Take-Two A Keeper Despite Stretched Valuations

| About: Take-Two Interactive (TTWO)

Summary

Take-Two stock has risen to the point that valuations no longer appear favorable.

The company is performing well and has a major release this fall.

There is one major risk that could tank the stock price.

Take-Two Interactive (NASDAQ:TTWO), owner of the Grand Theft Auto franchise, has been on an 18-month run, culminating in an 18% melt-up since January 1. Some stockholders and analysts say it's time to stash the profits in the trunk and hightail it out of Los Santos, but I think there's still loot there for the taking.

TTWO Chart

TTWO data by YCharts

Last week, Wedbush put out a neutral rating and a $47 target, saying it saw few catalysts. That didn't deter the stock. which jumped Friday, up 3.3%, after the company announced it was starting an NBA 2K e-sports league in conjunction with the NBA. This is the first time a league has joined with a game maker to sponsor the exploding business of video-game tournaments.

One of the prior holders that missed the recent rally is David Einhorn's Greenlight Capital. In its most recent quarterly report, the partnership had a witty way of announcing it had taken a profit.

Perhaps they should have only taken one and let the other one ride.

Let's take a look at some ratios compared to two of its big-fish competitors, Activision Blizzard (NASDAQ:ATVI) and Electronic Arts (NASDAQ:EA):

P/S P/TB P/E trailing P/E fwd. Gross profit margin Enterprise value
EA 5.7 14 21 19 71% $23.3B
ATVI 5.3 N.M. 37 24 63% $36.7B
TTWO 3.7 21 339 31 42% $4.7B

Source: Charles Schwab

TTWO looks overvalued on a P/E basis. Earnings have historically looked like a mouse going through a python because the company has been so dependent on the GTA cycle. For the third quarter, the company reported a loss of $0.33 a share on revenue of $476.5 million, a 15 percent revenue increase.

Earnings may not be the best measure - considerable revenue has to be marked as deferred because of accounting rules. Its price/sales ratio is less than either competitor and its price to tangible book is better than Call of Duty maker ATVI (which has negative tangible book).

Take-Two's lower gross margin isn't necessarily a worry because it reflects the company's philosophy of not sparing expense in producing high-quality games.

Cash flow from operations offers a better view of what's going on. This used to be negative in pre-GTA-release years when development expenses were heavy. The payoff came with the monster release of GTA V in 2014 - cash flow was plus $700 million.

Unlike previous cycles, operating cash flow remained positive at $214M in 2015 and $261M in 2016. For the nine months ended in December, it is $240M, up 27% from $189M last year.

TTWO Cash from Operations (Quarterly) Chart

TTWO Cash from Operations (Quarterly) data by YCharts

As the chart shows, operating cash flow in the most recent quarter even equaled the gold-mine quarter from the major GTA 4 release in 2008.

The success of the company in converting GTA disc buyers into online customers with microtransactions from GTA Online is a major factor in improving results in years without huge releases.

TTWO subsidiary Rockstar Games promises release of the Western game Red Dead Redemption 2 in time for the 2017 holiday season. Clues indicate an attractive 1890-ish setting, perhaps a prequel to RDR 1.

Sales of at least 15 million copies are expected, about half the size of GTA V's introduction.

Source: Rockstar Games trailer

There is one huge short-term risk - an RDR 2 product delay, similar to what happened with GTA V, which caused a major stock price hit. While painful for stockholders, a delay also could offer a great buying opportunity, as it did in 2012. (I missed that one, first buying the stock in 2013).

Conclusion: Take-Two is no longer a steal, but I plan to hold all my shares into the RDR 2 release and the anticipation of a shoot-'em-up performance at the end of 2017.

Disclosure: I am/we are 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.

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