Fool on Call: Bling-Bling for Take-Two

A 1977 film titled "Grand Theft Auto" was Ron Howard's directorial debut in the sure-to-be-snubbed-at-Oscar-time genre of comedy car chases. Fast-forward a few decades and it is "Grand Theft Auto IV," from video game developer Take-Two Interactive (Nasdaq: TTWO  ) , that will soon be stealing significant screen time among youth all over the world.

Avery Carrington, a character in Take-Two's "Grand Theft Auto: Vice City," declared, "Nothing drives down real estate prices like a good old-fashioned gang war." I'll add: Nothing drives up video game sales like a good old-fashioned gang war, either.

When it hits store shelves in October, will "GTA IV" provide the juice needed to drive Take-Two's stock to new highs in the latter half of 2007? My colleague Steven Mallas is not convinced. Another fellow Fool, Rick Aristotle Munarriz, isn't sold either, pointing to the possibility of other "muggings" that could happen between now and October. One such mugging, options backdating, seems to be finding some closure, according to remarks made in the latest conference call.

Looking ahead, will this be a year of ice and bling-bling for the video game developer? To help us get a better sense of what the upcoming year might bring for Take-Two, this edition of "Fool on Call" will investigate the company's latest quarterly earnings conference call, paying particular attention to its "GTA" series and sports segment.

Out of position in 2006
Weighing on the company in 2006 was its inability to properly manage the transition from the old consoles to the next-generation versions. In his prepared remarks, CFO Karl Winters states, "While much of our holiday lineup and recent investments were focused on titles for next-gen platforms, the market penetration of new hardware did not occur in line with our expectations."

As a result, a greater percentage of its 2006 sales came from older titles, which sold at lower prices. We can extrapolate the outcome from there: lower-priced unit sales resulting in lower margins (gross profit margin for 2006 was 20.5%, versus 34.5% in 2005).

Plugged back in for 2007
The good news is that 2007 should have the opposite effect, as more and more next-gen platforms are plugged in. "Sales of next-gen titles were over $300 million [in 2006], a significant percentage of our business at 41% of publishing revenue, but still a relatively small dollar number compared to where we see this business going in 2007 and beyond," Winters added.

Without question, when "GTA IV" is simultaneously released on both Microsoft's (Nasdaq: MSFT  ) Xbox 360 and Sony's (NYSE: SNE  ) PS3 in October, the impact will be, in the spirit of "GTA," off the chain. How significant is the "GTA" series to Take-Two? Consider that in the fourth quarter, the "Grand Theft Auto" franchise contributed about 36% of publishing revenue, and that was without a major cross-platform title release like we will see with "GTA IV."

Looking out to the remainder of 2007, management is expecting the company to generate revenue in a range of $1.2 billion to $1.25 billion. By year's end, Take-Two expects to return to profitability and be breakeven for the 2008 fiscal year. If this happens, it will be because of the performance of "GTA IV."

Winters indicated that he expects its publishing label Rockstar (the developer of the "GTA" series) to produce "roughly 45%" of the publishing revenue for the full year, which is up significantly from the 36% level at the close of 2006. We should see not only higher revenues by the holiday season, but also better-quality revenues. In other words, the sales from next-gen titles like "GTA IV" will carry a "premium" price tag, leading to improved profitability.

March Madness effect
"GTA" won't be the only breadwinner for Take-Two this year. The company's sports category should also see improved economics in 2007. For instance, it was pointed out that in 2006 the company sold approximately "5.5 million units of sports titles at an average wholesale price in the mid-$20s." Expect both figures to increase significantly this year; Take-Two is projecting to sell 8 million units of sports titles at roughly $30 for the average wholesale price.

The sports category will benefit from two major entries this year: "College Hoops 2K7" and "All Pro Football 2K8." March Madness is just under way, and Take-Two will be there to cash in with "College Hoops 2K7," to be unveiled this month for the PS3. CEO Paul Eibeler pointed out that this title is the only NCAA basketball game available for the PS3.

Another major title release for Take-Two is its new "All Pro Football" series. Investors will recall that Electronic Arts (Nasdaq: ERTS  ) secured sole rights to the NFL license, virtually monopolizing that portion of the market. In football terminology, Take-Two had to figure out a way to pull off an "end-around." Will "All Pro Football" get its sports segment back in the end zone? Eibeler sounded optimistic in the question-and-answer session, calling the new title "one of the most highly anticipated games in the fall."

Top pedigree?
Motley Fool Stock Advisor selected both Electronic Arts and Activision (Nasdaq: ATVI  ) to be a part of its portfolio of stocks. You can take a free 30-day trial to find out why these two were chosen and Take-Two was not.

While Take-Two may not yet be at the same level of operational performance as its major competitors, Foolish investors shouldn't write off the company altogether. Based on my findings, by the end of the year, Take-Two will see not only significantly higher revenues but also substantially improved quality of sales, lending to better margins.

My experience suggests that an accelerating top line coupled with increased profitability is often a recipe for substantial gains in an underlying stock. Prospective investors owe it to themselves to at least take a closer look at Take-Two.

Plug into more Foolishness on the electronic gaming industry:

Fool contributor Jeremy MacNealy has no financial interest in any company mentioned. Microsoft is an Inside Value selection. The Motley Fool has a disclosure policy.


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