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Hopes and Dreams Continue at Take Two Interactive Software

By Perry Rod, Published: December 28th, 2009 10:11 AM CST

He said in 1993 it was always his dream to run his own media company.  Strauss Zelnick left a nice job at Fox and took a big risk to work on a start-up video game company, Crystal Dynamics.  That risk turned out to be a failure for him at the time but provided him with a resume entry that would prove to be invaluable.

When Carl Icahn bought into Take Two (NASDAQ:TTWO) Interactive in late 2006, he ‘floated’ the idea of a management change and was very likely the man who suggested Strauss Zelnick.  Only a year earlier, he had partnered with Zelnick in a proxy campaign which won them both board seats at Blockbuster.  Zelnick would later put another Blockbuster board member, Robert Bowman, on Take Two’s board of directors.

As Chairman of Take Two and one month prior to the launch of megahit title Grand Theft Auto 4, Mr. Zelnick received and rejected a $26 buyout offer from Electronic Arts (ERTS) in February 2008 and appeared to immediately scramble to give himself lucrative stock options and a longer term contract with Take Two.  EA would later become disinterested in the deal, sending the stock falling back to the mid teens.

That same holiday, the financial crisis hit the industry hard and Grand Theft Auto (GTA) catalog sales disappointed.  More importantly, Take Two’s second best selling franchise, Midnight Club surprisingly bombed at retail.  The stock shockingly fell under $8 only ten months after the EA offer, even though the company was still cash rich.  It hit a low of $5.62 in March.

2009 was no year of recovery for Take Two as extension products of GTA failed, one after another.  Investors had hoped for a quicker follow up to GTA, but it wasn’t to come and as of today, there is no release date in sight.  Take Two also delayed one game after another and recently announced that it no longer expected a profit even through 2010.  On top of that, they would likely be cash flow negative and now carry more debt than cash, according to their recent conference call.


From late 2008 to today, Take Two has been surrounded by publishers cutting studios and making drastic reductions in headcount.  Yet, Mr. Zelnick has remained steadfast, persisting with expensive development for medium success franchises such as Bully, Spec Ops, Red Dead Revolver and high risk new intellectual property like LA Noire and Agent.

Many analysts have long suggested that Mr. Zelnick should be quick to want to sell the company.  But would a seller of a company be taking these long term expensive gambles on unproven properties, or would a seller cut them down and look to focus on low risk properties to make the company’s value more apparent to prospective buyers?  The answer should be obvious.  Mr. Zelnick has not been positioning the company for a buyout.

So has his fellow Blockbuster dissident board member, Mr. Icahn, bought shares to set him straight?


On a non-GAAP basis (excluding dilutive stock based compensation), Take Two is now forecasting that they will be unprofitable for a fourth year out of five fiscal years.  In fiscal year 2006, they lost $1.18, 2007 they lost $1.13, 2008 they gained $2.08, 2009 they lost $1.12, and now they project a loss of $0.58 in 2010.  That’s an average loss of $0.39.  Shares have also been diluted by over 15% since 2006.  If 2011 were a successful repeat of 2008 for Take Two, the company’s six year non-GAAP earnings average would be .04 (untaxed) profit per year.

The company now carries more debt than cash and says it will be cash flow negative in 2010.  It blames some of its problems on the deal with Major League Baseball, which expires in 2012.  Beyond that, it’s just a difficult time to be a video game publisher.  Electronic Arts shares, for example, have dropped 66% since their buyout offer for Take Two.  Take Two is actually outperforming them on that basis.  THQ has lost about 80% of its value since then.

Excluding low margin distribution business revenue, which was just sold off for a measly 43 million, in the last 4 completed fiscal years Take Two has averaged publishing revenues of 843 million per year and has yet to make drastic cuts in its business, similar to what other publishers have done in the last year.  An acquirer would likely only be interested in around 500 million of Take Two’s annual revenue and look to make deeper cuts.

The company also carries a net operating loss beneficial for tax purposes, but not nearly as beneficial to a buyer given annual IRS restrictions.  In fact, a buyer would lose the significant benefit of Take Two’s tax loss carry forward for the next GTA blockbuster, since the IRS places hefty annual limitations to NOLs after a buyout.  Take Two was not a taxpayer in 2008 in the year it released GTA4 and earned $2.08 in non-GAAP earnings, for example.  It will likely not be a taxpayer at least through 2011.  A buyer, however, would end up paying taxes on new GTA profits.

Take Two also signed an unusual contract with Rockstar executives through 2012, allowing them the freedom to work on their own wholly owned intellectual property with Take Two’s support.  Would a potential acquirer be interested in that kind of sweetheart arrangement?

What looks to be most valuable within Take Two are their intellectual properties.  But the industry has turned around to a point where it has become questionable whether or not once crucial franchises such as Midnight Club and Max Payne have any significant value at all anymore.  We are mostly left trying to place a value on GTA alone as a basis for valuation.  Activision bought the maker of Guitar Hero for 100 million in 2006.  They bought the Call of Duty maker for 5 million in 2003.  Would they suddenly buy the maker of GTA for well over half a billion, after suggesting on several occasions that they are uninterested?  Would Electronic Arts come back to the table when they have said they are pursuing a new strategy?


The last time some powerful traders bought into Take Two was in early 2007, when they profited and bailed out before Mr. Zelnick and his crew even got started.  Mr. Icahn was actually the first among the group to take his profits.  He was apparently looking to make money on a trade, not a long term investment.  Mr. Icahn and Mr. Zelnick sit next to each other on Blockbuster’s board and it seems questionable that they would suddenly become enemies or need to arrange discussions, as suggested in Mr. Icahn's SEC filings.  Mr. Zelnick seems to love his job as Chairman of a media company and Mr. Icahn loves his job as a mover and shaker.  He comes in, others buy, speculation swirls, rumors fly.  Mr. Icahn is already up on his trade.

Take Two’s recent sale of its distribution business, Jack of All Games, does suddenly raise some eyebrows, however.  Why now?  Analysts have looked for the sale to happen for years.  When one throws the timing of the recent Icahn purchase into the mix, it raises some reasonable speculation.

But the biggest hurdle for a potential acquirer of Take Two will likely not end up being Mr. Zelnick.  The biggest hurdle would not have been the Jack of All games distribution business either.  The biggest hurdle is Rockstar Games, Take Two’s subsidiary.  Executives there seem to tell Take Two what to do, not the other way around.  They have a reputation of taking risks and continue to do so, putting resources into upcoming questionable titles such as L.A. Noire, Bully 2, and Sony Playstation 3 exclusive Agent.  Other publishers would have likely cut the cord on these yet Rockstar seems to continue having the freedom to take big risks.  Would another publisher be as tolerant to the creative risk-takers at Rockstar?  Would they have a choice?

Take Two continues to provide as much drama as a publicly traded company as they do from their entertainment products.  Investors will just have to continue to hope that these guys are not playing games at their expense.


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