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Take Two Interactive: The best collection of owned intellectual property in the business?

Opdateret: 3. feb.

In an earnings call, Take Two Interactive's CEO, Strauss Zelnick, not only stated that they possess the finest assortment of owned intellectual property in the gaming industry, but he also expressed his belief that they have the most innovative individuals and highly skilled executives. It is encouraging to hear a CEO saying these things, but it does not 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 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 start your investment journey with as little as $50.

Take Two Interactive is an American video game company that was founded in 1993. The company owns three major publishing labels: Rockstar Games, 2K, and Zynga. 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. 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 second bestselling game of all time, while Red Dead Redemption 2 is the eighth 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.

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. 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. Overall, I am encouraged by these numbers, but I would like to see Take Two Interactive deliver a positive return on invested capital (ROIC) again soon.

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. The significant increase in equity in fiscal 2023 is attributed to the acquisition of Zynga.

Finally, we will investigate 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. Levered free cash flow margin is used because I believe that margins provide a better understanding. Free cash flow yield refers to the amount of free cash flow per share that a company is projected to generate in relation to its market value per share. Take Two Interactive has consistently generated positive free cash flow every year in the past decade, up until fiscal year 2023 when they acquired Zynga. From 2017 to 2021, the levered free cash flow margin has consistently remained above 20%. I anticipate that it will once again reach that threshold. Free cash flow yield should also increase once the numbers normalize after the acquisition of Zynga.

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 as Take Two Interactive had negative earnings numbers. However, after performing the calculation based on the fiscal 2022 earnings, I found that the company has 8,44 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. I would like to see management prioritize debt repayment moving forward.

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. According to Take Two Interactive's annual report, the interactive entertainment software industry is highly competitive. Not only are they competing with other video game developers such as Electronic Arts and Nintendo, but they have also experienced the pursuit and strengthening of interactive entertainment capabilities by well-funded technology companies. One great example is Microsoft, which acquired Activision Blizzard. Large technology companies like Microsoft have greater financial, technical, personnel, and other resources than Take Two Interactive does. 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 our top-selling titles. Therefore, development costs can be significant. If there are delays, Take Two Interactive may not be able to release new games within their budgeted costs. Dependent on a few game titles. Take Two Interactive depends on a few titles being successful. In fiscal 2023, Grand Theft Auto products contributed 14,6% of their net revenue, while their five best-selling franchises (including Grand Theft Auto) accounted for 52,9% of their net revenue. If Take Two Interactive fails to continue developing and selling new commercially successful "hit" titles or sequels to such titles, their revenue and profits may decrease substantially, and they may incur losses.

There are also numerous reasons to invest in Take Two Interactive. One reason is that the gaming industry is expanding. The gaming industry is already huge, with an estimated 3,2 billion gamers worldwide in 2022. Furthermore, it is projected that the number of gamers worldwide will continue to increase at a compounded annual growth rate of 3% until 2025. As new gamers enter the market, the gaming industry is expected to grow at a 9,3% compound annual growth rate (CAGR) until 2028. Thus, Take-Two Interactive will benefit from the growth in the sector. Their portfolio of games. Take Two Interactive has an impressive portfolio of games, as they have both the second best-selling and eighth best-selling games ever in their lineup. Additionally, they release new titles in their sports games category every year. The most highly anticipated release will be Grand Theft Auto VI, which is set to be released in 2025. Take Two Interactive has just released the trailer for Grand Theft Auto VI, and within the first 24 hours, it has garnered more views than any other video on YouTube ever has. Thus, it shows that the Grand Theft Auto franchise is still very popular, and it is expected that Grand Theft Auto VI will be highly profitable for Take Two Interactive. The Zynga acquisition. Take Two Interactive 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. While they expect to find cost synergies in areas such as reducing duplicative corporate overhead and contracts.

Take Two acquired Zynga in the fiscal year 2023. As a result, EPS, operating cash flow, and free cash flow were all negative. It means that I cannot make any calculations based on the fiscal year 2023. However, I have decided to base the calculations on the fiscal 2022 numbers.

Now it is time to calculate the price of shares in Take Two Interactive. 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 a great company, and I think their management is excellent. I don't want to place excessive emphasis on the numbers from fiscal 2023, as they are distorted by the Zynga acquisition. However, I would like to see management prioritize paying off debt moving forward. Take Two Interactive does have some risks as they are dependent on a few game titles, but so far, Take Two Interactive seems to hit on these titles at every launch. Development risk is a risk that all companies in the industry face, so it isn't something I'm particularly worried about because it is a known factor when investing in the industry. It will be interesting to see the influence that large technology companies will have on the industry in the future. However, I believe Take Two Interactive will thrive due to their impressive portfolio. If Take Two Interactive successfully incorporates the Zynga acquisition into the organization, it could achieve a significantly higher level of profitability in the future. Take Two Interactive will also benefit from the growing gaming industry, where its titles continue to be popular. Nonetheless, I prefer not to invest in Take Two Interactive at this time. I would like to see Zynga successfully incorporated and a reduction in debt before considering investing in the company.

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