It's difficult to choose one, but that's what we're going to do.
Take-Two's approach to game development is to delight the customer first, expecting that revenue and profits will take care of themselves.
This philosophy of making games has led to a string of hits with loyal followings over the years. Grand Theft Auto is one of the most valuable franchises in gaming. Take-Two's NBA 2K franchise is one of the best-selling and most authentic sports games in the industry, and the Sid Meier's Civilization series for PC has been causing sleepless nights for fans of the game going back 25 years.
Take-Two's operating subsidiaries 2K Games, Rockstar Games (developer of Grand Theft Auto), Firaxis Games (developer of Sid Meier's Civilization), and Visual Concepts (developer of NBA 2K) have turned game-making into an art form. The parent company of these studios doesn't pressure programmers with deadlines in order to meet Wall Street expectations; Take-Two management lets the company's talented developers spend as much time as they need until a game is ready.
The creative freedom given to Take-Two's developers is reflected in the staggered launch dates of its games. Three years lapsed between Grand Theft Auto: San Andreas and Grand Theft Auto IV. It was five years between Grand Theft Auto IV and Grand Theft Auto V.
This selective big-hit approach has set Take-Two apart from its major rivals -- Electronic Arts and Activision Blizzard -- which have been more aggressive in going after global audiences with mobile gaming and e-sports.
But there is a downside to Take-Two's method.
The problem has been its dependency on hit games. Grand Theft Auto V generated $1.4 billion of the company's $2.3 billion in total revenue for fiscal 2014. In fiscal 2015, total revenue dipped back to around $1 billion.
Take-Two is gradually addressing the issue, but management seems to have great patience. Company leadership expressed a goal of lessening dependency on Grand Theft Auto in 2007, when annual revenue was $982 million. For the last 12 months, Take-Two has generated about $1.5 billion in revenue, which is about the annual average for the last 10 years.
The cash flow picture mirrors the lumpiness of annual revenue. Take-Two has generated negative cash from operations in four years out of the last 10. The company had its best cash flow year with the release of Grand Theft Auto V in fiscal 2014, when Take-Two pulled in $700 million in cash from operations.
However, to management's credit, a positive trend is developing in which Take-Two is beginning to lay the foundation for generating more consistent cash flow. Additional content, such as NBA 2K's Virtual Currency and Grand Theft Auto Online, is helping the company build a recurring revenue stream around its hit games:
|Fiscal Year||Annual Cash From Operations|
Cash from operations has hovered above $200 million the last few years -- much more consistently than in previous years. On the most recent earnings conference call, CEO Strauss Zelnick said management expects cash flow growth in fiscal 2018 on the back of the highly anticipated release of Red Dead Redemption 2, the sequel to the popular Western action game. The original Red Dead Redemption sold 14 million copies after its release in 2010. The franchise is looking very similar to the sales patterns of early Grand Theft Auto games, and is a big catalyst for Take-Two in calendar 2017.
Take-Two's development studios seem to be firing on all cylinders right now. In addition to the ongoing success of Grand Theft Auto V, the recent release of Mafia III has shipped 4.5 million copies, becoming 2K Games' fastest-selling title in history. From its launch in 2013 to October 2016, Grand Theft Auto V shipped a phenomenal 70 million copies, with five million shipped between March and October of 2016.
Where Take-Two has focused on a boutique style of game development, Activision Blizzard couldn't be more different.
CEO Bobby Kotick has led Activision Blizzard to becoming a company that generates revenue year-round. One of the industry's most-played games, Call of Duty, gets a new release every fall and the franchise was the top-selling console game for 2016. The Blizzard side of Activision has a subscription-based business model, which spins off recurring, high-margin revenue. Between releases of new games, Activision maintains a steady flow of additional content for players to download, helping to maintain high engagement with titles, such as Call of Duty, Destiny, or Overwatch, among others.
Activision's approach is evident in its consistent annual cash flow -- the highest in the gaming industry:
|Fiscal Year||Annual Cash From Operations|
Along with recurring revenue, Activision has focused on creating games that are competitive in nature and are best suited to the growing popularity of e-sports, as well as game streaming on Amazon.com's Twitch.
In 2017, Activision will commence the inaugural season of Overwatch League, a professional gaming league owned by Activision. Overwatch League presents a big opportunity for sponsorship, broadcasting, and licensing revenue. SuperData expects e-sports to cross $1 billion in value in 2017, with the bulk of the value coming from advertising and sponsorship revenue. Overwatch League could become the most valuable competitive gaming league in the world, and serve as a catalyst to expand the e-sports market into multibillion-dollar territory.
Which is the better buy?
On one hand, Take-Two is heading in the right direction, and beginning to lay a foundation of more consistent financial performance. Even after a 200% run-up in the stock since 2013, Take-Two still trades at a reasonable 23 times free cash flow. I also like the creative freedom management instills with its development studios.
On the other hand, Activision has a more consistent operating history, and in Bobby Kotick we have a CEO with an unparalleled track record in the video game industry, leading Activision stock to outperform both the S&P 500 and its peers over the last 20 years. Activision is also less expensive than Take-Two, trading around 15 times free cash flow, and pays an annual dividend of $0.26 per share.
I could easily make an argument for owning both. But only choosing one, I would go for the company with the best track record, and that is Activision Blizzard.