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Are Executives At Rockstar Getting Half The Profits At Take Two Interactive?

By Perry Rod, Published: December 16th, 2013 12:45 PM CST

In 2008, after the successful launch of their hit title, Grand Theft Auto 4, Take-Two (TTWO) Interactive's (TTWO) CEO Strauss Zelnick said that they had secured an employment agreement with key Rockstar talent. The deal was an incentive program "primarily based on a profit sharing arrangement." At the time, there were reports that CEO Robert Kotick of Activision was trying to get Rockstar's talent to jump ship. The Rockstar executives also took Zelnick's side against Electronic Arts' (ERTS) attempted takeover. So what did it cost Zelnick and Take Two to make these deals?

The answer appears to be now hidden in Take Two's most recent balance sheet. Accounts Payable rose by 262 million sequentially. Accrued Expenses rose by 100 million sequentially. These are unusually large numbers that at first can easily go unnoticed among the larger highlights: most prominently, 1.15 billion in deferred revenue and 302 million in deferred cost of goods sold from Grand Theft Auto 5, and an overall 975 million increase in Accounts Receivable.

But the real question investors should ask is how much is Rockstar making in the "profit sharing agreement". Here is one way to figure it out:

Take Two's Non-GAAP net revenues were 1.289 billion. Yet it's Non-GAAP gross profit was only 497 million. The gross profit was only 38%? Where did 792 million go? Where are the details of these Non-GAAP expenses? Well, because they are Non-GAAP, they are not disclosed. We know that 1.15 billion of that 1.289 billion total revenue (89%) is from one title: Grand Theft Auto 5. We know that 302 million of that 1.15 billion (26%) is cost of goods sold from GTA5. That still leaves us with 490 million of unaccounted pre-gross profit expenses. The only other noteworthy change on the balance sheet is 71 million taken off the software development line. That still leaves a giant number unaccounted for in the non-GAAP figures.

And now we're back to seeing those jumps in Accounts Payable and Accrued Expenses by a total of 362 million. What can they possibly be besides a lucrative "profit sharing arrangement" between Rockstar employees and tycoon Carl Icahn's installed puppet government at Take Two, who were threatened with a hostile takeover in 2008 and the threat of Rockstar executives leaving and sinking the company? While investors try and figure out the meaning of the giant gaps in the non-GAAP figures, insider Carl Icahn meanwhile just recently sold his entire position and abandoned the Board of Directors.

So what exactly is the "profit sharing agreement" between Rockstar employees and Take Two? Judging by the striking similarity between the 490 million of unaccounted Non-GAAP pre-gross profit expenses and the 497 million of Non-GAAP gross profit, it appears that half of the profits of GTA5 are going into the profit sharing agreement.

Investors and analysts have mostly ignored this issue and assumed a flood of free cash will soon be hitting the balance sheet. Yet, 362 million in liabilities have quietly shown up in payables and expenses, half of the gross profits are missing, and insider Carl Icahn exited his entire position.

One more important note. Take Two management specifically refused to give guidance on Take Two's future cash position at their recent conference call despite giving earnings guidance, suggesting they may be well aware that analysts and investors are overestimating their future cash position by as much as hundreds of millions. Few are assuming that executives of a wholly owned internal studio could get such a lucrative deal. But this isn't any internal studio. It is the aptly named Rockstar, whose UK based management team has far outlasted prior management teams at Take Two Interactive.

Take Two's investor relations were contacted multiple times regarding this article and have not responded.

Disclosure: author has opened a short position in Take Two Interactive

Related: TTWO

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