Over the last five years, video games have been one of the hottest industries to invest in, especially when you compare the stocks to some well-known tech companies.
There's a simple explanation for these gains. Video game companies are no longer one-hit wonders that rely on sales of physical game discs. The big three U.S.-based video game companies -- Electronic Arts, Activision Blizzard, and Take-Two Interactive (TTWO 0.49%) -- are generating more revenue from higher-margin digital sales of games and content, which gamers can download directly to their consoles.
More importantly, game companies have shifted to a new business strategy of selling additional content that can be purchased in-game long after a game's release. Add-on content extends the replayability of a game and has provided game companies more money-making opportunities throughout the year, as opposed to relying on blockbuster game releases ahead of the holiday season to generate the bulk of annual revenue.
Previously, I reviewed how this new strategy has benefited Activision Blizzard and Electronic Arts. In this article, I'll examine Take-Two.
Growth of digital revenue is opening new doors
As digital revenue has grown, Take-Two has been able to earn more consistent annual profit based on its cash generated from operations, which is reported on a company's cash flow statement and shows the actual amount of cash a company receives and spends over a given time period.
Metric | 2017 | 2016 | 2015 | 2014 | 2013 | 2012 | 2011 |
---|---|---|---|---|---|---|---|
Digital revenue as a percentage of total revenue | 52% | 49% | 37% | 18% | 22% | 13% | 9% |
Cash from operations | $331 million | $261 million | $213 million | $700 million | ($5 million) | ($85 million) | $135 million |
Sales of digital content cost relatively little to produce compared to the cost of manufacturing physical copies of games on discs, so the bigger digital revenue gets as a percentage of annual revenue, the further margins will expand, boosting the bottom line and providing Take-Two more cash to invest in growth opportunities.
There are a few key components that make up what's reported as digital revenue. One is full-game downloading. Gamers are starting to follow the lead of their PC counterparts by purchasing full games directly over console. This trend is still in the early stages. About 25% of Take-Two's game sales are downloaded direct to console, as opposed to being purchased at a retailer.
Another component of digital revenue is in-game content, such as virtual currency in NBA 2K and Grand Theft Auto Online-- the two biggest drivers of in-game purchasing over the last few years. In many games that get released these days, players can buy additional content updates for about the cost of a fancy coffee and it immediately extends the life of the game several weeks or months.
A third component helping to grow digital revenue is mobile gaming. EA, Activision, and Take-Two have all been investing more in this fast-growing segment of the industry. Like its peers, Take-Two has released mobile versions for a few of its top-selling console franchises. Earlier this year it took a bigger step into the mobile gaming space when it acquired Social Point for $250 million.
Cash is piling up fast
The Social Point acquisition perfectly illustrates how digital revenue growth has transformed Take-Two into a stronger, more profitable company. Without the extra cash Take-Two generated over the last few years following the strong contribution to digital sales of Grand Theft Auto Online, Take-Two probably wouldn't have been in position to make that acquisition.
Metric | 2017 | 2014 | 2011 |
---|---|---|---|
Total cash on balance sheet | $1.4 billion | $935 million | $280 million |
Long-term debt | $252 million | $454 million | $107 million |
An acquisition of Social Point's size would have taken a bigger bite out of Take-Two's balance sheet a few years ago. Take-Two had less than $500 million in net cash in fiscal 2014 after subtracting debt. But with $1.4 billion of cash at the end of fiscal 2017 and very little debt, a $250 million acquisition is easily affordable for Take-Two -- all thanks to greater amounts of cash flowing into the company's coffers.
The shift to a digital distribution strategy has transformed Take-Two from a money loser to a cash-generating machine. In addition to acquisitions, management now has more cash to invest in the development of new game franchises, as well as potential share repurchases and dividends.