I have found it's usually better to invest in a great company with average leadership than to invest alongside an exceptional CEO overseeing an average business. But in the case of video game producer Take-Two Interactive (TTWO 1.26%), you can benefit from the best of both worlds.
A $1,000 investment in Take-Two stock at the end of Jan. 2011, right after CEO Strauss Zelnick took over, would be worth over $8,000 today. Before the recent sell-off in this year's on-and-off bear market, Take-Two had significantly outperformed industry peers, in addition to the S&P 500.
Data by YCharts.
Here's how Zelnick led a remarkable run for Take-Two, and why strong leadership will allow the company to outperform its peers again over the next decade.
Frugal culture
Before Zelnick took over in 2011, Take-Two had very little cash on its balance sheet and a history of inconsistent profitability. During the Jefferies Interactive Entertainment Conference in 2021, Zelnick said: "We had to be very judicious at first, because we had a pretty thin and wobbly financial structure."
Zelnick has led a tight ship, which has completely changed the company's fortunes. Take-Two doesn't spend lavishly on corporate overhead. There are about eight senior managers with a few assistants who share a modest office space in Midtown Manhattan. Zelnick explained they don't even enjoy the luxury of a cafeteria or security guards.
However, global headquarters is not being cheap when it comes to enabling its game programmers to create the best games they can. Over the last 10 years, Take-Two's research and development (R&D) expense as a percentage of revenue has doubled, while translating to more growth in game sales.
Data by YCharts.
Investors don't have to dig deep to see Take-Two's game releases under Zelnick have flourished like never before. Grand Theft Auto V (2013) is on pace to sell nearly 10 times as many units as previous entries in the series. Red Dead Redemption 2 (2018) and the NBA 2K series are following a similar pattern, with sales of recent releases up two times or more compared to previous installments.
Zelnick's goal is to ensure the company is maintaining, if not growing, its quality standards over time. Recent sales of these franchises suggest the company is meeting this objective.
More cash to reinvest
The good news is the company has more resources to invest in game development than before Zelnick's arrival. Entering calendar 2022, Take-Two had $2.4 billion of unrestricted cash on its balance sheet and no debt.
The company used a chunk of its cash to acquire leading mobile game company Zynga, positioning Take-Two for growth in the $100 billion mobile game market. The downside is Take-Two now has a net debt balance of $2.0 billion after financing the largest acquisition in its history.
The uncertainty over the near-term mobile advertising market, which is a key part of Zynga's business, is weighing on Take-Two's stock performance. However, I have no doubt Zelnick & co. will foster long-term returns with Zynga as they did with Take-Two's in-house studios.
Management said on the Nov. 8 earnings call that Zynga has already identified areas in which to improve performance and save money. Take-Two's guidance calls for $100 million in annual savings over the next two years.
On a price-to-sales basis, the stock hasn't been this low since 2017, and it now trades at an even greater discount to rivals Electronic Arts and Activision Blizzard.
Data by YCharts.
Given management's track record of squeezing more out of the business and growing the audience for its leading franchises, the stock deserves to trade at a higher valuation and should outperform other video game stocks from these low levels.
