TTWO
June 14, 2007
Research Associate: Priti Dhanuka,M.Fin.,.
Editor: Jyoti Lakhotia, M.Fin.
Sr. Ed.: Ian Madsen, CFA; imadsen@; 1-800-767-3771 x 9417
111 N. Canal Street, Suite 1101 ( Chicago, IL 60606
| Take-Two Interactive Software Inc. (TTWO -NASDAQ) | $20.98 |
Note: This report contains substantially new material. Subsequent reports will have changes highlighted.
Reason for Report: 2Q07 Results. (Prev.: News Update, May 30)
Recent News-Summary
June 11: TTWO announced financial results for 2Q07.
May 22: TTWO announced Carnival Games will be launched this summer exclusively for Nintendo's Wii.
April 10: TTWO announced The NASDAQ Stock Market has notified the company that it has regained compliance with NASDAQ's listing requirements.
March 06: TTWO announced Grand Theft Auto: Vice City Stories for the PlayStation 2 is available in North American retail stores.
February 28: TTWO announced the completion of its restatement of financial statements.
Overview
|Key Positive Arguments |Key Negative Arguments |
|The company has diversified its title portfolio away from mega-franchise |The sale of video games is highly seasonal, and is based on mega-hit |
|Grand Theft Auto, with internal development of Max Payne and the |titles. |
|acquisition of popular Duke Nukem and Civilization. |Delay in the launch of new products may lead to lower software sales. |
|Third-party exclusive agreements with Major League Baseball (MLB) and the|Piracy is an issue in international markets. |
|National Basketball Association (NBA), are high-cost agreements, but may |The company is sensitive to changes in consumer sentiment, GDP and |
|provide a recurring revenue stream. |disposable income. |
|TTWO principally aims at developing highly successful cutting edge |Major console transition cycle is about to begin, which may increase the |
|proprietary intellectual properties, establishing well-known product |risk in the gamer sector. |
|brands with significant potential for sequels, and focusing on delivering|Increased concern about management diligence and visibility, is an area |
|games that are attractive to a broad customer base. |of concern for investors. |
|Restructuring activities will help in substantial cost savings on an |The criminal investigation will certainly draw management focus away from|
|ongoing basis. |game development, and hence, analysts believe it will increase execution |
| |risk. |
Headquartered in New York City, NY, Take-Two Interactive Software Inc. (TTWO) is an integrated global developer, marketer, distributor, and publisher of interactive entertainment software games and accessories for the PC console (mainly Sony PlayStation family of entertainment systems, Microsoft Xbox video game and entertainment systems and Nintendo GameCube, and Game Boy Advance). TTWO is best known for its record breaking Grand Theft Auto (GTA) franchise. Other popular franchises include Max Payne, Duke Nukem, Mafia, Railroad Tycoon, and Midnight Club titles. Through its JoyTech subsidiary, TTWO also manufactures and markets video game accessories in Europe, North America and the Asia Pacific. For more information on the company, please visit its website at
Note: TTWO’s Fiscal Year ends on October 31.
Recent News-Details
On June 11, 2007, TTWO announced financial results for 2Q07. In 2Q07, revenue was $205.4 million, and reported loss per share was $0.71. The results continued to be adversely impacted by the video game industry's transition from current generation to next-generation platforms.
On May 22, 2007, TTWO announced Carnival Games will be launched this summer exclusively for Nintendo's Wii. The title is being developed by Cat Daddy Games, the Take-Two studio that created the popular "Deal or No Deal" PC game.
On April 10, 2007, TTWO announced The NASDAQ Stock Market has notified the company that it has regained compliance with NASDAQ's listing requirements. As a result, Take-Two's common stock will continue to be listed on The NASDAQ Global Select Market.
On March 06, 2007, TTWO announced Grand Theft Auto: Vice City Stories for the PlayStation 2 is available in North American retail stores. Developed by Rockstar Leeds in conjunction with series creator Rockstar North, Grand Theft Auto: Vice City Stories is available for the suggested retail price of $19.99, and is rated "M" for Mature.
On February 28, 2007, TTWO announced the completion of its restatement of financial statements to reflect the recognition of stock-based compensation expense and tax effects resulting from the previously announced investigation of past stock-based compensation awards. Take-Two's restated financial statements are included in the company's Annual Report on Form 10-K for the fiscal year ended October 31, 2006, filed with the Securities and Exchange Commission.
Revenue
In 2Q07, the company reported net revenue of $205.4 million (in line with the Zacks Digest average), versus $265.1 million in 2Q06. The company’s results surpassed the consensus estimate of $204.0 million.
According to management, the decrease in net revenue primarily reflected the significant sales contributed by The Elder Scrolls IV: Oblivion in the year-ago period, partially offset in the reported quarter by strong sales of Grand Theft Auto titles and Major League Baseball 2K7 in comparison to the same franchises in the prior period. Both Grand Theft Auto: Vice City Stories and Major League Baseball 2K7 sold over 1 million units each during the current quarter, according to analysts.
|Revenue - FY Oct 31 |
|Positive |20.0% |
|Neutral |60.0% |
|Negative |20.0% |
|Avg. Target Price |$18.40[pic] |
|Analysts with Targets/Total |10/15 |
Please refer to the Zacks Research Digest spreadsheet on TTWO for further details on valuation.
Capital Structure/Solvency/Cash Flow/Governance/Other
Balance Sheet
At the end of the reported quarter, the company’s balance sheet was in good shape. Take-Two has cash and cash equivalents of $109.0 million or $1.51 per share, and no debt. DSOs were 31 days, less than the prior year quarter’s 44 days, and were within a reasonable range. Reserve at the end of 2Q07 as a percentage of gross A/R, increased from 40.2% to 42.9%. According to analysts, current reserve levels are adequate to fully protect the company from the risk of future product returns or price protection. Inventory at the end of the reported quarter, was $80.0 million versus $92.0 million in 2Q06, down 13.0% y/y, primarily due to TTWO’s continued focus on managing Jack’s inventory levels. Accounts receivables were $70.0 million at the end of April quarter.
Change in Corporate Governance
As expected by the Street, a group of investors owning 46.0% of TTWO’s shares outstanding, successfully ousted the company’s Board of Directors on March 29, 2007. The slate of directors consists of Strauss Zelnick, Ben Feder, Jon J. Moses, Michael Dornemann, Michael James Sheresky and John Levy, who is an incumbent independent director of TTWO. Grover C Brown, an independent director, was also elected as a director by the new Board. Strauss Zelnick is the new Chairman of TTWO. Additionally, Bed Feder, a partner of ZelnickMedia since 2001, has been named as the new acting CEO. The Board stated it is working with Paul Eibeler, former CEO and President of TTWO, to ensure a smooth transition.
On June 11, 2007, after a comprehensive business review, Take-Two's new management team announced the first of a series of initiatives to revitalize the company. These initiatives are designed to enhance the efficiency of the organizational structure, support a highly creative and financially disciplined product development process, increase operating margins and improve the company's productivity and cost-effectiveness, according to analysts. Management commented the company’s evaluation process is continuing, and expects to report on progress in additional areas in the future.
Take-Two's restructuring plan to date consists primarily of the following key elements:
• Restructure Take-Two's international operations to consolidate and align the marketing, sales and operational functions according to business discipline rather than geography, to create a more efficient and responsive international organization.
• Realign label and studio administrative functions to report to the respective departments at the corporate level, thereby ensuring increased control and accountability.
• Consolidate the management, marketing and business development operations of the 2K and 2K Sports labels on the West Coast to improve access to resources, work more closely with the sports development teams, and provide a centralized organization to increase efficiency and better support the growth of these labels.
• Consolidate third-party PC distribution into North American sales.
Take-Two expects to reduce fixed overhead from these actions by approximately $25.0 million, which should be realized by the end of fiscal 2008 on an annualized run-rate basis. The company anticipates approximately $15.0 million of charges related to the restructuring, excluding any asset impairments, through fiscal 2008, with approximately half of the charges expected in fiscal 2007.
Amended incentive stock plan and new auditor approved
A proposal to amend TTWO's incentive stock plan to increase the number of shares of common stock reserved for issuance under the plan by 2 million shares, was approved. Additionally, a proposal to ratify the appointment of Ernst & Young LLP as the company's auditor for FY07, was also approved. A shareholder proposal requesting that the Board of Directors's Compensation Committee should include social responsibility, as well as corporate governance and financial criteria in setting executive compensation, was, however, defeated.
New Appointments
On June 11, 2007, Take-Two also announced Lainie Goldstein, interim Chief Financial Officer, has been named for the CFO position.
On April 18, 2007, TTWO announced the appointment of Robert A. Bowman to the company's Board of Directors. The company also appointed current director J Moses to serve on Take-Two's Audit Committee.
The news followed the resignation of TTWO’s Chief Financial Officer, Karl Winters, on April 09, 2007.
Potentially Severe Problems
None other than those discussed in other sections of this report.
Long-Term Growth
The average long-term growth rate for TTWO is 16.1%.
TTWO has pursued a growth strategy of capitalizing on the widespread market acceptance of video game consoles, as well as the growing popularity of innovative action games that appeal to mature audiences. TTWO has established a portfolio of successful proprietary software content for the major hardware platforms. The company expects to continue to be the leader in the mature, action product category by leveraging its existing franchises, and developing new brands.
TTWO has diversified its product offerings by capitalizing on significant growth opportunities in the market for sports, and other licensed action and strategy titles. 2K Games has made strategic acquisitions of leading sports development studios, and entered into license agreements with major sports leagues to develop sports titles. According to analysts, however, diversification strategies like sports, have not yet proven profitable. TTWO has also entered into license agreements for several popular entertainment properties, acquired well-known intellectual property rights, and entered into distribution and publishing arrangements for major action and strategy PC titles.
One firm (BMO Capital) believes the long-term outlook remains bright, despite lingering near-term challenges.
Upcoming Events
Products Pipeline
In the second half of fiscal 2007, 2K and 2K Sports are expected to release a variety of titles across multiple platforms, including BioShock for Xbox 360 and Games for Windows; The BIGS, an arcade style Major League Baseball title on multiple current and next-generation platforms including Wii; College Hoops 2K7 for PLAYSTATION 3; The Darkness; Fantastic 4: Rise of the Silver Surfer including Wii; The Elder Scrolls IV; All Pro Football 2K8 for next-generation consoles; as well as NHL 2K8 and NBA 2K8 across multiple current and next-generation platforms.
Global Star Software is expected to publish a PC extension of its popular Deal or No Deal game, and will continue its focus on video games, incorporating popular licensed and children's entertainment properties, with several titles planned for Wii later in 2007.
In 2008, Rockstar will introduce exclusive episodic content downloads for Grand Theft Auto IV. Rockstar will also release new titles based on its proprietary brands, including L.A. Noire developed by Team Bondi. In addition to the licensed 2K Sports lineup, starting in 2008, 2K will also have new content based on its Civilization franchise and other products, including both original intellectual property and third-party titles. The upcoming 2K titles under multiple platforms include Major League Baseball 2KB, NBA 2K9 and NHL 2K9.
On September 11, 2007, the company is expected to announce its 3Q07 results.
Individual Analyst Opinions
POSITIVE RATINGS
Wall Street Strategies – Buy ($23.00 target price) - 06/12/07: The firm upgraded the rating from Hold to Buy, and increased the target price from $21.00 to $23.00 based on positive outlook.
J.P. Morgan – Overweight (no target price) - 06/12/07. INVESTMENT SUMMARY: The firm continues to view the stock as attractive, attributed to the launch of Grand Theft Auto IV in October.
NEUTRAL RATINGS
BMO Capital – Market perform ($20.00 target price) – 06/12/07. INVESTMENT SUMMARY: Although Take-Two’s business should improve in the next 12-18 months as key investments made in games for the new consoles come to the market, the firm believes investors should remain on the sidelines. It opines significant catalysts for the company are led by the upcoming launch of Grand Theft Auto IV, with other catalysts including a solid release schedule for the balance of the year and an improving performance from the company’s sports category. However, countering these positive catalysts is uncertainty surrounding the ongoing litigation and how management endeavors affect the release slate, quality of games, and key employees. Until better clarity on the new management’s plans for the company and its assets is visible, the shares of TTWO are likely to remain range bound between the high teens and the low 20s.
Kaufman Bros. – Hold ($18.00 target price) – 06/12/07: The firm upgraded the rating from Sell to Hold based on the company’s stabilized fundamentals. INVESTMENT SUMMARY: The firm expects positive momentum over the next few months in terms of new product introductions, and believes current valuations reflect an aggressive outlook and the potential for operating leverage in 2008 and 2009 that will be difficult to achieve.
Needham – Hold (No target price): 06/12/07. INVESTMENT SUMMARY: The firm believes new management will likely change the corporate strategy, and recommends the investors to hold the shares until the core strategy is clear. It foresees the outperformance of the shares as an unlikely event until new management sets forth their plan, which is expected to take 3-6 months.
Pacific Crest – Sector Perform (No target price): 06/12/07. INVESTMENT SUMMARY: The company’s dependence on the Grand Theft Auto franchise, mixed success in new-title development and spotty financial execution led the firm to give a Sector Perform rating. Despite being attractively valued relative to its peers, Take-Two continues to struggle with poor execution and product delays, which prevent the firm from being positive on its shares.
AG Edwards – Hold (No target price): 06/12/07. INVESTMENT SUMMARY: The firm remains cautious on Take-Two’s prospect considering the reliance on the Grand Theft Auto franchise and the company has been unable to leverage diversification efforts into increased profitability. The company’s continual missteps, including several investigations and class-action lawsuits, also provided overhang to the stock.
B. of America – Neutral ($19.00 target price) – 06/12/07. INVESTMENT SUMMARY: The firm remains cautious on Take-Two shares due to questions surrounding its management and outstanding regulatory issues. Additionally, it prefers to remain on the sidelines until there is greater visibility into its FY08 line-up of non-GTA titles. According to the firm, shares of TTWO reflect expected overhead cost reductions, and the expected announced release of Grand Theft Auto IV in October 2007. The firm believes these will drive top-line growth of 17.5%, and allow the company to return to profitability with fiscal year 2008 EPS of $0.70.
CIBC – Sector Perform (no target price) – 06/11/07. INVESTMENT SUMMARY: Based on visibility issues of TTWO and disappointing FY07 guidance, the firm prefers to remain on the sidelines, and maintains its Sector Perform rating.
Piper Jaffray – Market Perform ($18.00 target price): 06/12/07: The firm reiterated a Market Perform rating, but decreased the target price from $20.00 to $18.00 based on reduced earnings expectations. INVESTMENT SUMMARY: Though a new management change was a welcome change in the organizational mode of the company, the firm believes Take-Two has deep-rooted structural issues that will make any turnaround a difficult and lengthy project. Areas that need to be addressed include alignment of product development groups, realignment of compensation plans that can benefit employees-stockholders-earnings, cultural change; reduction of off-balance sheet financing and development of new IP. In its view, significant realignment of the company could take more than two years and long-term earnings growth remains uncertain.
NEGATIVE RATINGS
Sterne, Agee & Leach – Sell ($12.00 target price): 06/12/07. INVESTMENT SUMARY: The firm maintained a Sell rating. According to the firm, expensive contracts, lack of managerial expertise and an uphill battle on gaining credibility with the Street are some of the issues that new management will have to immediately deal with.
Wedbush – Sell ($12.00 target price) – 06/12/07: The firm maintained a Sell rating and the target price of $12.00. INVESTMENT SUMMARY: The firm believes the company’s fundamentals are overvalued, and therefore, recommends investors to sell the stock.
Bear Stearns – Under perform ($13.00 target price) – 06/12/07 – The firm reiterated an Under perform rating and a target price of $13.00. INVESTMENT SUMMARY: The firm remains optimistic about the revenue growth, but believes profitability will be constrained by rising costs. It further believes obstacles to improve the economics of key franchises still remain.
DROPPED COVERAGE
American Technology – 03/26/07. The firm has terminated the research coverage of the stock based on analyst departure.
Citigroup – 03/15/07. The firm ceased the coverage.
Prudential – 06/11/07. The firm dropped the coverage on TTWO due to the departure of the analyst from the firm.
Research Associate: Priti Dhanuka
Reviewed by:
Copy Editor: Oindrila Banerjee
Content Ed.: Jyoti Lakhotia
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Zacks Research Digest
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