Take-Two Interactive's (TTWO 1.70%) move to acquire leading mobile game developer Zynga (ZNGA) for $12.7 billion didn't receive a round of applause. The stock price fell sharply on the news, although it has bounced back a few percentage points.
Take-Two already has a bright future ahead, with over 60 releases in the pipeline. Management is guiding for record operating results over the next few years as it starts to tap that slate. Investors were probably wondering why the company needed to make such a large deal, especially in the hit-and-miss mobile game market.
Image source: Getty Images.
However, the market is overlooking a couple of big opportunities with regard to growing Zynga's advertising business and expanding Take-Two's intellectual property to mobile platforms.
How the deal benefits Take-Two
On the surface, this acquisition is a strategic move by Take-Two to significantly accelerate and scale up its T2 mobile games business. Mobile is an increasingly important market in the video game industry. Total mobile sales were estimated to be $90 billion in 2021, according to Newzoo. That's out of a total of $175 billion across all gaming platforms.
Top game makers Activision Blizzard and Electronic Arts have both spent billions on mobile acquisitions in recent years. It was only a matter of time before Take-Two made its move. Take-Two's largest deal to date had been the $250 million acquisition of mobile developer Social Point in 2017.
Mobile has a reputation of being hit-and-miss with gamers, but Zynga is one of the better studios at retaining its 183 million monthly active users. It has a portfolio of "forever franchises" that have been generating consistent revenue for years, including FarmVille and Words With Friends. Zynga also has had success bringing new games to market, such as the 2020 release of Harry Potter: Puzzles and Spells.
Over the last four quarters, Zynga generated $282 million of free cash flow on $2.7 billion of revenue. That will cushion Take-Two's $414 million in trailing-12-month free cash flow, which has been lumpy over the last decade.
ZNGA Free Cash Flow data by YCharts
What Zynga brings to the table
Advertising is a key component of monetizing free-to-play mobile titles, and Zynga's capabilities in this area provide Take-Two a big advantage in growing its mobile business.
Zynga has faced near-term challenges with delivering ads to players following Apple's recent privacy changes for iOS users. But ad revenue still made up 19% of Zynga's business in the third quarter. In an effort to improve its ad tech capabilities and navigate the near-term headwinds in mobile advertising, in 2021, Zynga paid $250 million to acquire Chartboost. The acquisition gave Zynga access to a leading programmatic advertising platform that uses machine learning to deliver the right ads at the right time, and therefore, can improve returns on ad placements.
Zynga's adtech platform thrives on leveraging first-party player data. More data helps Zynga better predict how a gamer will respond to an ad placed in a game, which is key to improving monetization and growing revenue. The combined company will have over 1 billion user accounts to build a more sophisticated data-driven advertising platform.
Is "Grand Theft Auto" heading to mobile?
With massively popular franchises like Grand Theft Auto, NBA 2K, and Red Dead Redemption, Take-Two can leverage Zynga's mobile expertise to convert its console titles over to mobile. This is a huge opportunity where Zynga's data-driven ad business can identify and acquire highly engaged players to download one of Take-Two's mobile titles and enhance the returns that these titles generate on mobile devices.
Imagine Take-Two using Zynga's deep bench of mobile programmers to make a free-to-play mobile version of Grand Theft Auto -- a top-selling franchise that has sold over 270 million copies. Zynga would have a field day monetizing a property like that.
Zynga also acquired Echtra Games last year to bolster its cross-platform development capabilities, which it sees as a key component to its previously estimated $240 billion long-term addressable market. The combination of boosting Zynga's advertising business, acquiring new users, and cross-promoting titles across mobile and console is estimated to add more than $500 million of annual net bookings to the company over time.
Take-Two's stock is down after the announcement, despite the significant contribution in free cash flow from Zynga, as well as management's guidance for strong revenue growth. Management anticipates that the combined company can grow revenue at an annualized rate of 14% through fiscal 2024, excluding the estimated $100 million in annual cost synergies. All said I believe Take-Two is a buy ahead of these opportunities.
