Take Two Interactive: The best collection of owned intellectual property in the business?
Opdateret: 13. maj
In the last earnings call, Take Two Interactive's CEO Strauss Zelnick not only said that they have the best collection of owned intellectual property in the gaming business, but he also said that he thinks they have the most creative people and the most talented executives. It is encouraging to hear a CEO saying these things, but it doesn't necessarily mean that Take Two Interactive is a good investment. In this analysis I will investigate the investment case of 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 mention that at the time of this writing, I do not own shares in Take Two Interactive. I own shares in other companies in the gaming sector: Microsoft, Sony, Tencent (individual shares and through Prosus), and Turtle Beach. If you want to see or copy my portfolio, you can see how to do so here. As I have quite the exposure to the gaming sector, it is obvious that I have high hopes for the sector moving forward. Nevertheless, I will keep this analysis unbiased as always.
Take Two Interactive is an American video game company that was founded in 1993. The company owns two major publishing labels being Rockstar Games and 2K. The most known franchises of Take Two Interactive are Grand Theft Auto, Red Dead and NBA 2K. These franchises are what gives Take Two Interactive their moat. I would argue that 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 2nd bestselling game ever, while Red Dead Redemption 2 is the 13th bestselling game ever. Three other versions of Grand Theft Auto are also among the 50th bestselling games ever. NBA 2K is certainly also a popular game and in 2019 Take Two Interactive agreed on a 7 years $1,1 billion contract with the NBA to be permitted to continue making the game. Hence, I would argue that NBA 2K has a brand moat as well, and in contrast to the other franchises, this game will be published in a new version every year. Unfortunately, the large contract with NBA doesn't give NBA 2K a secret moat, as Electronic Arts also publish an NBA game called NBA Live.
Their CEO is Strauss Zelnick. He became the CEO in 2007 due to an investor staged take over, and is now the chairman, the CEO, and the largest single shareholder of Take Two Interactive. He has an MBA from Harvard Business School and a JD from Harvard Law School. Before being involved in Take Two Interactive he has been a CEO in BMG Entertainment and 20th Century Fox. He is also the founder and chairman of ZMC, which is a private equity investment firm that specializes in leveraged buyouts and growth capital. Back in 2007 just before Strauss Zelnick became the CEO, Take Two Interactive had an annual loss just under $200 million and their prior CEO had pleaded guilty in falsifying records, while it is now a $2 billion company with no debt. Once he was in charge, he quickly focused on recruiting talent and had great visions of incorporating rich characters and evolving stories into the games, which is something that is very apparent in their games today. As a manager he is described to be someone that very good at identifying talent and is known for his accessibility and responsiveness. Needless to say that Strauss Zelnick is a great manager, and he certainly has the credentials and results to show it.
I believe that Take Two Interactive has a brand moat. I really do like the management as well. Now let us investigate the numbers to see if Take Two Interactive lives up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.
The first and most important number we will investigate is the return on investment capital, also known as ROIC. We want to see 10 years of history and we want the numbers to be above 10 % in all the years. There have been some bad years, especially in 2015, while some years have been underwhelming. However, Take Two Interactive has consistently delivered a ROIC of more than 10 % a year ever since 2018. I'm encouraged about these numbers and would feel comfortable in investing in Take Two Interactive moving forward.
The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. As we saw previously, 2015 was a bad year for Take Two Interactive. However, ever since 2017 Take Two Interactive has delivered impressive growth in their book value The growth year over year has slowed down a but as the company is getting bigger but I feel very encouraged when looking at these numbers.
Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has left remaining after paying all of its financial obligations, I use the margin for it to make more sense. Free cash flow yield is the free cash flow per share a company is expected to earn against its market value per share. Take Two Interactive has delivered a positive free cash flow ever since 2014, which is very encouraging. Free cash flow did decreases significantly in fiscal 2022, which is hopefully an outlier. I would like to see that Take Two Interactive gets back to delivering numbers they did in the the period from 2017 to 2021, where levered free cash flow margin was consistently above 20 %.
Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years. We do so by dividing the total long-term debt by current cash flow. It is not something that you need to do on Take Two Interactive, as they have no debt by the end of fiscal 2022. However, Take Two Interactive will have debt moving forward due to $12,7 billion acquisition of Zynga, so it is something to monitor moving forward.
Based on the moat, management, numbers and debt, Take Two Interactive looks to be a great company to invest in. However, all investments have some risks and so do Take Two Interactive. According to their annual report one risk factor is that Grand Theft Auto, Red Dead and NBA 2K account for a substantial portion of their revenue, meaning that these franchises need to continue to perform. If any of these major franchises fall out of favor for some reason, it would significantly hurt revenue. Another risk they mention in their annual report is development risks, as they need to keep developing new products to gain market shares, which is needed to be done in a highly competitive market. The post-pandemic world. Take Two Interactive and other gaming companies benefitted during lockdowns. As the world turn back to normal, people are spending money on other things than video games. The numbers from May 2022 shows that video game sales were down 19 % year over year. It isn't a risk for Take Two Interactive only but for the whole industry.
There are also plenty of potential for Take Two Interactive moving forward. One is the acquisition of Zynga. The acquisition of Zynga will grow their audience in mobile gaming significantly. Mobile gaming is the fastest growing segment in gaming and is expected to grow by a CAGR of 12,2 % until 2030 according to P&S Intelligence. In the latest earnings call, management said that the acquisition will provide substantial cost synergies and revenue opportunities moving forward. Recurring revenue. GTA Online makes approximately $1 billion a year, and $800 million of these are from "shark cards". Shark cards translate to in-app currencies in GTA online. These shark cards will be introduced to other games as well. Furthermore, they also launched the GTA+, which is a new membership program that generate recurring revenue. Margins are growing. Gross profit margin has grown every year from 2019 (43,2 %) to 2022 (58,2 %). While operating margin has grown from 7,6 % in 2019 to 13,3 % in 2022. Furthermore, management believes that as they build their scale from the Zynga acquisition, it will grow their margins meaningfully. Management believes the shares are cheap. Management bought shares at a cost price of $158. In the latest earnings call, management elaborated about the decision, and CEO Strauss Zelnick said: "We make buybacks when we perceive there is a deep value opportunity in the marketplace, we perceived such deep value at $158. As we sit here today, we were wrong, but it is management's view that the $158 represents deep value for the company for what it is worth".
The general economic could face some serious headwinds moving forward. However, I did not write about macroeconomics as a risk nor an advantage for Take Two Interactive, as it is difficult to predict. However. in the latest conference call, we did get a history lesson from CEO Strauss Zelnick: "The entertainment business will be affected by the overall economic showdown. However, it can be seen as resistant to such as slowdown. So for example, if you go back to 2008 and 2009, the market actually grew in 2008 by 20 %. It did decline in 2009, but the 12 % drop was less pronounced than many other business segments. And after September 11 the US gaming market actually grew by 42 % in 2001 and 11 % in 2002." I don't know how Take Two Interactive, or the gaming sector overall will fare during economic slowdown, but I think this is valuable information to get.
All right, we have gone through the numbers and risks regarding Take Two Interactive, and now it is time for us to calculate a price for Take Two Interactive. To calculate price, we will need numbers that I have explained in the "MY STRATEGY" section of the website. I do not want to go through the whole calculation here. I chose to use an EPS as it was in 2022 at 3,58 (it is slightly higher than 2020 but lower than 2021). I chose an Estimated future EPS growth rate of 10 (management mentioned 11 % but I prefer to be conservative), Estimated future PE 20 (which the double of the growth rate, as the historically PE for Take Two Interactive has been higher) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY", we come up with the sticker price (some call it fair value or intrinsic value) of $45,91, and we want to have a margin of safety on 50 % , so we will divide it by 2 meaning that we want to buy Take Two Interactive at price of $22,96 (or lower obviously), if we use the Margin of Safety price.
Our second way to calculate a buy price is the TEN CAP price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions. The operating Cash Flow last year was 258. The Capital Expenditures was 159. I tried to look through their annual report to see, how much of the capital expenditures were used on maintenance. I couldn't find it though, so as a rule of thumb, you expect 70 % of the capital expenditures to be used on maintenance, meaning we will use 111 in our further calculations. The Tax Provision was 47. We have 115,49 outstanding shares. Hence, the calculation will be like this: (258 - 111 + 47) / 115,49 x 10 = $16,8 in TEN CAP price.
The last calculation is the PAYBACK TIME. It is also described in "MY STRATEGY". With the Free Cash Flow Per Share at 5,76 and a growth rate of 10 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $72,51.
I believe that Take Two Interactive is a great company and I believe that management is excellent. If they management to successfully incorporate Zynga into the organization, and generate recurrent revenue from other games that GTA, Take Two Interactive could see a significant growth in profitability moving forward. There are some risks moving forward but the moats that their franchises have should protect Take Two Interactive from most of these risks. The lower consumer spending on video games post-pandemic hurts the sector short-term but compared to the pre-pandemic it is still higher now. I'm really intrigued by Take Two Interactive, and I might have been too conservative in my calculations. Warren Buffett once said, it is better to buy a wonderful company at a fair price than a fair company at a wonderful price. My PAYBACK TIME price, it shows that intrinsic value of Take Two Interactive should be around $144. Some companies won't reach a 50 % discount and Take Two Interactive might be one of them. Hence, you should make up for yourself how large a discount you would like. I'm currently considering adding Take Two Interactive to the portfolio.
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