Take-Two Interactive (NASDAQ:TTWO) has been involved in an issue that seems to be the rage with public entities these days. The financial fad in question is the odious practice of backdating options. How should the potential of Take-Two's long-term prospects be judged in light of this?
A news piece out on the AP gives the latest on Take-Two's options problem. It reports that the software publisher has discovered backdating events which occurred between April 1997 and August 2003 while a former CEO was at the helm. This means that the dates on some options were changed so as to benefit the holders of the certificates; by doing this, one alters the value of the options, which is the right to buy a specified amount of stock at a fixed price during a certain exercise period. Backdating essentially allows a holder to receive a lower strike price, and therefore a higher payday. It's actually legal so long as it is disclosed properly.
Unfortunately, Take-Two indicated in December that several years of previous financial reports can no longer be relied upon. The numbers will eventually have to be readjusted to see exactly what type of hit the publisher will take. This isn't something that shareholders want to hear, certainly.
Let me say that I don't believe it will destroy Take-Two; it does increase the risk, but it does not necessarily indicate a hopeless situation (in fact, the stock has rebounded from its lows of the year). Indeed, with new systems from Sony (NYSE:SNE), Microsoft (NASDAQ:MSFT), and Nintendo currently building out their user base, Take-Two needs to be considered more so from its brand equity and its software pipeline perspective. As Rick Munarriz once noted in a past piece on delisting notices, the time to panic is if you are dealing with a completely speculative issue, something on the order of a penny stock. I'd argue that Take-Two does not fit this bill. In time, the maker of Grand Theft Auto and Bully should recover from this and do well as it brings its hot franchises over to the new platforms.
None of this is to say that I believe the backdating scandals are meaningless. They aren't. The people responsible should be ashamed of themselves, and the SEC should do whatever it needs to do in order to reduce this activity; likewise, investors should always keep up with the latest financial data as it relates to the backdating. But Take-Two isn't the only publisher to have had options problems. My personal favorites in this space are Electronic Arts (NASDAQ:ERTS), THQ (NASDAQ:THQI), and a company I already own shares in, Activision (NASDAQ:ATVI). All three have had to investigate their practices related to options; THQ recently quantified its charges. The point is that I recognize value in this sector for companies that have great franchises in their portfolios and that have produced decent cash flow over the years. That's how I'm judging these stocks.
Again, I am not diminishing the significance of this issue. Should you be angry about backdating? You bet. Investors should pressure regulators and corporate boards to stop the useless practice (believe me, backdating, whether it be to attract or retain employees, is a dubious value enhancer). Take-Two is not my favorite video-game stock right now, but that's because I believe the three I singled out above have better software slates to exploit on the next-generation platforms. As bad as backdating is, investors must realize that it's pretty ubiquitous at the moment, and that an investment shouldn't be jettisoned or avoided on that reason alone.
Check out some more Takes on backdating and video games:
Electronic Arts and Activision are Motley Fool Stock Advisor recommendations. To see why, take a free 30-day trial today.
Microsoft is an Inside Value pick.
Fool contributor Steven Mallas owns shares of Activision. As of this writing, he was ranked 1,968 out of 20,592 investors in the Motley Fool CAPS system. Don't know what CAPS is? Check it out. The Fool has a disclosure policy.
