The video game industry is always in motion. Popular game franchises and successful developer studios change hands all the time, and two of the most energetic movers and shakers in recent years just struck another deal.
In a $460 million contract, industry giant Take-Two Interactive (TTWO 1.38%) is buying Gearbox Entertainment from Swedish game-studio manager Embracer Group (THQQ.F 9.83%).
A lopsided deal?
The Gearbox deal has a curious structure. Embracer is parting ways with the main Gearbox studios in Canada and Texas, along with hit titles in the Borderlands, Duke Nukem, Brothers In Arms, and Tiny Tina's Wonderlands game worlds. That's about two-thirds of Gearbox, in terms of employee headcount and the book value of games currently under development.
But Embracer is holding on to a studio in San Francisco, formerly known as Perfect World Entertainment, and a handful of smaller groups. Perfect World manages massive multiplayer online (MMO) games under the Neverwinter, Star Trek Online, and Champions Online franchises. Compared to Take-Two's incoming Gearbox operations, these retained assets collected 20% more revenues last year -- and Embracer's slice of Gearbox was profitable while the divested operations weren't.
Take-Two said that the Perfect World studio and other not-acquired parts of Gearbox would be "non-core" to its business. At the same time, Embracer expects the retained operations to blend into other parts of the company and generate positive cash flows right away.
NASDAQ: TTWO
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What Gearbox means to Take-Two Interactive
I'm not saying that Take-Two Interactive is getting swindled here. The incoming Gearbox projects may not be profitable at the moment, but you're looking at a vibrant collection of valuable properties. And although it's far below the $12.7 billion Zynga buyout in 2022, this is the second-largest buyout in Take-Two's history. Management wouldn't strike a deal of this magnitude on a whim.
The core Borderlands games have sold more than 77 million copies so far, with another title under active development. The Duke Nukem series also comes with unit sales measured by the millions. Borderlands is wrapping up the production of big-screen movies starring audience magnets like Cate Blanchett, Kevin Hart, and Jack Black. Duke Nukem also had a movie in the works, but that film is just "under development" two years after finding a producer.
Fresh titles and supporting media should turn the Gearbox studio's frown upside down, and I expect the deal to make sense in the long run. If nothing else, a broader game portfolio could help Take-Two smooth out the lumpy financial territory between its massive Grand Theft Auto and Red Dead Redemption releases. Take-Two's deep pockets and long history of helpful studio buyouts suggest a profitable long-term outcome for this deal, too.
Embracer's strategic divestiture: A path to recovery?
And for Embracer shareholders like yours truly, the Gearbox sale marks the end to a quick burst of asset sales. The company spent about $5 billion on more than 40 studio acquisitions between 2017 and 2023, but an expected financing deal fell through last summer and the global inflation crisis reached Sweden, too. So Embracer is regrouping into a leaner, meaner business structure with a shorter payroll and fewer game brands.
I can only applaud the cash flow-boosting outcome of the Take-Two deal. Embracer's stock rose more than 20% this week as investors embraced the business simplification and its $460 million price tag. But shares are still changing hands at a rock-bottom 0.7 times sales or 0.5 times book value -- both metrics standing far below their three-year averages.
OTC: THQQ.F
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This could be a great time to buy Embracer stock
I can't promise that Embracer is getting back on its feet again, but I do like CEO Lars Wingefors' cost-cutting and efficiency moves. Leaders in the video game sector, such as Take-Two or Electronic Arts, command P/S and price-to-book ratios roughly 10 times Embracer's current readings. Just a fraction of that valuation would be a game-changing jump for Embracer investors, and I think the company deserves a robust valuation boost over time.
My own Embracer shares are deeply underwater so far. Yet, I have no intention of locking in these negative returns by selling any Embracer shares. I'm more inclined to double down on this low-cost position at bargain-bin stock prices. Follow my lead if you dare, but make sure to keep your Embracer bed on the smaller side. The potential upside is large, but the operating risks along the way are also substantial.
