This post is a summary of my analysis of Take-Two (Ticker symbol: $TTWO). I hope you enjoy reading it and feel free to add your take and agree/disagree with what's mentioned below.
The article is divided into the following sections:
- Introduction & Fundamental analysis of the business.
- Historical financial performance
- The Zynga acquisition
- The balance sheet
- Assumptions & valuation
- Valuation based on assumptions different than mine
Introduction & Fundamental analysis of the business
Take-Two is a video game company that grows primarily through acquisitions. It owns well-positioned, well-known IPs, such as Grand Theft Auto, Red Dead Redemption, NBA 2K, Civilization, Mafia, Max Payne, and many more.
In 2022, the company acquired Zynga, a company that owned a significant number of top mobile games, which fits well into Take-Two's portfolio.
Obviously, one of the big risks that come with every gaming company is, what if the next sequel of a popular game disappoints? What if the next Civilization isn't a big hit, what if the next Grand Theft Auto fails to meet the expectations of the gamers? Although Take-Two isn't immune to this risk, owning a large number of popular games allows them to diversify this risk to a large extent. If we take a look at Activision for example, a giant in the industry, the conclusion would be different as 3 of the franchises (Call of Duty, World of Warcraft, and Candy Crush) bring roughly 3/4 of the total revenue.
Historical financial performance
Before we move into the financials, it is important to note that the fiscal year of Take-two ends on March 31st. Hence, the fiscal year 2022 starts on April 1st, 2021, and ends on March 31st, 2022.
At the moment of this writing, the last publicly available report is as of December 31st, 2022, so LTM (last twelve months) is referring to the calendar year 2022.
The company's revenue grew 16% CAGR over the last 5 years, and a significant portion of this is coming from acquisitions. As Zynga was acquired in 2022, the full effect of its revenue isn't reflected in the financials yet. Its revenues for the LTM were $4,8 billion.
The gross margin has improved over the last 5 years from 43% to slightly over 50%. However, if we take all the operating expenses into account (Sales & Marketing, General & Administrative, Research & Development as well as Depreciation and amortization), it seems as if something is going wrong.
The operating margin was fluctuating between 8 and 19%, until the Zynga acquisition. Suddenly, the profitability is down to roughly 0%. To better understand this, we need to look into the Zynga acquisition.
The Zynga acquisition
The consideration for this acquisition was $9,5 billion:
– 46.3m shares of Take-Two ($5,4 billion)
– Cash ($4 billion)
– Equity awards ($0,1 billion)
The expected outcome of this acquisition by the management is as follows:
-
Revenue synergies of over $500m
-
Cost synergies of over $100m in the first 2 years
-
14% revenue growth in the next 3 years
When there's an acquisition, the acquiring company doesn't just take over what's on the balance sheet of the acquiree. Instead, there's an entire valuation and purchase price allocation process that takes place.
Let me elaborate: The accounting standards have very strict rules for recognizing (capitalizing) internally generated intangible assets (such as brands, trade names, etc.). The main reason is, if this is allowed, most companies would do that, which means instead of recognizing an expense, the capital used would be on the balance sheet (amortized over time), and the profitability of the business would be overstated, and would not reflect the actual performance.
However, when an acquisition happens, that's when the intangible assets that have been generated in the past are valued and recognized.
Because of this acquisition, Take-Two recognized intangible assets of $5,5 billion, in addition to the goodwill of $6.2 billion.
What this means is, all of these intangible assets (excl. the goodwill) will now be amortized and part of Take-Two's income statement, decreasing its operating profit by $700m per year and is the explanation for the significant decrease in the operating margin. However, this is a non-cash expense. Take-two has already paid for this in the past, so from a cash point of view, it doesn't exist.
Let's take a look at how Take-Two (with and without Zynga) compares to the key competitors:
| Company | Gross margin | S&M expenses | G&A expenses | R&D expenses | Total operating expenses | Operating margin |
|---|---|---|---|---|---|---|
| Take-Two | 55% | 15% | 15% | 10% | 40% | 15% |
| Zynga | 64% | 34% | 7% | 20% | 61% | 3% |
| Take-Two (/w Zynga) | 56% | 23% | 18% | 15% | 56% | 0% |
| Activision | 71% | 14% | 10% | 15% | 39% | 32% |
| Nintendo | 55% | 7% | 7% | 6% | 20% | 35% |
| EA Sports | 74% | 13% | 11% | 30% | 54% | 20% |
The explanation above also helps understand why Take-Two with Zynga has significantly worse margins than the two companies separately.
The balance sheet
Looking at the financial position, Take-Two has a fairly stable cash position of over $800m, but it rarely holds a significant amount of excess cash. After the acquisition of Zynga, the intangible assets make up roughly 3/4 of the entire balance sheet.
On the other side of the balance sheet, the company has a low level of debt ($1,7 billion, including leases) and it doesn't seem to be interested in increasing its financial leverage significantly.
Assumptions & Valuation
To value Take-two, there are two main inputs required: Revenue growth over time & Operating margin. Here are my assumptions:
Revenue growth: 25% in year 1 (mainly driven by the Zynga acquisition), followed by 8% until year 5 and a decrease to 3.5% by year 10, this represents revenue growth of 114% in the next decade.
Operating margin: 16% for the next year, improving to 18% over time as synergies kick in.
Discount rate (WACC-based): 7.78% increasing to 8.02% by year 10 (approaching a beta of 1, vs. the beta of 0.9 today)
Here's the outcome: The company's value is $14.5b ($86/share).
Valuation based on assumptions different than mine
If you have different assumptions regarding the revenue 10 years from now, as well as the operating margin, I hope the table below helps in valuing Take-two as a whole.
| Revenue / Op. margin | 14% | 18% | 22% | 26% |
|---|---|---|---|---|
| 100% ($9,7b) | $52.0 | $79.6 | $105.8 | $128.0 |
| 114% ($10,3b) | $56.6 | $86.2 | $114.2 | $137.9 |
| 150% ($12,1b) | $64.9 | $98.9 | $131.2 | $159.0 |
| 200% ($14,5b) | $76.2 | $116.1 | $154.4 | $187.6 |
As with any other company, there is a wide range of outcomes. Personally, I think the company is doing well and I'd love to own shares sometime in the future, but not at today's price.
If Take-two increases its margins significantly and moves closer to Activision/Nintendo, the company could be undervalued at today's price.
One important topic to mention is GTA6 as it is a game anticipated for quite a long period of time. Although its (lack of) success will have an impact on Take-two as a company, it is important to acknowledge that it is not the only game that's a cash cow, but it does represent a risk/opportunity in the short and medium-term.
Leave a Reply