No more Mr. Not-So-Nice Guy.
Electronic Arts (Nasdaq: ERTS ) is abandoning its hostile takeover bid to acquire Take-Two Interactive (Nasdaq: TTWO ) by tender offer. After Take-Two shareholders slapped it down over the past five months, EA finally realizes that it won't be able to persuade enough of them to hand over their stock at $25.74 a pop.
Take-Two will now show EA some non-public information, to see whether the two companies can agree on what the company behind the Grand Theft Auto series would be worth in an acquisition.
As Anders Bylund pointed out yesterday here at the Fool, the market didn't warm up to the news. Both stocks fell yesterday. With a 4% drop, Take-Two took the harder hit.
The market is having the wrong reaction, though. I'll tell you why, and I'll even explain why Take-Two is better off on its own unless it gets a really good premium buyout bid.
The audacity of dope
EA's fourth extension of its tender-offer quest to buy Take-Two proved fruitless yesterday. EA hasn't been able to sway enough investors to punch out in the mid-$20s, and it realizes now that it won't be able to acquire the company in time for the critical 2008 holiday season.
You'd think that EA needn't worry about acquiring its competitor. After all, its pipeline is always rich. The hyped-up Spore is finally weeks away from being released, and the EA Sports line just put out its latest NCAA and NFL gridiron installments to get the company back on the bestseller list after a rare absence. And there lies EA's concern. Rival Activision Blizzard (Nasdaq: ATVI ) just became the market leader after Activision joined forces with Vivendi's Blizzard Entertainment this year.
The market, meanwhile, read yesterday's news all wrong. EA's agreement to a private presentation from Take-Two is a prelude to a friendly buyout. For all of EA's claims to be "price-disciplined," this meeting is really about having EA raise its bid to a level at which Take-Two will bite. Maybe Wall Street is so spooked by the Microhoo fallout that it fails to understand that a target company can increase in value during negotiations. After all, EA, like Microsoft (Nasdaq: MSFT ) , is a juggernaut coming to terms with the limits of its organic growth -- but Take-Two is more than another Yahoo! (Nasdaq: YHOO ) .
Just walk away, Take-Two
Take-Two is going to show EA internal product-release schedules, revenue-stream models, and possibly even a few sneak peeks of titles in development. But it has to walk a fine line, because although it has to reveal enough to get EA to finally deliver a reasonable offer, it can't arm EA with the tools to compete against it in the future.
The company and its shareholders have shot down EA's offers of $25, $26, and $25.74, and they aren't going to bother with anything that doesn't approach the 30s. Any speculation that Take-Two will take a lower bid, with Grand Theft Auto IV having been a record-breaking hit, is nonsensical.
Besides, Take-Two's fundamentals have done nothing but shoot skyward since EA stepped up to the plate. In addition to GTA4, the company is back on the summer bestseller list with its latest Civilization game, and last year's sleeper hit BioShock has a sequel -- and a big-budget Hollywood movie -- on the way.
As for the financials, analysts see Take-Two earning $1.85 a share this year. Based on last night's closing prices, Take-Two is trading at just 13 times this year's projected earnings, while EA sits at whopping multiple of 31.
Granted, that may be an unfair comparison. Take-Two has the advantage of finally digging into its tax-loss carry-forwards after dry spells under previous management teams, and the company's effective tax rate through the first half of the fiscal year is a mere 13%. That will change, and with GTA4 in the rearview mirror, Wall Street is looking for fully taxed profits to come in at $1.60 a share next year.
Meanwhile, EA is coming off depressed earnings and is set to bounce back next year. But even then, Take-Two is still trading at less than 15 times next year's bottom-line guesstimates, while EA is perched at a loftier 21 times earnings. EA can go a lot higher with the deal still being accretive.
No one else has come along to save Take-Two from EA's clutches, and that's because, as Anders points out, no other software company has the greenery to compete with EA in an all-cash deal. But why are we limited to cash buyouts? Why are we limited to standalone software developers?
Don't forget that Viacom (NYSE: VIA ) is a major player in the video-game industry with its Rock Band game. Viacom and another media giant, Disney (NYSE: DIS ) , have made major investments in the niche, because they know that young audiences are doing more than just watching television these days. A comparatively lowbrow game maker may never be on Disney's shortlist, but as it tries to win back the MTV audience, Viacom is a no-brainer as a suitor for Take-Two.
My point is simply that there are alternatives. Take-Two's dirt-cheap current valuation will keep the price in check, no matter where EA sniffs for growth. Quite frankly, if Take-Two isn't going to be bought out at an industry premium, there's nothing wrong with remaining an old maid. It'll just be a really sexy old maid.
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