It took all of three days for Grand Theft Auto V to eclipse $1 billion in sales, a faster rate than any other video game or movie in history. Meanwhile, investors are likely shaking their heads at the fact that shares of Take-Two Interactive (NASDAQ:TTWO) aren't soaring into the stratosphere. While it's certainly frustrating to see a stock stagnate while appearing to have a blowout fiscal year in store, it's cause for investors to wonder why.
The vast success of Grand Theft Auto V in such a short time is truly an amazing feat. You'd think the stock would skyrocket on the news, but surprisingly, shares of Take-Two Interactive are actually down over the past month. Investors are likely at a loss for words, but all the while, an analysis of Take-Two Interactive underlying business and stock valuation reveals a plausible explanation.
What does the future hold?
Take-Two Interactive wasn't profitable in fiscal 2012 or fiscal 2013, which makes deriving a historical valuation difficult. The company also reported a loss in its fiscal 2014 first quarter. But, that doesn't mean we can't look ahead to what the future holds. Take-Two Chairman and Chief Executive Officer Strauss Zelnick predicted that fiscal 2014 was poised to be one of the company's best years ever, thanks entirely to Grand Theft Auto V.
At a price of $18 per share, Take-Two Interactive trades for just 7.5 times the midpoint of its expected fiscal 2014 earnings per share. You may be wondering why the stock doesn't take off, considering its low multiple and soon-to-be-announced blowout quarter.
What appears to be taking place is that the market is now looking to fiscal 2015 and beyond. Video games sales are notoriously volatile, and it doesn't look like investors are willing to pay a market multiple for a company's best year ever if future profits are set to decline. Should Take-Two Interactive's pipeline of future games fail to impress, today's valuation looks a lot less cheap than it seems.
Volatility of underlying fundamentals is widespread in the video game industry. Competitor Electronic Arts (NASDAQ:EA) recently released Madden 25, which sold more than a million units during its first seven days on store shelves, making it the highest-selling game in North America for the month of August. Investors have seemed to already forgotten this in light of Grand Theft Auto's accomplishments.
Meanwhile, like Take-Two, it's a constant struggle for EA to keep its head above water. EA is guiding investors to expect a net loss in fiscal 2014 in GAAP terms. This is despite the fact that EA's titles sold relatively well last year. EA has many popular titles in its library, including the FIFA and Madden franchises.
Ditto for Activision Blizzard (NASDAQ: ATVI), which had itself a banner 2012 thanks to its Call of Duty and World of Warcraft franchises. As a result, Activision Blizzard was strongly profitable last year, booking $1.01 in GAAP profits per share, a 10% increase versus the prior year.
Still, Activision Blizzard management was quick to warn investors that 2013 would be much more difficult. In the company's 2012 letter to shareholders, President and Chief Executive Officer Bobby Kotick wrote "We do not expect 2013 results at Activision Blizzard to resemble 2012. In 2012, many of our key franchises included a major release of all new content". This includes, but is not limited to, the first new Diablo release in over a decade. Activision Blizzard does not have any major new titles or expansion packs set for release in 2013, so investors are fairly warned.
More risk than meets the eye
It does appear Take-Two is cheap, but only if you focus on its very recent past. Whether Grand Theft Auto V is going to be a hit or not isn't the debate. It surely will be. What matters now, however, is whether the momentum can continue across the company's other titles and into future years. Take-Two is guiding investors to expect a big year, but like other video game developers, the future is a mystery.
Remember that the stock market is a forward-looking mechanism. The biggest gains in Take-Two's stock were realized before the release of Grand Theft Auto V. Normalizing earnings is an important piece of placing value on a stock, a task that is extremely difficult with video game publishers. It took six years for the newest version of Grand Theft Auto to hit store shelves; you can bet the market won't have the patience to wait another six years for Take-Two Interactive to turn a profit. Put simply, the financial windfall created by Grand Theft Auto V appears to be priced in, and investors who missed out on the gains would be wise to consider what the future holds before buying Take-Two Interactive now.
Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Activision Blizzard and Take-Two Interactive . The Motley Fool owns shares of Activision Blizzard. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.