EA's Gloves Come Off in Take Two Acquisition Battle

Includes: EA, TTWO
by: Seth Gilbert

Take Two (NASDAQ:TTWO) may be developing a boxing game but Electronic Arts (ERTS) has a mean left hook. Thursday, they showed just how mean by escalating their takeover attempt for the maker of Grand Theft Auto to hostile. EA also aimed a power punch straight at the jaw of T2’s management team by adding a purchase price adjustment that gives shareholders an ultimatum to decide between fattening their own wallets or those of the company’s management.

At issue is the underlying management agreement through which Zelnick Media is compensated for running Take Two.

The Background
Last spring, in an investor revolt, Take Two’s shareholders booted much of the board and hired Zelnick Media to manage the company (which had suffered through a mess of managerial problems in the past). As part of the arrangement, Zelnick Media employees including Strauss Zelnick and Ben Feder were installed in leadership positions. A management agreement was put in place to provide compensation. All of the Zelnick employees are paid through this agreement.

On February 15th, the Zelnick Media deal was extended for five more years by Take Two’s board of directors. Under the new terms, the Zelnick employees will receive a salary of just $1 from Take Two. Their real payment comes from a management fee of $208,333 paid per month to Zelnick Media (this was previously $62.5k under the first agreement). In addition to cash, Zelnick Media also has bonus potential for $2.5m annually and will receive grants for up to 1.5m shares of restricted stock, subject to performance milestones.

The catch: at least 780,000 of those shares are governed by “change of control” provisions that will accelerate their vesting entirely in the event of a corporate takeover. These new terms have not yet been approved by the shareholders.

On April 10 at the annual meeting, if shareholders approve the agreements governing these payments, then at least 780,000 shares of stock will vest in the event of EA’s takeover being consummated. At $26a share, that is a payment to Zelnick Media of a little more $20m.

The Current Slugfest
In the press, management from both companies has been sparring. EA thinks their offer is fair. Take Two’s management contends that the offer under-values their company and is ill timed to snag them before the release of their next major product (Grand Theft Auto IV releases April 29).

Upping the deal to a tender offer will take the referendum to the shareholders. That’s hostile, by definition and intent, but it gets truly nasty with the inclusion of Zelnick Media’s payment structure.

$20m is a lot of money but taken out of a $2.1b dollar deal, it’s barely relevant. EA could have let Zelnick Media have their payday. Instead, they’re making it a point of contention. For their shareholders and Take Two’s, every dollar counts; call it principle, or call it personal.

Accordingly, in the tender offer documents filed with the SEC Thursday (Summary Term Sheet is here), EA added an aggressive price reduction trigger to their offer. Now, in the event that the new management agreement terms are approved, EA will reduce their offer to $25.74 net per share (that is a reduction equal to the payment Zelnnick Media will get if their shares are vested).

To the shareholders it is a simple ultimatum: “Pay yourselves or pay the company’s management. You decide.” To Zelnick Media, it’s a hard punch.

Earlier this week, Take Two’s two largest shareholders drastically reduced their holdings. Seemed they wanted to take some money off the table rather than get caught up in this fight.

Now, there’s no question - it’s most definitely a fight… and the gloves came off.