titanfall." Why wouldn't Electronic Arts want to use their 20Xs peak earnings stock to buy single-digit P/E Take-Two?

It's not just the financials that make sense. Both Activision and Electronic Arts are facing a need to acquire top-flight engineers. Activision lost a ton of talent from Blizzard to Riot Games, which makes "League of Legends." Activision also lost the original team that created "Call of Duty," which left to form Respawn. Take-Two's Rockstar and 2K studios with the best engineers in the business would be nice fill-ins to shore up their talent.

Microsoft (NASDAQ:MSFT) and Sony (NYSE:SNE) are both launching next-generation consoles in a few weeks. Acquiring Take-Two with an enterprise value of $1.3 billion would be a brilliant acquisition for either of them to get the leg-up in this cycle. "Grand Theft Auto 6" and "Red Dead Redemption 2" exclusive to Xbox One or Sony PS4? That would be a big console war-winning move; huge strategic value when tens of billions of dollars are at stake. Microsoft benefited from acquiring "Bungie"/"Halo" two cycles ago. They have done this before.

Carl Icahn is also the largest shareholder of Take-Two. Carl's son, Brett [the brains behind Carl's Netflix (NASDAQ:NFLX) investment], was re-elected to the Board of Directors of Take-Two in recent weeks. One of Carl's favorite moves is to find potential acquirers for his companies. The Wall Street Journal reported when Carl Icahn first bought his Netflix position, he held many meetings with large technology and media companies to convince them to acquire Netflix. Carl should do the same with Take-Two.


Take-Two is a compelling value at the current price. I believe the $1.3 billion enterprise value after net cash is severely under-estimating the profit generation over the next 4-5 years and doesn't take into account the upside potential of GTA Online and the strategic value to acquirers. A year ago, I chose Zillow (NASDAQ:Z) as my favorite long idea with large upside potential for the coming year. This time, it's Take-Two.

Disclosure: I am long TTWO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.