Take-Two Interactive Still A Buy After Post-Earnings Drop

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About: Take-Two Interactive Software, Inc. (TTWO), Includes: ATVI, EA
by: The Freedonia Cooperative
Summary

TTWO slumped immediately after its Feb. 6 earnings call - losing 12% on share price, after losing nearly 25% in late 2018.

Sales and revenue from its main games were strong but not as strong as analysts pegged it, causing sell-offs amongst the whole sector.

TTWO is better positioned than its competitors, even as it deals with a change in gaming brought on by Fortnite and others.

TTWO has such a strong balance sheet and recurring revenue opportunities that it should be able to rise back from this week's losses.

Take-Two Interactive (TTWO) announced its quarterly earnings this week. Despite strong sales of its keynote game, Red Dead Redemption 2, and delayed sales from NBA 2K and GTA games, the stock saw a sell-off following the morning call of up to 12%.

We laid out the case for buying the stock before the earnings call and clearly missed in our analysis. Obviously, analysts had priced in Red Dead sales and other factors that TTWO had going (like the waterfall revenue that will be seen from its new exclusive 7-year $1.1 billion deal with the NBA).

So what happened?

Well, sales didn't meet analyst expectations. Revenue amounted to somewhere near $500 million after estimates of $600 million. Red Dead Redemption 2 sold 17 million copies in its first month, but totals for the quarter flat lined around 23 million.

In fact, this week all three major gaming stocks took a dive after TTWO's earnings. Electronic Arts (NASDAQ:EA) announced earnings soon after and saw almost no recovery. TTWO has seen a slight recovery (adding 4% today after losing about 12%). And Activision (NASDAQ:ATVI), despite losing half of its value in 4 months has seen an uptick ahead of its earnings call next week.

Chart Data by YCharts

The 'Fortnite Effect'

Immediately after TTWO's post-earnings drop, the articles came out detailing the 'Fortnite Effect'. Fortnite has been clear and away the most 'important' game of 2018. It had impact that has been felt in mainstream culture far beyond Rockstar's Red Dead (Rockstar is owned by Take-Two). While Red Dead Redemption scored points with gamers, Fortnite ushered in a whole new gaming crowd. Along the way, it racked up north of $1 billion in revenue.

The threat here is not Fortnite alone, however. It's what Fortnite represents. It's a free game with dynamic online play. Each game is different and there are myriad ways to both market and sell within the game to new players. Tournaments sprung up with big cash prizes, showing that the future of eSports is still enough to drive what was the big spike in TTWO, EA, and Activision in the first place.

How to combat the Fortnite effect? Well, that's the big question that TTWO and Rockstar have to contend with. The answer is a mix of new gaming technologies, changing audience perspectives, and more. Luckily, this quarter left TTWO with $1.6 billion of cash on hand to invest in solutions (or acquire!). So we'll see where it goes, but we should expect movement.

Where Does TTWO Go From Here?

Of its three biggest titles, we know that two have long-term sales health behind them. NBA 2K and GTA are still driving residual revenues and 2K will see new models come out each year for the next seven years (at least). It also has a burgeoning eSports league attached to it that could drive revenue up even more. 2019's NBA 2K registered amongst the best selling sport games of all time, and if 2020 can continue that trend, then TTWO has a solid backbone on yearly sales ahead of it.

GTA won't see its next title likely until 2020 or 2021 - but it will be one of, if not THE, biggest release of that year.

The biggest factor in the near term for TTWO is the sustaining of revenue after its blockbuster release quarter with Red Dead. That will likely fall on the online version of Red Dead, which will compete even more closely with Fortnite and other online-only games. So far, Red Dead online has been slow to develop and garner the kind of excitement that its original release had. But, Rockstar has a habit of rolling these out slowly. And for good reason, it has millions of gamers waiting to play and a shoddy online game will turn too many away too fast. Luckily, it has GTA to model after, which still has consistent gamer growth and play 5 years after its initial release.

With all of this, one big takeaway from TTWO's earning call was that the company now has $1.6 billion cash on hand to develop its next line of games. There's no debt and the 2K series should be a yearly cash cow to replenish investments into GTA and other game lines.

Analysts

Post fall, analysts are still bullish on TTWO, especially with the strength of its three lines. EA and Activision both have been soured by analysts as they've released enormous blockbuster games to anemic sales in the last six months.

Analysts are still listing TTWO as a strong buy with some price targets hovering near $130 and some as high as $145. This would match the all-time high for TTWO before it started to lose share as Fortnite gained prominence and the U.S. gaming sector started falling.

Just this week, the stock fell a bit on one analyst's downgrade, citing a lack of player growth in Red Dead. This is short sighted. Of course, player growth will slow and the online portal has come to full fruition, so players are looking elsewhere for new games. I'm confident that TTWO has a long-term plan to bring players back to RDR2. It took seven years to make the game and I expect in those years a roadmap was devised for long-term player appeal. If that's true, and we've seen in-game revenue up 33%, it should pay for investors later on.

I'm still bullish on TTWO based on RDR2 results, but moreso on the backbone provided by the other titles. With the influx of cash from 2018's arguably biggest release, TTWO is in a position that looks more enticing than EA or Activision and a share price that's already 25% of an all-time high with room to grow back to that point with a solid 2019 of online play, NBA 2K's consistency, and the hype later in the year that we'll see around the next GTA game.

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.