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Better Buy: Take-Two Interactive Software vs Electronic Arts

By John Ballard - Mar 10, 2017 at 5:17PM

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Take-Two makes games that set the industry standard, while Electronic Arts has a stronger mobile portfolio. Which is the better buy?

Investors interested in the video game industry should find both Electronic Arts (EA 0.27%) and Take-Two Interactive Software (TTWO 1.30%) appealing. Both are expanding margins as digital revenue opportunities from in-game content and mobile gaming continue to propel the industry forward.

Read on to find out more about what both companies are doing to keep the good times rolling.

Electronic Arts

Electronic Arts' Mass Effect game

EA's Mass Effect: Andromeda is a major short term catalyst. IMAGE SOURCE: ELECTRONIC ARTS INC. 

Growing revenue from mobile games, in-game content, and full game direct downloads via consoles has fueled a rapid rise in Electronic Arts' digital revenue from $1.4 billion to an expected $2.8 billion for fiscal 2017 ending in March.  As packaged goods revenue from physical game sales remains flat, digital revenue growth has been fueling Electronic Arts' growth in profits.

This has been an industrywide trend that is likely here to stay as players have come to expect downloadable content to be a given when they purchase a game. The additional content is relatively inexpensive, and it stretches the longevity of a title -- something very valuable to gamers.

Total revenue is expected to be $4.8 billion by the time Electronic Arts reports its fiscal fourth-quarter financial results. This would represent 9.1% growth over fiscal 2016. The higher margin from digital revenue is expected to generate $1.35 billion in operating cash flow for fiscal 2017.

Along with its competitors, Electronic Arts is building a diversified portfolio of revenue channels from advertising, subscriptions, mobile games, and eSports to lessen its dependence on physical game sales.

Looking further out, EA has a strong short-term catalyst in the new science fiction action game Mass Effect: Andromeda, releasing in March 2017. Later in the year, in time for the holiday season, EA will release a new Star Wars Battlefront game, which promises to be bigger and better than the previous version of the game.

Also, in the last earnings release, there was mention of a new franchise that has the potential "to fundamentally disrupt the way people think about an action title, bringing friends together to play in exhilarating new ways."

This game has been designed to "attract a global audience," a quality Activision Blizzard has been aiming for in its recent titles like Destiny and Overwatch.  Designing games this way is becoming commonplace as game companies target the large, fast-growing global audience for eSports.

Game publishers are in a race to create the biggest audience. The emergence of eSports, advertising, consumer products, media rights, and mobile gaming have opened up opportunities to smooth out the volatility of single-game hits, which companies relied on in the past.

Take-Two Interactive

Take-Two's Red Dead Redemption 2 logo

Take-Two has a major catalyst in the upcoming Red Dead Redemption 2 game. IMAGE SOURCE: TAKE-TWO INTERACTIVE SOFTWARE INC. 

The same trends benefiting Electronic Arts are opening the door for Take-Two to free itself from the dependency of its best-selling franchise, Grand Theft Auto.

At the beginning of February 2017, Take-Two announced the acquisition of mobile game developer Social Point for $250 million. This is a small transaction relative to Take-Two's market value of nearly $6 billion, but it's an important sign for investors that Take-Two management is pushing the company further into the profitable, fast-growing market of mobile game publishing.

Excluding Social Point, Take-Two has been successful with the mobile version of its best-selling console franchise, NBA 2K. The latest installment in the basketball series -- NBA 2K17 -- is one of the top-grossing games in Apple's app store at the time of this writing. A deeper push into mobile gaming with strategic acquisitions like Social Point will help Take-Two build a consistent, growing revenue stream.

Fiscal Year

Annual Cash From Operations

2017 guidance $350 million
2016 $261 million
2015 $213 million
2014 $700 million
2013 ($5 million)
2012 ($85 million)

Data sources: Take-Two annual reports and fiscal third-quarter 2017 earnings report. 

In recent years, Take-Two has been growing its digital revenue from in-game content like virtual currency for NBA 2K and Grand Theft Auto Online. As with Electronic Arts, the Grand Theft Auto maker is seeing more players download games directly over consoles, which represented more than 25% of Take-Two's current generation console titles purchased digitally in the last year. Since the game publisher doesn't have to hold a lot of inventory for physical copies of games, full game downloading is much more profitable for the gaming companies.

Overall, Take-Two expects to report $1.75 billion to $1.8 billion in revenue for the current fiscal year 2017, ending in March. For cash flow, the company expects to generate $350 million, an increase over $261 million in fiscal 2016.

As for short-term catalysts, Take-Two's sequel to the original Red Dead Redemption is coming in fall 2017. The highly anticipated western action game is not expected to sell anything close to the phenomenal 75 million copies of Grand Theft Auto V, but it should sell at least as well as the first Red Dead Redemption's 14 million.  

Another future growth driver is the NBA and Take-Two's recent announcement to create an eSports league built around the NBA 2K franchise.

Which is the better buy?

Strong tailwinds are affecting the video game industry right now, but not every company is made equally. Each of the three major publishers -- Activision Blizzard, Electronic Arts, and Take-Two -- have their own twist on strategy.

Between Electronic Arts and Take-Two, I favor Electronic Arts for its higher cash generation, its mobile game portfolio, and its presence in eSports with its Competitive Gaming Division. But I expect that, over time, Take-Two will catch up to its rivals in broadening its revenue diversity, so this really isn't the edge for Electronic Arts it seems to be today.

EA Chart

EA data by YCharts.

On valuation, Electronic Arts sells for about 20 times expected earnings and cash flow. Take-Two's valuation is 20.7 times expected earnings and 16.6 times expected cash flow. Because Take-Two is much smaller revenue-wise than Electronic Arts, investors who are looking for higher growth potential should consider Take-Two.

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Stocks Mentioned

Electronic Arts Inc. Stock Quote
Electronic Arts Inc.
$121.98 (0.27%) $0.33
Take-Two Interactive Software, Inc. Stock Quote
Take-Two Interactive Software, Inc.
$124.12 (1.30%) $1.59

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