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Is Take-Two's Stock Price Rally Sustainable?

By Luis Sanchez CFA – May 27, 2020 at 9:31AM

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Investors may want to excise caution as a light game-release schedule could lead to lower earnings in the coming years.

Take-Two Interactive (TTWO 3.31%) is the famed video game maker behind the Grand Theft Auto and Red Dead Redemption series. Sales of its video game titles soared this year as stay-at-home mandates and social distancing efforts eliminated a host of alternative uses for people's spare time. In response to that positive revenue and earnings news, Take-Two's stock price has soared to new all-time highs -- but can it sustain them?

2020 a banner year so far

When Take-Two reported its Q1 2020 earnings last week, investors finally got a chance to see exactly how the COVID-19 pandemic has impacted its business, and they were not disappointed. The company's revenue rose 41% year over year to $760.5 million and net income rose a whopping 54%.

Metrics Q1 2020 Q1 2019 YOY Change
Revenue $760.5 million $539.0 million 41%
Net income $634.7 million $413.5 million 54%
Diluted EPS $1.07 $0.50 110%

Data Source: Take-Two Financial Reports.

Key contributors to the company's strong performance were NBA 2K20, and the Grand Theft Auto and Red Dead Redemption franchises. The strong contribution from NBA 2K20 was somewhat surprising because it had been partially blamed for the disappointing Q4 2019 earnings report. Grand Theft Auto and Red Dead Redemption have continued to capitalize on their ability to sell additional downloadable content. In fact, Grand Theft Auto Online achieved its best-ever quarter in terms of the number of active users logged into the game.

A light release schedule

Despite the strong start to 2020, investors may want to temper their expectations for how much Take-Two will earn in the next few years. The company has noted that its game release schedule in 2021 will be light, and there is significant uncertainty over what titles will be launched further down the road.

Most notably, a new Grand Theft Auto game still hasn't been announced since GTA V was released in 2013. Granted, Take-Two still makes a lot of money from selling expansions via Grand Theft Auto Online, but a new installment in the series is overdue.

A couple of complications will hinder the company's new game release schedule. First, new gaming consoles are scheduled to be released this winter, which will create additional work for Take-Two's engineers as they adapt to new development toolkits and hardware capabilities. Second, while COVID-19 may have increased gamer activity, it has likely slowed new game development, which requires a great deal of collaboration among large teams of engineers, designers, and game testers.

Two hands holding a video game controller with a yellow background

Image Source: Getty Images.

On the first-quarter earnings call, CEO Strauss Zelnick commented:

Transition to a new console cycle is always a very exciting time for our industry, and our development teams are already taking their creative aspirations to a new level by finding ways to push the limits of this new technology; however, the speed of these transitions can be unpredictable, particularly in a year upended by COVID-19.

The video game business relies on a steady stream of new releases -- if a game maker releases a lighter slate, its revenue and earnings will most likely decline.

Returning to normal

After months of lockdown, people are anxious to get back to something that resembles their normal lives. When society does reopen, the number of hours the average gamer spends on video games will likely decline. And declining content consumption generally results in lower revenue for game publishers like Take-Two.

Given that Take-Two's stock price is around its all-time high, investors may want to tread carefully. Expectations are high for the company after its banner quarter, but those expectations may need to be adjusted downward if it doesn't release as many new titles as planned, and if content consumption declines after the recent binge.

Luis Sanchez has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Take-Two Interactive. The Motley Fool has a disclosure policy.

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