EA Can't Steal Take-Two

The rules of Grand Theft Auto are simple. If you want something, you take it, even if it means resorting to brute force. Resistance and rejection are mere obstacles to clear when you find the shiny vehicle you want to ride out.

Electronic Arts (Nasdaq: ERTS  ) is apparently ready to play, making its $26-a-share offer to rival game maker Take-Two Interactive (Nasdaq: TTWO  ) public over the weekend. Take-Two rebuffed the unsolicited offer, just days after turning down EA's first buyout offer at $25 a share.

Going public with the boardroom volleys is a noble tactic on EA's part. It knows that Take-Two's stock is stuck in the teens. It realizes that the heavily shorted Take-Two will rally on the news in the mother of all short squeezes, further planting the thought that EA is a savior in shareowners’ minds.

Of course, this is also exactly what Microsoft (Nasdaq: MSFT  ) did in taking its private offers to Yahoo! (Nasdaq: YHOO  ) public earlier this month. By letting the court of public opinion weigh in on the issue, EA is forcing Take-Two's board to answer to its investors if it doesn't have a better plan to maximize shareholder value.

The fatal flaw for EA is that Microsoft offered a healthier premium for a company in decline. If I can lean on the Grand Theft Auto metaphor again, EA is quite frankly trying to steal Take-Two.

Microsoft's offer values Yahoo! -- a company set to post its third consecutive year of lower earnings -- at 67 times forward profitability. EA's offer prices Take-Two at less than 20 times forward earnings.

EA describes the proposed purchase of Take-Two as a "long-term" move, but with its own shares priced at 27 times next fiscal year's profit target, snapping up Take-Two at a cheaper multiple would make the deal accretive in the near-term, too.

You're a thief, EA, and you're not fooling anybody.

Don't get mad, get Madden
I'm not a sap for reluctant acquisition targets. I took Yahoo! to task for rejecting Microsoft's advances. However, I did that because I felt that Yahoo! was living in denial. Its paid-search platform upgrade has been a flop. Its page-view monetization skills have been horrendous. The company's own wave of layoffs this month tells you that Yahoo! is in retreat.

It's a different story at Take-Two. Sure, the company has had its share of accounting scandals, operating hiccups, and staff turnover in the recent past. The key here that the company is already on the rebound.

BioShock’s surprising success last year gave Take-Two another workhorse franchise. Manhunt 2 finally hit the stores. Its Grand Theft Auto IV juggernaut is now just two months away from a firm release date.

Why would Take-Two want to bow out now? Things are finally starting to go its way. It even has a $50 million deal with Microsoft for creating exclusive episodic installments of the game for Xbox users, lubricating Take-Two as the next big winner of high-margin, digitally delivered add-ons to monster titles.

Take-Two also knows it has EA where it wants it. After December's move by Activision (Nasdaq: ATVI  ) to combine with World of Warcraft parent Blizzard, the creation of Activision Blizzard would supplant EA as the top dog in terms of both sales and profitability (on a trailing basis, at least).

Shares of smaller game developers like Take-Two Interactive and THQ (Nasdaq: THQI  ) climbed higher the morning after the Activision Blizzard deal was announced, thanks to rightful speculation that EA would do something to win back its crown.

"This probably won't be the last deal," I wrote at the time in bringing up the attractiveness of both Take-Two and THQ as rebound trophies. "Take-Two is the better buyout candidate of the two. THQ's portfolio of licensed character games is appealing, but Take-Two's the one with the knockout franchises."

You can't take to Take-Two so cheaply
I applaud David Gardner for having the vision to recommend Take-Two to his Rule Breakers subscribers five months ago, while the stock was in the mid-teens. Investors deserve the fruits of their due-diligence labor when they unearth truly undervalued growth stocks.

Unfortunately, I can't extend the same pat on the back to EA here. It knows what every Take-Two investor knows. By the end of this year, Take-Two on its own merits can be worth substantially more than EA's parachute if the oft-delayed Grand Theft Auto IV puts Take-Two back on the map.

EA has two months to convince the public otherwise before the destiny of GTA4's initial sales number carries Take-Two higher or lower. EA will argue that it's not stealing. It doesn't have a ski mask, a criminal record, or even a mug shot.

Unfortunately, EA can't hide from the crime. Its fingerprints are everywhere. The drive-by offer is hostile. The buyout premium is as meager as it is selfishly accretive. There may be a price at which Take-Two has little choice but to give in, but it's not going to happen here, now, and in increments of a buck at a time.

You can't offer an exit strategy to a company that has rediscovered the entrance. You can't offer a parachute to a company learning to fly.


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