Take Two Interactive (TTWO) at Risk Despite High Scoring Earnings

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Take Two Interactive (NASDAQ: TTWO), the video game publisher behind such successful franchises as Grand Theft Auto and Bioshock, seems to be weathering the steep decline in video game sales. The company closed its third quarter yesterday, with Take Two earnings posting a return to profitability.

That’s thanks in large part to the success of Red Dead Redemption, a gritty Western that released at the end of May. In the TTWO earnings report, Take Two posted $354 million in sales with a net income of $6 million. Certainly a more promising third quarter than in 2009, when the company reported $94 million in sales and a loss of $56 million. Now, with recent release Mafia II seeing strong initial sales and a holiday line up that includes a new entry in the popular franchise Civilization, it might seem like the time is ripe to purchase Take Two stock again. Shares are up by almost +10% today, at $9.66 per share, and +15% in the last five trading days.

Not so fast. Even though TTWO has proven that it can, as CEO Ben Feder says, “be profitable in a fiscal year without a major multi-platform Grand Theft Auto release,” the publisher is nonetheless relying on releases developed by Rockstar Games. Red Dead Redemption is at heart Grand Theft Auto with horses instead of cars. Also, there’s no question about why Take Two delayed the release of Rockstar’s LA Noire just two days before announcing their third quarter earnings. That game, a money sink now entering its fifth year of development, is just Grand Theft Auto in the ’50s. Take Two’s slate of major console games, and the massive budgets needed to develop them, are killing the company while the stray releases of Rockstar made titles keep them afloat. That means the recent gains in TTWO stock may be short lived.

Even with Red Dead Redemption though, Take Two is a shadow of its former self. In June of 2008, just months after the release of Grand Theft Auto IV and an attempted hostile takeover bid from Electronic Arts (NASDAQ: ERTS), TTWO was selling for just under $28 per share. When market crashed in the fall of 2008, TTWO plummeted with it, with shares selling at an all time low of $6.21 at the beginning of February 2009. They have slowly recovered in the past twelve months, but the past two years are hardly the first time that Take Two has seen its value fluctuate wildly. While nowhere near as steep a decline as the one in early 2009, the publisher saw share prices plummet from $28.10 in June of 2005 to just over $10 a year later.

What happened then? In the spring of 2005, Take Two had just published Grand Theft Auto: San Andreas. In 2006, there was no Grand Theft Auto-style game from Rockstar at all.

While the recession clearly impacted Take Two’s fortunes over the past eighteen months, just as its hit Electronic Arts, Activision Blizzard (NASDAQ: ATVI), THQ (NASDAQ: THQ), Ubisoft and every other major video game publisher, Take Two has been stuck in this vicious cycle ever since Grand Theft Auto III released in the summer of 2001 and went on to become a cultural touchstone of the last decade. There have been other factors to hurt their earning potential over the years, particularly the loss of the NFL license of their line of 2K Sports games to Electronic Arts exclusivity agreement, but nothing more than their reliance on Rockstar’s venerated franchise. The return to profitability brought by Red Dead Redemption is a promising start for Take Two, one that should continue provided LA Noire releases on time in the spring of 2011. As many analysts say, it’s by no means time to sell. Without an official time frame for the release of Grand Theft Auto V, though, it’s definitely not time to buy.

It’s impossible to expect Take Two to create “another Grand Theft Auto” to supplement these periods without major product from Rockstar Games. Demanding a company find new revenue by producing zeitgeist defining software is just idiotic. There are ways, however, for Take Two to create a healthier, more stable company whose growth potential isn’t reliant on a single development studio. The best thing Take Two can do right now is to aggressively seek out new talent, small independent studios capable of using licensed technology like Epic’s Unreal Engine or others to quickly turn around a compelling home console product. Easier said than done, but other publishers are already seeing returns on retail releases with smaller budgets. THQ’s Metro 2033, the debut from small Ukrainian studio 4A Games, was finished within one year of development and while it has hardly sold in Grand Theft Auto numbers, it has nonetheless proven profitable.

If Take Two can learn this lesson, if they can stop resting all of their potential on games that take years and million of dollars to develop, then they can finally stop having to explain to investors why the company’s stock plummets by over 50% every couple of years.

As of this writing, Anthony Agnello did not own a position in any of the stocks named here.

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Article printed from InvestorPlace Media, https://investorplace.com/2010/09/take-two-interactive-ttwo-risk-despite-high-scoring-earnings/.

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