Merger mania has given investors fewer options in the video game space. Activision Blizzard is headed to Microsoft, and Zynga was purchased by Take-Two Interactive Software (TTWO 1.26%). But the space is still an exciting one if you're seeking businesses with attractive growth and profit outlooks.
Take-Two has been trailing the market by a wide margin so far in 2022. Let's see why the stock might make a good addition to your portfolio despite some significant short-term risks to the business.
1. Steady flow of content
Take-Two's biggest achievement in the past five years is bulking up its portfolio so that its annual sales aren't as dependent on just a handful of releases. Sure, the Grand Theft Auto and 2K Sports franchises drive a big portion of its business today.
But investors don't have to worry about a single flop tanking annual earnings anymore. The purchase of Zynga puts the company on par with bigger rivals like Electronic Arts (NASDAQ: EA) in having a major presence across PC, console gaming, and the massive casual gaming space.
Unlike EA, Take-Two had to buy its way into that last market, and that fact helps explain why the stock is underperforming today. Investors are worried about the cost of the Zynga acquisition and whether the integration will cause hiccups like higher costs or delayed releases. It's already causing weaker earnings, but ideally that pressure will start to ease in 2023 and beyond.
2. Rising margins ahead
Investors have some concrete promises that they can judge the management team by over the next several years, but the biggest is Take-Two's goal of steadily boosting its profit margins. The company is hoping to keep raising its base of recurring spending at a 20%-plus compound annual rate thanks to the shift toward subscription-type gaming purchases.
This move is making video game businesses look like software-as-a-service companies, which tend to see strong cash flow that flows down to the bottom line. Again, Take-Two's merger activity has pressured this key metric in 2022 compared to peers like EA. But shareholders can reasonably expect to see annual cash flow rise over time, supporting more cash returns through stock buybacks.
3. Looking to 2023
Take-Two has its biggest pipeline yet of new releases on the way, including two dozen major titles in its core portfolio and nearly 40 mobile games. The consumer reception of these launches will largely drive its stock returns over the short term, at a time when spending might slow in the video game segment.
Yet the long-term outlook is bright for the gaming industry, and that's a great reason to look at one of the cheaper players. Take-Two today is valued at roughly four times annual sales compared EA's ratio of five and the 12 times sales investors are paying for Roblox right now. If you don't mind holding the stock while the business moves toward higher profitability, then Take-Two might make a great addition to your portfolio.
