Take-Two Interactive (NASDAQ:TTWO) is the maker of popular gaming franchises Grand Theft Auto (GTA), Red Dead Redemption, and NBA 2K. The stock price has skyrocketed 850% over the last five years, as sales of GTA V (released in 2013) is still delivering the goods.

But how risky is the stock?

Grand Theft Auto game art depicting character riding a jet ski.


Reliance on Grand Theft Auto

The strong sales of GTA V have served shareholders well, but this also presents an element of uncertainty for investors going forward. The 4-year-old game accounted for an astounding 37.4% of Take-Two's revenue in the first six months of fiscal 2018, a period that ran through the end of September.

Generating such a high percentage of sales from one title obviously creates a risk that the next installment won't be as successful, causing lower revenue and earnings.

As we saw with Activision Blizzard's Call of Duty: Infinite Warfare in fall 2016, game companies can sometimes disappoint even with games that have a wide following. However, lower sales of Infinite Warfare didn't even cause a dent in Activision's financial results because the company is so diversified with several top-selling franchises to pick up the slack -- something Take-Two lacks right now.

That said, GTA V may be Take-Two's ticket to building diversification as management begins to use profits the game has generated to invest in new opportunities.

Financial fortitude

Since GTA V launched four years ago, Take-Two has built up a larger cash hoard on its balance sheet, and it's also reduced debt. These extra resources give management flexibility to invest in the development of potentially new franchises and make profitable acquisitions -- a unique position Take-Two hasn't been in before.

The following table shows Take-Two's financial position right before the release of GTA V in 2013 compared to the most recent quarter.

Metric As of September 30, 2017 As of June 30, 2013
Cash $1.263 billion $646.3 million
Debt $52.4 million $408.9 million


Management is starting to put its more than $1 billion in cash to work for shareholders, diversifying the company's revenue channels, as they did earlier this year with the acquisitions of Social Point and the maker of the PC game Kerbal Space Program. Part of management's strategy is to expand their offerings to new emerging gaming platforms such as smartphones and tablets, while staying focused on developing a select few console titles that offer the best return on investment.

Take-Two has been one of the more risky video game stocks to own in the past because of its dependence on GTA, but that risk should gradually diminish over time as it uses its newfound treasure trove to invest in the mobile game market, new franchises, and esports.

Recurrent consumer spending 

Another way Take-Two is becoming less risky is through the release of additional content offerings that players can purchase while playing. This lessens dependence on new game sales, and generates a more predictable stream of revenue.

An example of this is GTA Online or NBA 2K's virtual currency, which have become important contributors to Take-Two's recurrent consumer spending, which totaled 44.9% of total revenue in the first six months of fiscal 2018, up from 30.9% in the prior year's comparable period.

Management is planning an online component for next year's release of Red Dead Redemption 2 similar to GTA Online, which means Red Dead 2 will likely generate more revenue over time from digital in-game content than initial purchases of the game.

The digital distribution strategy Take-Two is pursuing is still in the early innings. Management expects digital revenue (which includes recurrent spending) to become a larger part of the business over time. As that happens, profits should continue to grow, since digitally delivered content is less costly to produce than physical goods.


Finally, we have Take-Two's stock to think about.

The huge gains over the last few years have left the stock trading for 24 times forward earnings estimates for fiscal 2019, which is higher than the forward P/E of 19.5 for the average stock in the S&P 500 Index. There's a lot of growth baked in to Take-Two's valuation, but I believe those high expectations are justified.

If the company can begin to string together hit games starting with Red Dead Redemption 2 next year, there should be a growing stream of profits to follow, especially with a steady stream of additional content offerings. 

Growth stocks are going to trade for high P/E ratios -- that's a given. But as management allocates more capital toward new opportunities, Take-Two will likely look a lot different in 10 years than it does today. Investors with a long time horizon to invest should feel comfortable owning Take-Two shares in their portfolio.