The Reed Report Company Spotlight Take Two Interactive 11/29/2016
Business Overview Take Two Interactive Software (Ticker: TTWO) ( Take Two ) is a leading developer, publisher and marketer of interactive entertainment (video games) for consumers around the world. They develop and publish products through their two wholly-owned labels Rockstar Games and 2K. Their products are currently designed for console gaming systems such as the Sony Computer Entertainment, Inc. ( Sony ) PlayStation 4 ( PS4 ) and PlayStation 3 ( PS3 ), Microsoft Corporation ( Microsoft ) Xbox One ( Xbox One ) and Xbox 360 ( Xbox 360 ); and personal computers ( PC ), including smartphones and tablets. They deliver their products through physical retail, digital download, online platforms, and cloud streaming services. Previous Quarter On November 02, 2016, Take Two reported net revenue of $420.2 million which was up 21% from last year and beat estimates by $18 million. They reported EPS of $0.45 which beat estimates by $0.16. The biggest contributors to the quarter were the launch of NBA 2K17, demand for Grand Theft Auto V, and increased consumer spending (virtual currency to spend on downloadable add-on content for games) from Grand Theft Auto Online. NBA 2K17 had the strongest launch in the history of the series with sales of more than 4.5 million units. More than 3 years after its initial launch, Grand Theft Auto V continues to be in demand as more than 70 million units have been sold. Grand Theft Auto Online remained the single largest contributor to recurrent consumer spending. Growth Opportunities In the 2016 annual report, Take Two outlined their growth plan: Take-Two s strategy is to develop the highest-quality, most compelling interactive entertainment franchises in the business, and deliver them on every platform around the world that is relevant to our audience. Complementing our core business with digitally-delivered offerings that drive ongoing engagement with, and recurrent consumer spending on, our titles after their initial purchase is one of our most important long-term growth and margin opportunities and, therefore, a key strategic priority of our organization. First let s start with the video game industry. On the Q3 2016 conference call, CEO Strauss H. Zelnick said Interactive entertainment is the fastest growing part of the audio and visual entertainment industry, and it s going to stay that way for a long time to come. Helping to propel the gaming industry is the rise of esports (competitive online gaming) and digital distribution. The market research firm Newzoo projects that the Esports audience will double from 2015 2019. Refer to the chart below for more details.
Newzoo isn t the only one who has taken notice. In the past year, Yahoo and ESPN have created new online channels dedicated to the coverage of esports. Arby s, Credit Karma, and Buffalo Wild Wings joined together as sponsors of a brand new league called Eleague. It is focused on video games and catering to Millennials. ELEAGUE broadcasts across digital platforms and airs on TBS. Lastly, according to the market research firm NPD Group, video games sales were up 6% in October 2016 from last year. Four of the top 10 games were produced by Take Two (Mafia III, NBA 2K17, WWE 2K17, and Civilization VI). The video game industry has begun a transition to digital distribution of content. We ve seen this happen in the movie industry going from DVD s to streaming, the music industry going from CD s to streaming, and retail in general with the rise of e-commerce. So it was a matter of time before it made its way to the video game industry. Digital distribution of video games is becoming increasingly common, with major publishers and retailers paying more attention to digital sales. According to a study conducted by SuperData Research, the volume of digital distribution of video games worldwide has reached $6.2 billion per month during February 2016. Also, digital distribution has helped video game developers as they are able to keep consumers engaged with games long after the release date with downloadable addon content. Take Two continues to take advantage of the industry s ongoing shift to digital distribution. More than 20% of units for new-generation consoles (PS4 and Xbox One) and over 90% of units for PC are delivered digitally. During Q3 2016, digitally delivered bookings (the amount billed by the company for products that will be digitally delivered to consumers in Q3 or future periods) grew by 59% to $210.8 million. This growth was driven by recurrent consumer spending and full game downloads. Recurrent consumer spending grew by 63% and accounted for 52% of digitally delivered bookings. The largest contributors to the bookings were NBA 2K17 and 2K16 and Grand Theft Auto V and Grand Theft Auto Online. Take Two has been able to stand out in the video game industry by making great games. The creative teams at Rockstar Games and 2K are renowned for their consistent ability to deliver games that set new benchmarks for excellence. Take Two s diverse portfolio of intellectual property includes 11 series with at least one five-million unit selling release, and 50 individual, multi-million unit selling titles. The Grand Theft Auto Series was created by Rockstar Games and is one of the most popular series in the video game industry. It has sold more than 235 million units including more than 70 million units of the latest installment Grand Theft Auto V. Also, Grand Theft Auto V reached $1 billion in retail sales faster than any entertainment release in history and continues to have ongoing engagement through Grand Theft Auto Online. Another top Rockstar Series is Red Dead Redemption. The first installment has sold more than $14 million units. In October, Take Two announced the next chapter of the series would be released in Fall 2017. Red Dead Redemption 2 will have a vast open-world similar to Grand Theft Auto that provides the foundation for both an epic story and a brand new online multiplayer experience. Also, the announcement trailer received a tremendous response from consumers and analysts as the stock went up 5.7% after it was released. The NBA 2K series was created by 2K and is the top rated and top selling NBA game with more than 50 million units sold. Also, virtual currency sales for the game have continued to grow with each new release and remained the largest contributor to recurrent spending next to Grand Theft Auto Online.
During Q3 2016, recurrent consumer spending on NBA2K grew by 160% driven by both online play and the MyNBA 2K mobile companion app. On October 7, 2016 2K launched Mafia III, a highly immersive and action packed addition to their organized crime series. It is the fastest growing game in 2k s history with first week sales of more than 4.5 million units and ongoing strong demand. 2K s creative approach has paid off with a great storydriven experience that sets a new bar for storytelling in video games. 2K has more content planned for Mafia III in the near future. On October 11, 2016, 2K released WWE 2K17. The game has received strong reviews from critics including Forbes which gave it 8.6 out of 10 and called the game easily the best wrestling release in over a decade. WWE 2K17 is expected to sell more units than last year continuing the trend that began when 2K acquired the license in 2013. It also comes with a variety of downloadable add-on content including a Season Pass which gives players access to many of the additional offerings at a reduced price. On October 21, 2016 2K launched Sid Meier s Civilization VI which is the latest offering from their award winning series that has sold over 37 million units. The title has received great reviews from critics including 9.5 out of 10 from Game Informer, 9.4 out of 10 from IGN, and 93 out of 100 from PC Gamer. Civilization VI is the fastest selling title in the history of the series already surpassing 1 million units. Take Two is actively pursuing opportunities for interactive entertainment on emerging platforms such as tablets, smartphones and virtual reality, and in developing markets, such as China and Korea. WWE Supercard, a free to play mobile game has been downloaded more than 11 million times. NBA 2K Online in China has over 31 million registered users. On October 28, 2016, 2K launched Carnival Games VR their first offering for virtual reality. No longer does Take Two have to rely on retailers to sell physical copies of their games and hope that consumers stay interested in them. With the advances in technology, Take Two has more ways to reach consumers directly and keep them engaged than ever before. Below is the chart for Take Two for 2016. Technical Analysis
As of November 25, 2016, the stock is $48.81, up 40% this year and is a little less than 3% from its all-time high of $50.12 which it hit on November 7, 2016. The stock has been on a consistent uptrend this year due to the sentiment regarding the gaming industry is positive, the announcement of Red Dead Redemption 2 coming in Fall 2017, and Take Two has beat expectations every quarter this year. Take Two s biggest competitors, Activision Blizzard (Ticker: ATVI) and Electronic Arts (Ticker: EA) have both sold off in the last month due to Q4 2016 guidance that was less than what the analysts expected. In my opinion, this is the result of the analysts getting ahead of themselves and setting expectations too high and the companies are looking to reign them back in. During their Q3 2016 conference call, EA CFO Blake Jorgensen said We're very optimistic about obviously both Battlefield 1 and Titanfall 2. We're just early in the holiday sales cycle. And while there's incredible excitement around both, we just don't want everyone to get ahead of themselves in the case of focusing on units forecast. But don't take that as a negative on either product. We're very excited about both of them and think there's a long opportunity, not just in the quarter, but for a good one to two years to come. Also, I believe Activision and EA are being cautious because their biggest and most recent releases (Activision s Call of Duty and EA s Battlefield 1) are going head to head and the companies are not sure how things will play out during the holiday season. Battlefield 1 has received better reviews than Call of Duty and I personally got Battlefield 1 instead of Call of Duty because I was told by people that have played Call of Duty for years that Battlefield 1 is better. Meanwhile, Take Two has games like NBA 2K and WWE 2K that have little to no direct competition. This gives them access to a unique consumer base which they can use to grow their business. Since Take Two records a loss on their income statement, I used the price to sales ratio (P/S) to determine the valuation of the company. The price to sales ratio is calculated by dividing the market cap of the company by the total revenue over the last 12 months. The market cap is the share price multiplied by the number of shares outstanding. Take Two s P/S is 2.77. I compared this to the P/S of Take Two s competitors. Activision Blizzard has a P/S of 4.65. Electronic Arts has a P/S of 5.25. Ubisoft Entertainment has a P/S of 2.49. It seems that Take Two is undervalued. When reviewing an income statement, I primarily focus on the year over year change in revenue and margins. For the first 6 months of TTWO s 2017 fiscal year, (fiscal year is from April to March) revenues increased 17.6% and gross margins increased by 140 basis points (or 1.4%). This is a good sign that the company is executing well as they are able to grow sales and cut product costs. But, for the first 6 months of TTWO s 2017 fiscal year, selling and marketing costs increased 50.7% from last year. This is due to higher advertising expenses primarily related to Mafia III. So far, it seems as if it was a good investment as Mafia III set the record for the highest first week sales in 2K s history. Going forward, I will keep an eye on these costs as I expect them to decrease now that Mafia III has been released. Refer to the income statement below for more details.
When reviewing a balance sheet, I calculate the debt ratio. The debt ratio is total liabilities divided by total assets. Anything less than 1 means the company has more assets than debts. I use this to determine if a company has any financial issues. Take Two s debt ratio is 0.87 and that s not including goodwill and other intangible assets. Refer to the balance sheet below for more details.
Recommendation Video games have been around since the 1950s. In 2016, according to Newzoo, the industry is worth $99 billion. The recent growth has been driven by Esports and digital distribution and I do not see it slowing down anytime soon. The key to the rise in Esports is that anyone can play video games. You don t have to be blessed with any natural physical gifts like you do to play other sports like basketball or football at a professional level. It reminds me of when the World Series of Poker grew every year from 2000 when the main event first place prize was $1.5 million to 2006 when the main event first place prize was $12 million. Not only could anyone do it which was proven by amateurs winning tournaments, you could play in the comfort of your own home on your computer and didn t have to go to a casino. That shift from the casino to the home is similar to what we are seeing with digital distribution. No longer do you have to go to a store and wait in line to purchase a game that you can only play it so much until you are no longer interested.
Now the game you want and additional downloadable content is just a click away on your computer, gaming console, or mobile device. This is keeping consumers playing games longer and spending more money. NBA2K has gone for being played during the NBA season to all year around and Grand Theft Auto V continues to sell units 3 years after its release. So if you like the company when should you buy the stock? Looking at the chart, Take Two hit $46 in late September and stayed around there until it reported Q3 2016 earnings on November 2, 2016. After earnings, the stock went up to as high as $50.19. Between September and November $46 was resistance also known as a ceiling for the stock. Now that the stock has broken through the resistance $46 becomes support also known as a floor. Unless some bad news comes out about the stock or the overall market the stock should not go lower than $46. The stock briefly dipped below $46 on November 10, 2016 but rebounded and finished the day above the $46 level. Also, $46.17 would be an 8% pullback from the alltime high of $50.19. An 8% pullback was the bottom for the stock of Nvidia so I will try it again here and recommend buying the stock at $46.17.