Activision Blizzard (NASDAQ:ATVI) and Electronic Arts (NASDAQ:EA) are often credited for their game diversity, and therefore, a lower-risk business profile. Some investors, including me, have perceived Activision and EA to be less risky than Take-Two Interactive (NASDAQ:TTWO) because of the latter's dependency on primarily three franchises -- Grand Theft Auto, NBA 2K, and Red Dead Redemption -- for a significant portion of its annual sales.
However, when comparing the three companies on an important measure of profitability -- return on invested capital (ROIC) -- Take-Two comes out on top. Take-Two's return on invested capital over the last year was 17.82%, and while it oscillates year-to-year, the long-term trend has been up:
Take-Two's steady improvement in ROIC over the last decade raises the question of whether it really is riskier than Activision and EA. After all, it wasn't Take-Two, but Activision and Electronic Arts, that reported weak player engagement trends in the last few quarters. Meanwhile, Take-Two has reported better-than-expected engagement numbers for Grand Theft Auto V -- a five-year-old title -- in addition to strong sales numbers for Red Dead Redemption 2 and NBA 2K19.
Being smaller doesn't mean higher risk
On the surface, Activision and EA seem less risky because each company has made several blockbuster franchises over the years that attract millions of fans all over the world. Before Activision recently sold back the rights of Destiny to game developer Bungie, it was the only game maker that claimed to have eight franchises that had generated at least $1 billion in lifetime sales.
Across mobile, PC, and console games, Activision has 345 million monthly active users, while EA has more than 500 million. Take-Two reported last quarter that it had 90 million unique player accounts across Grand Theft Auto and Red Dead Redemption, and NBA 2K19 had sold more than 9 million copies since its September 2018 release.
Take-Two has an impressive number of users given its relative lack of game diversity, but those users are spread over fewer titles, which makes Take-Two seem more vulnerable to competition if players decide to spend more time with other titles on the market.
However, it should be noted that Rockstar Games -- the Take-Two subsidiary that created the Grand Theft Auto and Red Dead franchises -- has gained the reputation of being one of the best and most consistent game development studios in the industry.
Grand Theft Auto is one of the best-selling franchises of all-time. The idea that gamers could lose interest in playing either Grand Theft Auto or Red Dead Redemption would be like seeing fans suddenly lose interest in watching Marvel and Star Wars movies.
Is Take-Two better at allocating capital?
A good case can be made that Take-Two CEO Strauss Zelnick is the best capital allocator in the industry. Take-Two's stock price has outperformed its rivals since Zelnick became chairman of Take-Two in March 2007. (He took over as CEO in 2011.) Over the past 10 years, Take-Two stock is up over 1,000%, while Activision is up 372% and EA shares are up 272%.
Take-Two has achieved this remarkable run by spending a fraction on research and development compared to Activision Blizzard and Electronic Arts, which must spend vast sums to support dozens of titles. Take-Two is generating superior returns by concentrating on fewer games, and those games typically rank among the best-selling titles every year.
To be fair, the stock performances of Activision and Electronic Arts is nothing to be ashamed of -- both have soundly beaten the broader market. Both companies have consistently turned out blockbuster games over the years and each company generates robust amounts of free cash flow.
However, it's tough to overlook the missteps recently at Activision and EA with player engagement issues, while Take-Two has continued to push forward. Activision recently announced it was having to cut unnecessary expenses to focus on investment in its biggest franchises, which means the company's operating expense budget was bloated.
Also, EA reported weak sales for Battlefield V and FIFA 19 in the fiscal third quarter, which ended in December, and EA's most recent quarter disappointed investors again with uninspiring results, which can be attributed to a crowded marketplace of compelling games right now.
While Activision and EA are dealing with current softness in player engagement, Epic Games is making a fortune from a single game -- Fortnite -- and, of course, Take-Two continues to see stable performance out of Grand Theft Auto V, while Red Dead Redemption 2 has already sold 24 million copies since its fall 2018 release. The big winners in the video game industry today seem to be coming from smaller companies that are focused on a small lineup of titles.
The winner in video gaming
Activision and EA are enormously profitable businesses, but Take-Two is clearly generating more bang for the buck on game development. To the extent that Take-Two can continue to invest in the right content and see growth in its adjacent opportunities such as esports, the company's focused bets on fewer titles could lead the stock to continue outperforming its peers.