Is Take-Two A Buy?

Video games are not just child's play -- they're also serious business. When Microsoft (Nasdaq: MSFT  ) released Halo 3 in 2007, sales topped $300 million in its first week on store shelves. To put that performance into perspective, Hollywood's finest opening week, The Dark Knight, topped out at $239 million. Game franchises like Activision Blizzard's (Nasdaq: ATVI  ) Guitar Hero and Electronic Arts' (Nasdaq: ERTS  ) The Sims are billion-dollar businesses in their own right.

But there are a bewildering number of video game producers on the publicly traded market today, ranging from dabblers like Microsoft to dedicated industry giants like EA and Activision, to smaller upstarts such as Take-Two Interactive (Nasdaq: TTWO  ) and THQ (Nasdaq: THQI  ) . I'm here today to show you why Take-Two stands out from the pack as an investment today, and why I own the stock myself.

What makes Take-Two different?
Grand Theft Auto makes Take-Two tick (say that six times quickly!). This blockbuster franchise has also spawned a number of spinoff titles across multiple platforms. Grand Theft Auto: Chinatown Wars title is a best-selling game in the Apple (Nasdaq: AAPL  ) iPhone app store, for example.

The company also sports a number of successful sports games, Sid Meyer's Civilization series, the critically acclaimed Max Payne and BioShock franchises, and more. But all of these products notwithstanding, Take-Two pretty much lives and dies by the GTA tentpole titles. You can bet that the fifth installment in that series is under development; analysts expect it to appear in 2011.

Doing the buyout bachata
And that's where the fun starts. The last time Take-Two had a brand-new GTA title ready to hit your local gaming store, Electronic Arts liked the game so much that it tried to buy the company. But fellow Fool Rick Munarriz called the 40% buyout premium "as meager as it is selfishly accretive," EA refused to sweeten the bid, and the deal fell apart over the coming months.

That cycle could very well repeat itself in 2010, only with a more lucrative outcome for Take-Two shareholders. This time, Take-Two has a couple more proven money-makers under its belt in the BioShock and spaghetti-Western-influenced Red Dead series, and acquisitions seem to be the only certain path to growth in today's video game industry.

The most likely buyers would be EA (again) and Activision, as the two 500-pound gorillas jockey for the title of the biggest game guru in the world. But Microsoft is no stranger to buying a game company it likes, either, and you never know which dark horse might want to enter a new market these days. We could see a real bidding war this time, and it could start any day now.

Really? How come?
The market is treating Take-Two as if it will never again have a runaway hit. Among 19 Wall Street analysts following the company, not one of them expects Take-Two to make a profit in 2010. OK, so the next Grand Theft Auto isn't expected until fiscal 2011, but you can buy a share of Take-Two for 7 times the consensus estimate for that year's earnings. By comparison, EA trades for 30 times expected forward earnings, and Activision has a forward P/E of 14.

I expect those estimates to shoot up when Take-Two announces the next GTA game, and the stock price will follow suit -- with or without takeover offers. This is a cyclical stock of sorts, and the cycles are very much tied to the golden calf in its stable of game titles. And right now, The Street is ignoring that fine animal.

Isn't that risky?
Investing in Take-Two means putting most of your eggs in one big basket called Grand Theft Auto. You may not be comfortable with that strategy, and I respect that. Take-Two is a Rule Breakers pick, not a straight-up value play. If you want a diverse company that dabbles in gaming, you'd frankly be better off with Microsoft or Time Warner (NYSE: TWX  ) , where games are just a distraction from bigger and more stable mainline operations.

But if you have the stomach to ride through some intense volatility and the steely nerve to make a potential acquisition play with a long time horizon, then Take-Two could be exactly what you want. I bought my shares when the first EA deal crumbled, because I knew that Take-Two has something that its larger rivals want badly -- and will eventually come around with an offer we shareholders can appreciate. The thesis hasn't changed much in two years.

So yeah, I think that Take-Two is a buy. What do you think, dear Fool?