Take-Two Interactive's (TTWO 0.49%) stock price plunged 13% on Monday on news that the company would buy Zynga (ZNGA +0.00%) in a $12.7 billion deal. The stock has now fallen about 24.5% over the last 12 months and has suffered comparable price losses to longtime rival Activision Blizzard (ATVI +0.00%) (27%) over the same timeframe.
Nonetheless, the Zynga purchase brings with it innovative mobile and casual games as well as compelling franchises. The question for investors is whether the lower price and the expanded lineup can revive the video game stock?
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How Zynga could boost Take-Two's business
Take-Two owns popular gaming franchises including Grand Theft Auto, NBA 2K, and Red Dead. However, it has long geared its games for console and PC use. Though it had established T2 Mobile Games, it lags the presence in mobile that has benefited Activision Blizzard and Electronic Arts (EA +0.27%). In recent years, it has also had to compete with companies such as Tencent and the Sea Limited gaming division, Garena.
By buying Zynga, it follows in the footsteps of its long-standing U.S.-based competitors by entering the mobile gaming market through acquisition. Activision Blizzard acquired King Digital in 2016, while EA bought Glu Mobile last year.
Zynga will merge with T2 Mobile Games, remaining a separate division of Take-Two, and Zynga CEO Frank Gibeau will continue to lead that division under the Zynga name. Consequently, Take-Two can now become a force in mobile as the owner of Zynga Poker and Words With Friends.
Through the Zynga purchase, Take-Two can also establish itself as a leader in hyper-casual gaming (mobile games that are free, easy to play, with minimal user interfaces) since Zynga bought out Rollic Games in 2020. Additionally, since Zynga owns Chartboost, Take-Two can more effectively link marketers to its gaming audience once the deal closes.
A financial boost
Take-Two's financials have suffered in recent quarters. Revenue of $858 million for the second quarter of fiscal 2022, which ended Sept. 30, climbed by 2% compared with the same quarter in fiscal 2021. Conversely, net income dropped by 83% to $20 million, as operating expenses rose 30% with the rising costs of marketing, head count, IT, and merger expenses (from its previous purchase of Nordeus) weighing on the bottom line.
Zynga reported about $705 million in revenue in the third quarter of 2021, its latest quarter. This represented a 40% increase year over year. It also lost $42 million in the third quarter, but that improved from a $122 million loss in the year-ago quarter as the company slowed the growth in operating expenses.
Zynga has nearly matched Take-Two on revenue. Hence, if this pattern holds, the combined company could soon see double-digit income growth due to the merger. It could also boost profitability over time as the revenue growth had helped reduce losses for Zynga.
Admittedly, valuation offers a mixed picture for Take-Two stock. The company's falling profit boosted the price-to-earnings (P/E) ratio, and its 30 earnings multiple comes in well above Activision's P/E ratio of 19. Nonetheless, Take-Two's 4.9 price-to-sales ratio comes in slightly lower than Activision at 5.5 and EA at 5.8, making Take-Two more comparable in valuation to its closest peers.
Should you consider Take-Two?
Take-Two's purchase of Zynga might become one of the great bargain buys for 2022, but it could take time to bear fruit for average investors. Zynga's losses will reduce profitability initially, and the costs of the merger will probably keep Take-Two's operating costs higher for a time.
Nonetheless, the Zynga division of the new Take-Two should immediately boost revenue growth and close the competitive gap between it and its main rivals. With a lower P/S ratio and the stock selling at a significant discount from its highs, investors could profit in the long term.
