In an earnings call, Take-Two Interactive's CEO, Strauss Zelnick, emphasized that they possess the finest assortment of owned intellectual property in the gaming industry. He also expressed his belief that they have the most innovative individuals and highly skilled executives. While it is encouraging to hear such confidence from a CEO, it does not necessarily mean that Take-Two Interactive is a good investment. In this analysis, I will investigate the investment case for Take-Two Interactive.
This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.
For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares of Take Two Interactive. If you would like to view the stocks in my portfolio or copy my portfolio, you can do so on eToro. Instructions on how to do so can be found here. I do, however, own stocks in Tencent, which is one of their competitors. I own stocks in Tencent directly and through Prosus. Nonetheless, despite owning shares in one of their competitors, I will keep the analysis unbiased. If you want to purchase shares or fractional shares of Take Two Interactive, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $100.
Take-Two Interactive is an American video game company founded in 1993. The company owns three major publishing labels: Rockstar Games, 2K, and Zynga, but also publishes games through a segment called Private Divisions. The most well-known franchises of Take-Two Interactive are Grand Theft Auto, Red Dead, and NBA 2K. These franchises are what give Take-Two Interactive their moat. Especially Grand Theft Auto and Red Dead are such well-known franchises that they can be considered to have a brand moat. Grand Theft Auto V is the second-bestselling game of all time, while Red Dead Redemption 2 is the seventh-bestselling game of all time. Three other versions of Grand Theft Auto are also among the top 50 bestselling games of all time. NBA 2K is also a popular game, and in 2019, Take-Two Interactive agreed to a 7-year, $1.1 billion contract with the NBA to continue producing the game. Hence, I would argue that NBA 2K also has a strong brand presence, and unlike other franchises, this game is released in a new version every year. Unfortunately, the large contract with the NBA doesn't give NBA 2K a monopoly, as Electronic Arts also publishes an NBA game called NBA Live. Take-Two Interactive derives their revenue from the sale of their interactive entertainment content, which includes internally developed titles as well as third-party developed titles, the sale of in-game virtual items and advertising, and live services on console, PC, and mobile.
Their CEO is Strauss Zelnick. He became the CEO in 2007 as a result of an investor-staged takeover and currently holds the positions of chairman, CEO, and largest single shareholder of Take-Two Interactive. He holds an MBA from Harvard Business School and a JD from Harvard Law School. Before joining Take-Two Interactive, he served as the CEO of BMG Entertainment and 20th Century Fox. He is also the founder and chairman of ZMC, a private equity investment firm specializing in leveraged buyouts and growth capital. Back in 2007, just before Strauss Zelnick became the CEO, Take-Two Interactive had an annual loss of just under $200 million, and their prior CEO had pleaded guilty to falsifying records. However, the company has since grown into a $5 billion company with no debt until they acquired Zynga. Once he assumed leadership, he promptly prioritized talent acquisition and harbored ambitious aspirations of integrating complex characters and evolving narratives into their games. These aspirations are clearly evident in their current game offerings. As a manager, he is described as someone who is very good at identifying talent and is known for his accessibility and responsiveness. Needless to say, Strauss Zelnick is a great CEO, and he certainly has the credentials and results to prove it.
I believe that Take Two Interactive has a strong brand moat. I really like the management as well. Now, let us examine the numbers to determine if Take Two Interactive meets our criteria for a strong competitive advantage. In case you want an explanation of what the numbers represent, you can refer to "MY STRATEGY" on the website.
The first and most important number we will investigate is the return on invested capital, also known as ROIC. We want to see a 10-year history, with all the numbers being above 10% for each year. There have been some difficult years, particularly in 2015, while others have been disappointing. However, Take-Two Interactive has consistently delivered a return on invested capital (ROIC) of more than 10% per year since 2018 until fiscal year 2023. This can be attributed to the acquisition of Zynga, which amounted to over $12 billion. The ROIC was negative in fiscal year 2024 as well, which is due to Take-Two Interactive taking a big goodwill impairment on its Zynga acquisition. Thus, there is an explanation for the negative numbers in the past two years. Nonetheless, I would like to see Take-Two Interactive getting back to a positive ROIC in fiscal 2025.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the percentage growth year over year. As we saw previously, 2015 was a challenging year for Take-Two Interactive. However, ever since 2017, Take-Two Interactive has delivered impressive year-over-year growth in their equity, with growth consistently in the double digits until fiscal year 2023. The significant increase in equity in fiscal year 2023 is attributed to the acquisition of Zynga. The significant decrease in equity in fiscal year 2024 is because of the goodwill impairment on its Zynga acquisition. Thus, I expect that Take-Two Interactive will return to growing its equity in fiscal year 2025.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. Take-Two Interactive consistently delivered positive free cash flow for the first eight years of the past decade. However, free cash flow turned negative in fiscal year 2023 and remained negative in fiscal year 2024, partly due to the Zynga acquisition. It's not surprising that fiscal years 2019 and 2021 delivered the highest free cash flow. Fiscal year 2019 saw the release of Red Dead Redemption 2, demonstrating how major releases positively impact free cash flow. Fiscal year 2021 coincided with the pandemic, during which the gaming industry experienced an uptick due to lockdowns. The levered free cash flow margin was above 20% from 2017 to 2021. Unfortunately, it has decreased since then, and as Take-Two Interactive delivered negative free cash flow in the past two years, the levered free cash flow margin was also negative. Due to the low or negative free cash flow in the past three years, we cannot determine if the stock is trading at attractive valuations based on the free cash flow yield. However, we will revisit valuation later in the analysis.
Another important aspect to consider is the level of debt. It is crucial to determine whether a business has manageable debt that can be repaid within a three-year period. We calculate this by dividing the total long-term debt by earnings. I cannot perform the calculation based on fiscal year 2023 or fiscal year 2024 as Take-Two Interactive had negative earnings numbers. I cannot make the calculations based on free cash flow either, as free cash flow has also been negative in the past two years. However, after performing the calculation based on the fiscal 2022 earnings with an EPS of 3,58 and the current number of shares outstanding, I found that the company has 5,01 years of earnings in debt. It exceeds the required 3 years. However, it is worth noting that Take-Two Interactive usually operates without debt, except for the Zynga acquisition. Thus, I will not exclude Take-Two Interactive as an investment solely based on its large debt. However, I would like to see management prioritize debt repayment moving forward.
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Based on my findings thus far, I believe that Take-Two Interactive is an intriguing company. However, no investment is without risk, and Take-Two Interactive also has its fair share of risks. One risk is competition. The interactive entertainment software industry is highly competitive. Take-Two Interactive competes for both licenses to properties and the sale of interactive entertainment software with Sony and Microsoft, each of which is a large developer and marketer of software for its own platforms. Take-Two Interactive also competes with game publishers, such as Electronic Arts Inc., Embracer Group AB, Microsoft, Nintendo, Tencent, and Ubisoft Entertainment. Take-Two Interactive also faces competition from online game developers and distributors who have primarily focused on specific international markets and with high-profile companies with significant online presences with new and expanded mobile gaming offerings, such as Apple, Google, and Microsoft. In addition, the gaming, technology/internet, and entertainment industries have converged in recent years, and larger, well-funded technology companies are pursuing and strengthening their interactive entertainment capabilities, which increases competition. Furthermore, as there are relatively low barriers to entry to develop a mobile or online game, Take-Two Interactive expects new game competitors to enter the market and existing competitors to allocate more resources to develop and market competing games and applications. Development risks. Like all other companies in the video game industry, Take-Two Interactive is subject to product development risks that could result in delays and additional costs. The development cycle for new games generally ranges from 12 months or less for most mobile titles and annual console/PC sports releases to multiple years for certain of Take-Two Interactive's top-selling titles. Therefore, Take-Two Interactive's development costs can be substantial. If Take-Two Interactive or its third-party developers experience unanticipated development delays, financial difficulties, or additional costs, for example, as a result of unforeseen circumstances, Take-Two Interactive may not be able to release titles according to its schedule and at budgeted costs. Furthermore, there are rising costs in developing AAA games, which is an ongoing concern for the gaming industry. GTA 4, in 2008, cost Rockstar $100M to make; this increased to $300M for GTA 5, and now analysts are estimating that it will cost Rockstar $2B to develop and market GTA 6, reflecting a development and marketing cost CAGR of around 20% per year. Dependent on a few game titles. Take-Two Interactive is heavily reliant on the future success of its Grand Theft Auto franchise and other key titles. The company must continue to publish "hit" titles or sequels to such "hit" titles to remain competitive in the industry. Grand Theft Auto, Red Dead Redemption, and NBA 2K are among the top-performing products and have historically accounted for a substantial portion of the company's revenue. For the fiscal year ended March 31, 2024, Grand Theft Auto products contributed 14,7% of net revenue, and the five best-selling franchises (including Grand Theft Auto) accounted for 56,5% of net revenue. If Take-Two Interactive fails to develop and sell new commercially successful "hit" titles or sequels or experiences delays in product releases, its revenue and profits may decrease substantially, potentially leading to losses. Furthermore, competition in the industry is intense, and a relatively small number of "hit" titles account for a large portion of total revenue in the industry. "Hit" products offered by competitors may capture a larger share of consumer spending, causing revenue generated from Take-Two Interactive's products to fall below expectations.
There are also numerous reasons to invest in Take Two Interactive. One of the most compelling reasons to invest in Take-Two Interactive is the enduring success and popularity of the Grand Theft Auto (GTA) franchise. The series continues to deliver impressive performance, driven in part by free content updates for Grand Theft Auto Online. Unit sales for Grand Theft Auto V exceeded management's expectations, with approximately 200 million units sold worldwide by the end of fiscal year 2023. Remarkably, a decade after its initial release, Grand Theft Auto V and Grand Theft Auto Online saw their audience sizes grow by 35% and 23%, respectively, in fiscal year 2023. The continued strong performance of Grand Theft Auto V, even ten years post-release, is noteworthy. It continues to outsell many new releases from competing companies. Management has confirmed the highly anticipated release of Grand Theft Auto VI for the fall of calendar year 2025. They expect this release to drive tremendous growth for the company. The trailer for Grand Theft Auto VI set a record on YouTube, generating more views in the first 24 hours than any other video ever. This level of anticipation and engagement underscores the franchise's significant impact and potential for continued success. Mobile games. Take-Two Interactive acquired Zynga in January 2022, and while the company took a big goodwill impairment last year, management believes that they can unlock significant revenue opportunities and cost synergies from the Zynga acquisition, which has the potential to meaningfully enhance the profitability of Take-Two Interactive. Some of these revenue opportunities in mobile gaming include enhancing the monetization of in-game advertising and introducing mobile games based on their most popular and successful intellectual properties. Management has mentioned that mobile games delivered outstanding results in fiscal year 2024, led by robust in-app purchases. For instance, Match Factory is accelerating and proving to be a hit, already establishing itself as a Top 20 grossing game in the US Apple App Store and reaching millions of new users with its launch on the Google Play store. Another catalyst in mobile games has historically been casual and hyper-casual mobile games that its users played for a short amount of time, but Take-Two Interactive has the possibility to use their experience to introduce games outside of the casual games, using some of its intellectual properties to develop games. International growth. Management has mentioned that they see geographical growth opportunities that they are very focused on, and that these opportunities are a huge part of Take-Two Interactive's growth strategy. Management mentioned that Take-Two Interactive's business and its competitors' businesses remain largely US and Western Europe-focused (Take-Two Interactive generated approximately 61% of its revenue in the United States in fiscal year 2024). Management has mentioned that they think there are enormous opportunities for growth in Asia, India, and Africa, where Take-Two Interactive is deeply underpenetrated. Thus, Take-Two Interactive has a strategy to broaden the distribution of their existing products and expand its online gaming presence, especially in China. If they succeed, it should boost profitability in the future.
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Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators.
Take-Two Interactive's EPS, operating cash flow, and free cash flow were all negative in both fiscal year 2023 and fiscal year 2024. This means I cannot make any calculations based on fiscal year 2023 or fiscal year 2024. However, I have decided to base the calculations on the fiscal 2022 numbers.
I perform three different calculations that I learned at a Phil Town seminar. The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 3,58, which is from fiscal year 2022. I have selected a projected future EPS growth rate of 10%. (Management has previously mentioned 11% growth, but I prefer to be conservative.) Additionally, I have chosen a projected future P/E ratio of 20, which is double the growth rate. This decision is based on the fact that Take Two Interactive has historically had a higher P/E ratio. Lastly, our minimum acceptable rate of return is already set at 15%. Doing the calculations, we come up with the sticker price (some call it fair value or intrinsic value) of $45,91. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Take Two Interactive at a price of $22,96 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is called the Ten Cap price. The rate of return that an owner of a company (or stock) receives on the purchase price of the company is essentially its return on investment. The return should be at least 10% annually, and I calculate it as follows: The operating cash flow in fiscal 2022 was 258 and capital expenditures were 159. I attempted to review their annual report to determine the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated for maintenance purposes. This means that we will use 111 in our calculations. The tax provision was 47. We have 170 outstanding shares. Hence, the calculation will be as follows: (258 – 111 + 47 / 170 x 10 = $11,41 in Ten Cap price.
The final calculation is called the Payback Time price. It is a calculation based on the free cash flow per share. With Take Two Interactive's Free Cash Flow Per Share at $5,76 and a growth rate of 10%, if you want to recoup your investment in 8 years, the Payback Time price is $72,51.
I believe that Take-Two Interactive is an intriguing company because of its intellectual property, which means that they own some of the most popular games in the world. I really like the management as well. Take-Two Interactive has delivered negative ROIC and negative free cash flow in the past two years due to the Zynga acquisition and their impairment of goodwill. I would like to see both ROIC and free cash flow turn positive in fiscal year 2025. Take-Two Interactive is facing intense competition from some of the greatest companies in the world, and these well-funded technology companies are pursuing and strengthening their interactive entertainment capabilities, which means that competition is heating up. Take-Two Interactive is also facing development risks as games are more expensive to develop than previously, and marketing spending has also increased. If some of these games are delayed or flop, it will affect the results of Take-Two Interactive. Take-Two Interactive is dependent on a few titles that generate the majority of their revenue. Nothing suggests that these titles won't continue to be a success, but "hit" products offered by Take-Two Interactive's competitors may take a larger share of the overall consumer spending. Take-Two Interactive has one of the best franchises in Grand Theft Auto, and it is impressive how Grand Theft Auto V continues to deliver strong sales year after year. Grand Theft Auto VI will soon be released, which will be a huge catalyst for Take-Two Interactive. Take-Two Interactive also sees its mobile games growing and wants to leverage its experience in storytelling to develop long-lasting mobile games. Finally, Take-Two Interactive has enormous potential to grow internationally, especially in Africa, Asia, and India, which could boost profitability in the future. Nonetheless, I prefer not to invest in Take-Two Interactive at this time, as I will need to see ROIC and free cash flow being positive before I consider investing in the company.
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