Games, are ultimately creative. But making money out of games, as we all know, is about retailing and online reach. Or is it? It seems to us that the games world is changing and nothing illustrates this better than the manner in which, so far, Take Two Interactive has evaded the grasp of the ultimate in channel management control ‘ Electronic Arts.
Now Take Two has managed to bring its Grand Theft Auto IV to market just in time to hike its value, keeping shareholders onside, and keeping the unwanted $2 billion offer for the company at bay. This week EA extended its offer deadline for the fourth time and revealed that it now has acceptances of 15% of the stock, up from 8% since the last time it extended the deadline on its offer of $25.74 a share.
Shareholders would be crazy right now to sell a stock that without this offer would have risen way beyond its current value and its senior management has taken some cute advice and told the market through Chairman Strauss Zelnick, that it has opened up discussions with two or three other suitors which will not undervalue the stock in the way the EA deal has.
EA Games’ revenue last year was just $3.7 billion, a rise of 19% and that due to revenue deferrals, this yielded it a loss of $454 million up from last year’s net income of $76 million. By releasing a Non-GAAP net income, which doesn’t defer all that revenue, it says that it would have earned $339 million, up from $247 million the previous year. Since there are no rules for non-GAAP accounts you can take that number or leave it, but EA has $2.3 billion cash in its locker, and with a value of $15.3 billion, looks like it is valued as cash plus 4 times revenues. EA will come out with a new set of figures next week, and a blockbuster quarter, which should happen, might just change the nature of the bidding equation for Take Two, but we doubt it.
With Take Two only just releasing its second quarter accounts ended April 30, there is some basis for comparison. It had revenues of $540 million for the quarter, compared to $205.4 million a year ago. But it’s hard for shareholders to see this for what it is. Games like new releases of GTA IV don’t come out every quarter, not even every year, so has the GTA affect already come and gone for this company? The title smashed the all time entertainment record for its first week of sales with 6 million units sold at a retail value $500 million. Already 11 million units have now been sold although some are still in the retail chain.
All of this yielded a net income of $98 million for the quarter, but this time last year it lost $51 million. Clearly it is a smaller company and it is held up by this, its strongest game. But the company is broadening the base of its games. It will shortly have a version out for the best selling Nintendo Wii and it will have further episode updates for the Xbox ahead of Christmas, so the GTA bandwagon has not stopped rolling by any means.
The six months picture gives a clearer view with revenues at $780 million, up from $483 million and net income at $60 million compared to a loss of $72.8 million. It only has $73 million in the bank, although it has inflated its accounts receivable from around $100 million that it usually is to $362 million, so it will shortly replenish its coffers.
But there is plenty of other evidence that this is not the only good thing going for Take Two with its second top game BioShock about to come out in a PS3 version (previously only Xbox) and at the games show E3 last week Universal Pictures said it is developing a feature film based on the game.
As a result it managed guidance of third quarter revenue around $325 to $375 million and revenue for the year of $1,400 to $1,500 million. By any sensible valuation process, Take Two, as an acquired product range, operating in a larger, financially stable group, must be worth that same EA multiple of revenues, around 4 times, making it worth $4 billion today and something closer to $6 billion if it manages to complete the year to prediction. As a public company this has to be discounted back considerably by the current US financial marketplace (games sales are never affected by recessions), and by the small size of the company and the cyclical nature of its business. But not all the way down to $2 billion.
This is perhaps the rare case of a bid for the business actually keeping the share price down, and if the EA bid goes away, surely the success of GTA will continue to lift the share price of Take Two. However nothing will lift it better than a white knight and that could come from a number of areas ‘ but here’s two to consider Activision Blizzard, which just took EA Games’ title of largest games company in the Western World, when it merged with Vivendi Universal’s games division which brought it a market capitalization of 24 billion, and private equity groups everywhere.
Although Activision Blizzard has only just come out of a merger, the deal would not cost much in terms of cash, and as a company it is closer to the creative ethos which Take Two boasts about. One negative for EA shareholders must be that Take Two has a raft of sports games, similar to EA games, and the overlap is likely to be either culled or under exploited within EA or cause the deal to founder on anti-trust issues. That should not happen with Activision.
Now there is also the issue that EA Games needs to acquire the Take Two business in time for Christmas, and shove GTA IV into its own channels, or the entire basis of acquiring it now will be pointless. That means that a deal has to be cut in the next few weeks, and given that it has just extended its offer for another five weeks, the only way that could happen is if it raises it offer.
So we would expect EA to raise its offer, perhaps to $30 a share, but this still may not be enough to make a difference, because these mysterious other discussions are almost certainly going to find the light of day, either by announcement or leaks, and then shareholders should be held in thrall long enough to get past the effective ‘must do’ date for the EA deal. Shareholders will also be aware that even an increased offer by EA may fall foul of the Federal Trade Commission which is considering if the deal creates antitrust issues, especially if it decides that sports based games represents a separate market. If it does that won’t necessarily stop the deal, but it could lead to some of the sports games being up for sale as a condition of approving it.
But there are yet many further market changes in the gaming market, which give us pause for any shareholder carrying out a deal right now. First off the positive impact of in-game advertising is going to begin to be felt in quarterly results over the next two or three quarters, a business which has the potential to double the revenue among the more popular games. Secondly there is a radical swing going on in the platform market away from Xbox. Thirdly the emergence of portable gaming platforms, not just Nintendo DS and PlayStation Portable, but on phone devices ‘ such as a PlayStation phone and some deals on smart phones ‘ means that an entire new games dimension is about to open up. All of this in a games market where US the games sales are currently up by over 50% over this time last year.
In this environment if you are lucky enough to hold shares in a games distributor, it would seem short sighted to sell them.
Ask any gamer about the lack of the Sony PS3’s solid successes over the last few years and they will tell you, ‘Wait until the PS3 exclusives start hitting the market,’ and we have one out this week in Metal Gear Solid
US game tracking researcher NPD, not only reported that Konami’s Metal Gear Solid dominated this month’s games sales charts with 775,000 copies sold, but that this had an enormous influence over sales of PlayStation 3, which rose in the US to 405,500 PS3s sold this month, compared to 219,800 Xbox 360s. Both are still behind the Nintendo Wii, which racked up 666,700 systems last month.
But this is the second month that the PS3 has stayed ahead of the Xbox 360 on its home soil, and around the rest of the world, Xbox is doing less well.
One issue here is pricing. Both Sony and Xbox cut prices last month, in the same pricing sandwich that Nintendo and Sony have had Xbox in for its entire previous generation. But during the past five years or so, whenever Xbox dropped its price the Gamecube Nintendo home console below it, also dropped its price. This is no longer happening, and as the Xbox comes down in price, the popular Wii just holds the line squashing the Xbox sweet spot.
The Xbox will shortly be faced with being cheaper than the Wii in order to make sales, which may stimulate sales for a while, but it will have both Sony and Nintendo then setting the Microsoft Xbox system price. In two years Nintendo has not moved its device price. If it lowers it further, it might wipe out Xbox 360 sales.
So gaming companies that have a lot of Xbox exclusives in their catalog might be just wondering right now if they should be re-considering either a Wii exclusive or a deal with Sony. And with Microsoft’s insistence that it will never ship an Xbox with a Blu-ray drive, this raises the distinct possibility that the device is about to go into a spiral of sales which the last few months already suggests.
One of the key issues about these new major gaming companies (not the console owners, but EA and Activision) is just what their increased market power allows them to do. We have seen last week that Activision is planning to leverage a move into online music sales from its Guitar Hero game, suggesting a rivalry with iTunes. Electronic Arts at E3 launched its own identity system, which it is calling “Nucleus.” This has traditionally been the province only of games console owners. The Xbox Live! network has a similar idea called Gametags. The idea is to use the identity to keep track of just how good any given player is on any given game, but for the EA system these details will move with them from one platform to another ‘ but only on EA built games. Microsoft provides the ability for players to have a kind of ‘grandmaster’ status for all Xbox games, now EA has it for all EA games on all platforms. What the humble gamer wants is a universal system across all games and all platforms ‘ and EA is even having a go at this, because at E3 it talked about Rupture, a social networking site acquired back in May, developed by Napster founder Shawn Fanning. Rupture which will let gamers track and challenge friends across all platforms as well as other publishers’ games, although at present there is no automatic scoring system.
Both of these steps shows something of the ambition of EA that it thinks it has enough market reach to introduce Nucleus and Rupture up against both Sony and Microsoft.
EA also announced a new publishing deal with id Software, creators of the Doom franchise which has been an exclusive with Activision until now.
Finally the mobile dimension was addressed this week, once again by EA, launching the intergalactic Spore Origins on the AT&T wireless network for HSDPA customers. This is the equivalent of bringing a Multi-Player online game onto a handset ‘ which was just a matter of time. On the other hand, reviewers point out that the multiplayer aspects have not materialized in this version of the game after all, and that it has no direct relationship with the PC and console versions of the game expected in September. It is little more than an advert for the real game, and the fact that it plays on an iPhone is not going to sell more iPhones, but it will perhaps sell more copies of the PC versions of the game.
But how long before Multiplaying genuinely does make it to the handset, and the billing for it is wrapped up in mobile billing, and that the $20 a month to play games like World of Warcraft, are shifted to a discounted extra for your phone, or an incentive paid for by your cellular operator on your behalf, where perhaps game play gets you real world phone credits. This is a first step to open that door, and like every other market that ends up on a cellphone, gaming, once it arrives there, is likely to be even bigger than the market it is copying, console games.