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Take-Two More Like A Big Game Call Option Than A Real Company
There's no such thing as a perfect way to value any company, but cash flow analysis has long suggested that Take-Two Interactive (Nasdaq:TTWO) isn't worth an investor's long-term attention. The stock's performance over the past five years has backed that up, though it's worth noting that Electronic Arts (NYSE:EA) has fared no better (meaningfully worse, actually) and there have been repeated trading opportunities.
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With a continued pattern of poor earnings outside of blockbuster launches and delays in bringing major titles to market, it looks like little is going to change. Take-Two can be an interesting trading vehicle to play big-name title launches, but it doesn't look like management has the ability to make this company a consistent generator of free cash flow.
Better Revenue Swallowed by Costs
Take-Two did surpass Wall Street revenue expectations by about 5%, but that still meant that revenue fell 19% from last year and 37% from the prior quarter. This is not an unfamiliar pattern in quarters lacking major new title launches, and it really isn't out of line with what gaming retailer GameStop (NYSE:GME) reported the week before in terms of revenue from new software sales.
While revenue surpassed analyst estimates, so too did expenses. Gross margin (GAAP) fell 13 points from last year and more than 25 points sequentially, and the company's operating loss tripled from the year-ago quarter.
For the full year, Take-Two reported negative free cash, the fourth time in the last nine years. What makes this even more bothersome is that the good times aren't nearly good enough to make up for the bad years - for the past decade, the average annual free cash flow production is negative. Not surprisingly, then, while Take-Two has had some very good years from a return on invested capital perspective, the long-term averages are quite poor.
SEE: Power Up Your Portfolio With Video Game Stocks
Titles Slipping, but Might as Well Get Them Right
One of the chronic sources of frustration with Take-Two has been the frequency with which major titles have missed their initial launch dates. Take-Two is hardly alone in the industry in this regard, but it almost feels like the rule of thumb here. Accordingly, it's hard to express much surprise that "BioShock Infinity" will be coming out about four months later.
Given how this company operates, however, it doesn't really matter. This is a company built for the home run, so they may as well take the extra time and make sure they get the games right. To the extent that Take-Two is an investment based in buying ahead of the launches and selling into them, a bad launch from a botched game is much, much worse than a delayed launch.
Does Management Have a Realistic Long-Term Plan?
The state of the gaming market is pretty miserable right now. Maybe there's a chicken-and-egg argument as to whether the market is bad because there are no blockbuster products, or whether there are no blockbusters because the market's bad.
Either way, it's worth asking if this blockbuster-based operating model is really the right one. Activision Blizzard (Nasdaq:ATVI) has a decent business franchise in massive multiplayer online games, while Zynga (Nasdaq:ZNGA) has been posting revenue growth far above industry averages on the strength of its social network games. Neither of these are positions of strength for Take-Two, and it's likewise worth asking whether its core gaming expertise will really migrate well to mobile devices.
While investors ponder whether Take-Two has a sustainable plan, it's also worth mentioning again that management is compensated quite well for their work. The employment agreement pays ZelnickMedia $2.5 million a year, in addition to a targeted bonus of nearly $2 million and close to 3 million in restricted shares. Personally, I don't think shareholders are getting their money's worth.
SEE: Knowing Your Rights As A Shareholder
The Bottom Line
I seriously doubt that there are many investors holding Take-Two shares for their value or long-term growth potential; these shares are for traders and most traders probably don't care about the long-term business model, free cash flow or economic returns of the business.
That's fine. There are plenty of ways to make money in the market, and owning Take-Two shares as a play on future "Grand Theft Auto" releases may well be a valid trade. But for investors looking for a longer-term home for their money, there's nothing here to suggest that Take-Two is a promising prospect.
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.
With a continued pattern of poor earnings outside of blockbuster launches and delays in bringing major titles to market, it looks like little is going to change. Take-Two can be an interesting trading vehicle to play big-name title launches, but it doesn't look like management has the ability to make this company a consistent generator of free cash flow.
Better Revenue Swallowed by Costs
Take-Two did surpass Wall Street revenue expectations by about 5%, but that still meant that revenue fell 19% from last year and 37% from the prior quarter. This is not an unfamiliar pattern in quarters lacking major new title launches, and it really isn't out of line with what gaming retailer GameStop (NYSE:GME) reported the week before in terms of revenue from new software sales.
While revenue surpassed analyst estimates, so too did expenses. Gross margin (GAAP) fell 13 points from last year and more than 25 points sequentially, and the company's operating loss tripled from the year-ago quarter.
For the full year, Take-Two reported negative free cash, the fourth time in the last nine years. What makes this even more bothersome is that the good times aren't nearly good enough to make up for the bad years - for the past decade, the average annual free cash flow production is negative. Not surprisingly, then, while Take-Two has had some very good years from a return on invested capital perspective, the long-term averages are quite poor.
SEE: Power Up Your Portfolio With Video Game Stocks
Titles Slipping, but Might as Well Get Them Right
One of the chronic sources of frustration with Take-Two has been the frequency with which major titles have missed their initial launch dates. Take-Two is hardly alone in the industry in this regard, but it almost feels like the rule of thumb here. Accordingly, it's hard to express much surprise that "BioShock Infinity" will be coming out about four months later.
Given how this company operates, however, it doesn't really matter. This is a company built for the home run, so they may as well take the extra time and make sure they get the games right. To the extent that Take-Two is an investment based in buying ahead of the launches and selling into them, a bad launch from a botched game is much, much worse than a delayed launch.
The state of the gaming market is pretty miserable right now. Maybe there's a chicken-and-egg argument as to whether the market is bad because there are no blockbuster products, or whether there are no blockbusters because the market's bad.
Either way, it's worth asking if this blockbuster-based operating model is really the right one. Activision Blizzard (Nasdaq:ATVI) has a decent business franchise in massive multiplayer online games, while Zynga (Nasdaq:ZNGA) has been posting revenue growth far above industry averages on the strength of its social network games. Neither of these are positions of strength for Take-Two, and it's likewise worth asking whether its core gaming expertise will really migrate well to mobile devices.
While investors ponder whether Take-Two has a sustainable plan, it's also worth mentioning again that management is compensated quite well for their work. The employment agreement pays ZelnickMedia $2.5 million a year, in addition to a targeted bonus of nearly $2 million and close to 3 million in restricted shares. Personally, I don't think shareholders are getting their money's worth.
SEE: Knowing Your Rights As A Shareholder
The Bottom Line
I seriously doubt that there are many investors holding Take-Two shares for their value or long-term growth potential; these shares are for traders and most traders probably don't care about the long-term business model, free cash flow or economic returns of the business.
That's fine. There are plenty of ways to make money in the market, and owning Take-Two shares as a play on future "Grand Theft Auto" releases may well be a valid trade. But for investors looking for a longer-term home for their money, there's nothing here to suggest that Take-Two is a promising prospect.
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.
by
Stephen D. Simpson, CFA
Stephen D. Simpson, CFA, is a freelance financial writer, investor, and consultant. He has worked as an equity analyst for both sell-side and buy-side investment companies in both equities and fixed income. Stephen's consulting work has focused primarily upon the healthcare sector, while he has also written extensively for publication on topics pertaining to investments, security analysis, and healthcare. Simpson operates the Kratisto Investing blog, and can be reached there.
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