Thanks, but no thanks, Take-Two Interactive (NASDAQ:TTWO). Electronic Arts (NASDAQ:ERTS) is ending buyout negotiations with the fast-growing video game publisher, after Take-Two agreed to open up its books -- and its playbook -- to secure an acceptable buyout offer.
Did Take-Two get too greedy? Is EA overestimating its ability to catch up to Activision Blizzard (NASDAQ:ATVID) with organic growth? We may never know those answers, but they aren't the questions that investors should be asking.
There are really just three things that need to be answered:
- Is Take-Two better on its own?
- Is EA better off without Take-Two?
- What happens next?
Is Take-Two better on its own?
A healthy buyout premium would have been a welcome near-term gain for Take-Two shareholders, but the company is growing nicely. In other words, it has enough in the tank to get there on its own, and beyond.
This isn't Microhoo revisited. Take-Two's fundamentals have actually improved since EA went public with its unsolicited offer for Take-Two at $25.74 a share. Grand Theft Auto IV broke records. The BioShock franchise has a sequel on the way, as well as Pirates of the Caribbean director Gore Verbinski on board to give the property the Hollywood theatrical treatment.
Earlier this month, the lingering awesomeness of GTA4 helped power another blowout quarterly report for Take-Two, but even more obscure titles like its Top Spin 3 tennis game and Sid Meier's Civilization Revolution sold briskly in driving results higher.
The strong showing was enough to make analysts ratchet up their expectations yet again. Over the past week alone, Wall Street's profit target for this fiscal year has gone to $2.10 a share from $1.83 a share.
In other words, EA was hoping to buy Take-Two for what is now just 12 times this year's bottom line. If you think that's cheap, pull up a current quote on Take-Two, divide it by $2.10 and see how much cheaper it is in reality.
This is why I believe that Take-Two will bounce back from this a lot quicker than Yahoo! (NASDAQ:YHOO) did after its prolonged courtship with Microsoft (NASDAQ:MSFT) came up empty.
Yes, next year will be different. The company's tax bite is likely to be more than the 13% rate it paid through the first three quarters of fiscal 2008 as it eats through its tax-loss carryforwards. Life after GTA4 will be a hard act to follow, too, though Mr. Softy is paying Take-Two $50 million for a pair of episodic installments that will be exclusive downloads for Xbox 360 players. Digital delivery is going to be a high-margin revenue stream for video game makers, and Take-Two should do well.
Analysts are looking for a profit of just $1.53 a share out of Take-Two in fiscal 2009. That is lower than this year's, but Take-Two is still trading at a lower earnings multiple than its peers.
Is EA better off without Take-Two?
EA doesn't need Take-Two. However, trading at 20 times next year's projected profitability, it could have paid $30 a share for Take-Two and the deal still would have added to earnings. In fact, with EA's logistical advantages and cutting out redundant elements, EA could have paid quite a bit more than that and the deal still wouldn't have diluted forward earnings.
There would have been other advantages, too. EA could have cornered the sports title market. More importantly, it would have had a say in release dates to make sure that Take-Two's marquee titles didn't interfere with EA's slate.
The only way that walking away makes sense for EA is if Take-Two were asking for some outlandish price.
What happens next?
Nothing really has to happen next. Take-Two shareholders can't blame executives, because those investors perpetually turned down EA's tender offers. The company can also point to its improving fundamentals.
The more likely scenario is that other companies may begin sniffing around. Activision has now had plenty of time to digest Blizzard. This is the kind of deal that would really tick EA off. A media mogul like MTV parent Viacom (NYSE:VIA) that is already tasting success with its Rock Band video game series would look great with Take-Two on its arm. Japan's Konami (NYSE:KNM) can also make a bigger stateside splash with Take-Two. Finally, let's not forget about Microsoft. If the company thinks enough of Take-Two as a shoehorn for Xbox 360 sales by paying for digital episodes, why not buy Take-Two outright and make the entire catalog exclusive to the Xbox?
In short, this may not be a golden day for Take-Two investors, but Mr. Market will eventually do the math. No sniffling, Take-Two. Go out there and play the field.
Other games to play:
