Take Two Interactive: Why The Delays Are A Smart Move

Summary

• After a spectacular 2020, TTWO stock is down 27% YTD.
• The company recently beat estimates and reaffirmed its guidance.
• The delay of game releases led analysts to downgrade the stock.
• Why I think these delays are a smart decision and analysts got it all wrong.
• Why I think TTWO makes for a great investment, and why buying an expensive washing machine pays off.

Mario Tama/Getty Images News

Introduction

Aging is a curious thing. It happened to my idol Warren Buffett, and though I thought it might never happen to me, now that I turned 40, it did. I became a buy and hold investor. While in my 20 years of investing I mostly stuck to small caps and deep value stocks, buying cheap and selling at fair value, reading a multitude of books and the great work of various contributors here on Seeking Alpha (and lastly filling out extensive tax statements each year) finally convinced me that buy and hold isn’t dead. Of course, it takes extensive research and a certain amount of trust to hold a stock through thick and thin, but if there is one public company I really trust, I would pick Take Two Interactive (NASDAQ:TTWO).

Source: Company presentation

After a spectacular 2020, in which TTWO was one of the “stay at home” darlings and its stock nearly doubled, it subsequently retraced and after analyst downgrades now sits around its 2018 highs. While a retracement only seemed logical, I tend to strongly disagree with the analysts’ take on the subject of delays, so I decided to elaborate on these recent developments, and on why I think Take Two makes for an attractive long-term investment.

Recent developments

On August 2^nd, the company reported its Q1 2022 earnings and beat analysts’ estimates. This didn’t really come as a surprise, for TTWO has been beating estimates for 15 out of the last 16 quarters.

For the year, we are reiterating our outlook, as there has been some movement in our release schedule, including two of our immersive core titles shifting to later in fiscal 2022 than contemplated by our prior guidance. As we deliver on our expansive multi-year pipeline, we believe that we will achieve sequential growth in fiscal 2023 and establish new record levels of operating results over the next few years.

Source: Q1 2022 earnings release

As you can see, the company did reaffirm its guidance for fiscal 2022, but announced that it would delay 2 of their core titles, with one of them being GTA VI, though TTWO never mentions it by name.

Then, on September 9^th, only a month later, Take Two put out a press release in which the company reaffirmed its guidance once again, but declared it would also delay its previously announced enhancements for its cash cow GTA V, from November 11^th 2021 to March 22^nd 2022. This seemed to be too much for analysts, and resulted in a wave of downgrades, calling the delays a “ disconcerting trend” or a “blemish”. The company’s stock meanwhile accelerated its downtrend and soon thereafter found its preliminary low at around $145, down almost 30% for the year.

While at first glance one might agree with the analysts that the delays come as a disappointment, I strongly disagree, and below I will explain why.

Why the delays were a smart move

First of all, I think it's important to say that Take Two, and especially its subsidiary Rockstar, is notorious for its perfectionism. Delays are a common occurrence, since TTWO is known for not releasing anything until it is living up to the company’s high standards. This is greatly appreciated by the millions of customers, who cherish Take Two for this trait, which is somewhat of an anachronism in today's gaming industry.

This time though, I believe the recent delays were not only motivated by the company’s perfectionism, but for a different reason as well, which I think makes perfect sense.

Supply chain issues

Every investor has read about it recently. Caused by the pandemic (factory closures, herding effect) and to a smaller part the blockage of the Suez canal, supply chain issues have been arising all around the globe, which instead of abating seem to intensify more and more. First it was lumber and building materials, then came semi-conductors – I guess everyone here is familiar with the problem by now. My question is: are analysts as well?

One has to keep in mind, the GTA franchise is enormous, with GTA V being on the market since more than 8 years and having sold over 150 million copies. Now, with the supply chain issues widening and consoles like Sony’s PlayStation being affected as well as the PC-market, I am asking you: If your company has cash cows like GTA V and GTA online which generate enough money for you to reaffirm your guidance, why on Earth would you release anything into this uncertain market? I bet you wouldn’t!

Asked about demand and supply of the console market, CEO Strauss Zelnick replied in the Q1 2022 earnings call:

We know the demand for console's remains high, that's not in doubt. We're hopeful that supply will be enhanced by year end and that will be in a good place. But most importantly, the demand is there.

Source: Q1 2022 earnings call

Very subtle. But reading between the lines, Strauss Zelnick already hinted his concerns during the earnings call.

My personal guess after following Take Two for many years, first as a consumer, then later as an investor, is that GTA VI has been more or less finished for 2 years. First came the pandemic-related boom for GTA V, and now we are facing supply chain issues. I strongly believe these delays were the smartest move the company could have made. They give Take Two the time to fine-tune its product to perfection on the one hand, and sit out uncertainties on the other, while making enough money to once again reach the company’s guidance. A luxury problem only a few select companies can handle. TTWO is one of them.

Investor takeaway

While being down for the year, on an absolute basis Take Two’s stock surely isn’t cheap.

Source: table created by Author using Seeking Alpha

In terms of P/E, TTWO is obviously valued at a hefty premium over its direct competitors Electronic Arts (EA) and Activision Blizzard (ATVI). Notice though, that on a Price/Cash Flow basis that gap clearly narrows.

In relative terms, TTWO’s valuation offers a different take, in my opinion. Like I wrote above, the company’s stock currently sits somewhere at its 2018 highs. If it were to correct further to the $120-$130 region, which I think is a possibility considering the current overall markets, the stock would be, where it last was seen 2017.

In 2018, TTWO did roughly $1.8 billion in revenues and an EPS of $1.54, with a P/E multiple of roughly 84x. In 2017 it had an EPS of $0.72 on about the same revenues as 2018, and a 165x P/E. And back then the overall market multiples were considerably lower than they are today. Applied to the midpoint of Take Two’s guided FY 2022 EPS of $1.95-2.2, this would mean a share price of $174-$342. While I don’t believe the upper end of that range being realistic in the near term, keep in mind that fiscal 2022 will be a transition year for TTWO, with estimated growth rates at 40% for 2023, 20% for 2024 and 40% for 2025. So, relatively spoken I believe TTWO currently IS a bargain worth picking up!

I think it is widely accepted to state that GTA VI will be a guaranteed success. The only other franchise with guaranteed success, at least that I know of, is the James Bond franchise. And that one has been delayed several times recently, too.

Usually, I would hesitate to buy a stock with a forward P/E of 55x, as it is currently the case with TTWO. But the way I see it, the current range offers a very appealing entry level for a long-term investment. Below $130 I would even dare calling it a screaming buy.

I want to finish with an at first glance obscure analogy. Did you know that it actually pays off to buy an expensive washing machine? One generally saves money by its more efficient use of energy and water. But most of all, the lifespan of a washing machine increases relative to the price you pay for it. In a way, this might be the case as well with TTWO.

The global gaming market is expected to reach a value of $287.1 billion by 2026, up from $167.9 billion in 2020. That is a CAGR of 9.24%. As the industry leader, TTWO will in all likelihood profit the most from this growth.

Source: Company presentation

Granted, there exists the risk of Netflix (NFLX) and Amazon (AMZN) taking away market share, which both have entered or will enter the gaming market. But in my opinion, they are still very far away from achieving that. On the contrary, they could even work as an accelerant for Take Two, as they might bring a different target group into the world of gaming than established players like TTWO and EA do.

Summing up, I believe that Take Two is poised for excellent returns in the years ahead and it could be a stock to hold for the long term, all while granting a good night’s sleep. So, pay up for your washing machine, and of course TTWO’s stock!

Analyst’s Disclosure: I/we have a beneficial long position in the shares of TTWO either through stock ownership, options, or other derivatives. 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.