After three years of strong Grand Theft Auto V sales, Take-Two Interactive (TTWO 2.14%) is sitting in the catbird seat, with $1.15 billion in net cash on its balance sheet.
Capital allocation is a crucial factor in evaluating a CEO's ability, as legendary investor Warren Buffett knows firsthand, so having a lot of cash doesn't mean anything unless management exercises diligence in how cash is used. We'll take a look at the moves Take-Two has made recently, and how CEO Strauss Zelnick has demonstrated thoughtfulness and discipline in allocating the company's cash on behalf of shareholders.
Take-Two has the potential to turn itself into the cash gushing machine of its peer Activision Blizzard depending on what decisions management makes with the company's cash going forward. In that light, it's especially encouraging to see Take-Two's CEO express the need to be disciplined and thoughtful in how it chooses other companies to acquire. In the fourth-quarter 2017 conference call, Zelnick commented:
We're not interested in pie in the sky. We're not interested in talking about strategy and overpaying for something. We're certainly not interested in buying a money-losing enterprise.
Earlier this year, Take-Two acquired Spanish mobile game developer Social Point for $250 million. Social Point is profitable, with about $20 million in operating earnings. This is Take-Two's first step in expanding beyond its own developed games into the broader mobile gaming market. I wouldn't be surprised to see the company acquire another mobile game studio at some point given how attractive the free-to-play market is, both for its fast growth and profitability.
Take-Two is also showing interest in acquiring new intellectual property from other development studios, as it just did with the announced acquisition of independent developer Squad, the maker of the hit space simulation game, Kerbal Space Program. This game fits in with Take-Two's current portfolio of highly praised, unique games that attract a loyal following of fans. Kerbal Space Program has received great reviews, and there's no telling how much better the game may get in the future with the financial support of Take-Two.
Return cash to shareholders via share repurchases
Additionally, Zelnick has shown a willingness to return cash to shareholders in the form of share buybacks, although it's a rare occurrence -- as it should be. Share buybacks should be conducted with the same thought and care that you manage your own stock investments. In other words, companies should buy back shares when the stock price offers compelling value, otherwise shareholders would be better off receiving the cash as a dividend.
Take-Two last conducted a major share repurchase in the third quarter of fiscal 2014, the same year Grand Theft Auto V was released. Management repurchased $276 million worth of shares, which is all the company could afford since it entered fiscal 2014 with only about $67 million in net cash on the balance sheet. The repurchase at the time represented 13.5% of the company's total shares outstanding, a very meaningful amount. The timing couldn't have been better, since Grand Theft Auto V has been the company's biggest-selling game in its history, and is largely responsible for the company's outstanding performance over the past three years.
I don't think Zelnick imagined Grand Theft Auto V would go on to sell a mind-boggling 80 million copies over the next three years, but it looks to me he foresaw how impactful the game would be on Take-Two's bottom line. He saw the stock's valuation did not adequately account for the future value of the Grand Theft Auto franchise, as well as the beneficial changes happening as a result of the company's digital distribution strategy, and he pounced on the opportunity to repurchase Take-Two's shares on the cheap.
On Take-Two's fiscal fourth quarter 2017 conference call, Zelnick explained his rationale for doing share repurchases:
We'll do buybacks when we can execute them at deep value in our view and in any scholarly view of merit. That's the only time it ever makes sense for an organization to do a buyback. We've done two, both at deep value and with hindsight. Of course, we didn't have hindsight when we made the decision. And we will contemplate other forms of returning cash to the shareholders.
It's very rare to find CEOs who treat share repurchases opportunistically and with care as Zelnick demonstrated here.
Pay down debt
Finally, with Take-Two raking in plenty of cash, it can pay off the roughly half a billion dollars in debt it has carried for a while. Management has cut that in half to $251 million, and they are looking to completely eliminate it and become debt-free. That will give Take-Two even more flexibility in how it allocates its cash, whether in making more acquisitions, buying back shares, or paying dividends.