The headwinds impacting the broader market have not spared leading video game maker Take-Two Interactive (TTWO -0.08%). Weak sales trends across the video game industry have sent the stock price down 30% since 2021.
Take-Two's top franchises, including Grand Theft Auto V and NBA 2K23, are performing well, but it seems smaller games on the PC and consoles are below par.
The gaming industry's weak sales currently have Wall Street's full attention, but the market is missing a huge opportunity for Take-Two in mobile gaming. On that front, the acquisition of Zynga could become Take-Two's biggest growth catalyst in the next bull market, and this opportunity is not reflected in Take-Two's stock price right now.
Mobile is the biggest sales driver for Take-Two
Take-Two closed its acquisition of leading mobile game maker Zynga last year. It expands the company's growth opportunity to a mobile market worth $131 billion in 2021, according to IDG Consulting.
Zynga raises the percentage of Take-Two's annual bookings (a non-GAAP measure of revenue) coming from mobile games from less than 10% to nearly half. That completely changes the composition of the business, and Wall Street hates uncertainty, which probably contributed to the stock's underperformance last year.
Mobile gaming is an attractive market. It has grown into the largest category of video game sales over the last decade. Still, mobile revenue fell an estimated 6% in 2022, according to Statista. The timing of the acquisition certainly wasn't the best, but what matters is the long-term outcome.
Adding to the near-term uncertainty, management lowered its full-year outlook for bookings to $5.2 billion to $5.25 billion. The macro environment is causing players to lower their spending on new releases, but mobile in-app purchases weren't cited as the reason for Take-Two's lower guidance. Management reported that Zynga's games performed in line with expectations, but weakness across several of Take-Two's PC and console titles offset the performance from Zynga.
It appears that the acquisition of Zynga is preparing Take-Two for a potential acceleration in top-line growth coming out of this downturn. There are a few catalysts that are not appreciated by the market right now, as reflected in Take-Two's relatively low price-to-sales ratio.
Why Take-Two is undervalued
Over the long term, Take-Two sees several ways to grow the value of the combined company. It can expand some of its best-selling games on console to mobile. The team at Zynga are experts at generating growing revenue from in-app purchases and advertising. Take-Two can lean on this expertise to increase the value of its NBA 2K sports franchise on mobile, particularly in a mobile-first region like China where the NBA is very popular.
Before Take-Two acquired the company, Zynga was already targeting long-term margin expansion by investing in its own ad tech capabilities. In 2021, Zynga acquired Chartboost, a leading programmatic advertising and monetization platform for mobile developers. It's no surprise that Take-Two said it is on pace to exceed $100 million in cost savings within the first two years of closing the acquisition, which will be a catalyst for higher profits.
Meanwhile, Take-Two is trading at its lowest price-to-sales ratio since 2017, and at a significant discount to competing video game makers.
Data by YCharts
Take-Two stock delivered a return of over 700% over the last 10 years. The addition of Zynga could keep Take-Two growing fast enough over the next decade to deliver similar market-beating returns. In the fiscal third-quarter earnings call, CEO Strauss Zelnick cited strong engagement among Zynga's active player base and stable market share in the mobile gaming market.
Keep in mind, management's initial forecast for top-line growth at the time of the acquisition was a compound annual rate of 14% through the first two years, which is consistent with Take-Two's annualized revenue growth over the last 10 years. That obviously was thrown off last year, but once the dust clears in the economy, investors should expect Take-Two to grow consistent with that original forecast.
For these reasons, buying this top video game stock at its lowest valuation in over five years should deliver attractive returns.
