Over the last few years, the video game industry has struggled as the widespread decline in hardware sales has led to an even steeper decline in software sales . The slowdown in hardware is due mainly to the fact that the current generation of game consoles has lasted longer than usual; 7-8 years, versus the prior generation's life cycle of 5-6 years. With Microsoft and Sony(SONY -1.67%) set to release their next-generation gaming consoles in a few months, dubbed the Xbox One and Playstation 4, respectively, the entire industry seems ripe for a turnaround.
Not surprisingly, the share prices of most major video game publishers have recovered nicely from multi-year lows, and all appear to be viable plays on the impending acceleration in new hardware sales. However, Take-Two Interactive (TTWO -0.92%) has lagged significantly behind the other game publishers in terms of stock appreciation, and currently offers investors the most upside.
Growth catalysts
It's hard not to like a $1.48 billion market cap company that can generate nearly $1 billion in a single day. That is exactly what Take-Two managed to do with its recent multi-platform release of Grand Theft Auto 5, which generated a staggering $800 million in its first day and hit the $1 billion mark just two days later . Keep in mind that the $1 billion threshold takes even major motion picture releases like the recent blockbuster Iron Man 3 months to cross. In comparison to other popular video games, Take-Two's epic crime saga is leading all others. It even beat out Activision-Blizzard's (NASDAQ: ATVI) perennial Call of Duty series, whose most-recent entry Black Ops 2 previously held the launch day record with $500 million in sales.
In addition to its current success, the company's modest market cap also belies Take-Two's growth potential. As the next generation approaches I expect to see an announcement for GTA 5 on Xbox One and Playstation 4 as well as PC, which should make the world's fastest-growing entertainment property even more successful. The simple fact is that at the end of the next quarter, when factoring in the $1 billion-plus in revenue GTA 5 will end up having generated, Take-Two could very well have more cash on its balance sheet than the company's entire market cap valuation.
It is also important that Take-Two is primed for growth outside of the Grand Theft Auto series. Extremely promising is the increasing likelihood of a sequel to the company's popular Western-themed series Red Dead Redemption, as well as further installments in the BioShock and Borderlands franchises. All three series were recently listed by Take-Two management as "permanent franchises," indicating that sequels to each are inbound. The latter two franchises showed admirable strength in sales as of late, despite a drastic decline in hardware purchases. When hardware sales begin to accelerate with the launch of next-generation consoles, Take-Two's popular series' stand to perform even better.
Furthermore, since many of the company's franchises have immense brand-name recognition among consumers, the company appears to be a viable takeover candidate considering its relatively small market valuation. With $576.05 million in debt and $646.32 million in cash , which doesn't even factor in the immense revenue that GTA 5 is currently generating, the company's balance sheet is relatively healthy. Additionally, a high-quality but somewhat streaky business like Take-Two's blockbuster-driven model would seem a perfect fit for a larger company like Activision-Blizzard to acquire and assimilate into a more stable game lineup.
Risks
While Take-Two has almost nothing but high-quality brand names in its game lineup, the company struggles with revenue and earnings consistency. The lengthy time period it takes to churn out blockbuster hits (GTA 5 required five years for development ) is what makes Take-Two somewhat volatile and unpredictable. A single delay in one of the company's signature blockbuster games can defer hundreds of millions in revenue from one quarter to another.
Companies like the aforementioned Activision-Blizzard and even Electronic Arts (EA -0.77%), which has very effectively taken advantage of its popular franchises like Madden, FIFA, and Need For Speed by creating yearly installments of each series, are what Take-Two should strive to be more like. The good news is that management has indicated it is already on the path to doing so by attempting to establish its core gaming brands as permanent fixtures in the gaming community. Doing so would entail delivering more games to consumers at a quicker pace.
Conclusion
Both Electronic Arts and Activision-Blizzard appear more stable with regards to forward-looking revenue and EPS growth. The former is projected to increase revenue 6% and earnings per share 19.7% in 2014, while the latter is projected to grow revenue 8.6% and EPS 43.8%. This growth stability is a direct result of the effective strategies that both Electronic Arts and Activision-Blizzard have adopted with regard to their game libraries. Yearly installments of the former's Madden and Fifa sports series and the latter's Call of Duty series have provided both companies with recurring streams of revenue, which subsequently decreases the risk for investors.
On the other hand, Take-Two is projected to experience a massive slowdown in both revenue and EPS next year as the company does without a major GTA release. However, shares of Take-Two still seem like a no-brainer at current levels. The company is pulling in massive amounts of cash thanks to Grand Theft Auto 5, and that will soon be added to its already sizable stockpile of $646.32 million (which is already equal to 43.67% of the company's total market capitalization). If management expands the success of GTA 5 into the next generation and opens up its considerable lineup of blockbuster series to Microsoft and Sony's incoming consoles, Take-Two is a steal at current valuation levels. It should reward shareholders handsomely in the long-term.
