The video game industry generated an estimated $212 billion in 2023 and with a base of 3.2 billion players, this business is only expected to grow over the coming years. As for investing in the industry, one stock, Take-Two Interactive Software (TTWO -0.77%), has been on a tear over the past year with a 50% price appreciation.
The video game publisher has undergone a seismic change over the past couple of years and owns fan-favorite franchises like 2K, Grand Theft Auto, and Red Dead. With Take-Two's recent meteoric rise, prospective investors should know these five things before deciding whether to buy, sell, or hold.
1. Take-Two Acquired Zynga in 2022
There has been significant consolidation in the video game industry over the past couple of years, most notably with Microsoft's $69 billion acquisition of video game publisher Activision Blizzard and Take-Two's $13 billion acquisition of mobile game publisher Zynga.
The latter transaction accelerated Take-Two's growth into mobile gaming, where advertising and recurring revenue are higher than traditional console games. Additionally, mobile gaming represented an estimated 60% of the global video game market in 2022, which immediately gave Take-Two exposure to a growing market.
The company's revenue jumped from $3.5 billion in its fiscal 2022 to $5.3 billion in its fiscal 2023, a 51% increase. Notably, Take-Two did not own Zynga during its fiscal first quarter of 2023, suggesting further growth potential.
2. Take-Two's growth came at a cost
To fund the transaction, Take-Two paid Zynga shareholders $3.50 in cash and 0.0406 shares of Take-Two stock for each share of Zynga stock. As a result, Take-Two's strong net cash (cash and cash equivalents minus total debt) position took a hit. Take-Two had roughly $2.5 billion in net cash before the transaction and now has approximately $2.3 billion in net debt, meaning its cash position worsened by about $4.7 billion. The company will pay a higher interest expense in the future to service the debt as interest rates remain elevated and may need to take out additional debt as the company expects a net loss this year.
The other requisite of the acquisition included giving Zynga shareholders Take-Two stock, which diluted shareholders' ownership stake in the latter. With employee stock compensation and potential dilution from convertible notes, Take-Two's shares outstanding have increased approximately 47% since the transaction. Again, as the company is currently unprofitable, shareholders shouldn't expect management to reverse course with buybacks anytime soon, meaning current shares could be further diluted.
3. Take-Two is unprofitable
As mentioned, Take-Two is currently unprofitable, so let's look at its recent performance and management's guidance in this area. First, the company posted a net loss of $750 million through the first half of its fiscal 2024, more than doubling its losses year over year. Management wrote down an impairment charge of $255 million related to acquired intangibles and $161 million of goodwill impairment.
On the one hand, those are considered one-time dings against profitability, but on the other hand, goodwill impairment is a sign that management overpaid for an acquisition. Management declined to give any color to the impairment charges on its most recent conference call, leaving investors in the dark about the miscalculation.
Management has guided for a net loss range of $957 million to $910 million for its fiscal 2024, meaning shareholders can expect up to $207 million in additional losses for its next two reported quarters.
4. Grand Theft Auto VI is coming in 2025
For those unfamiliar with Take-Two, you may be rightfully asking yourself why its stock is up 50% over the past year with the company's growing debt, share count, and net losses. One reason is that the company recently announced a release date for the latest game of one of its biggest franchises: Grand Theft Auto VI. The open-world video game known for its adult themes is set to release the newest installment in 2025.
As for why that is bringing hype to the stock now, the company's previous Grand Theft Auto title, released in 2013, sold an estimated 190 million copies. Considering how much the video game industry has grown in the decade since, investors are reasonably excited about the potential of the newest release. Take-Two CEO Strauss Zelnick previously said he believes the company can hit $8 billion in net bookings -- a metric the company defines as the net amount of products and services sold -- for its fiscal 2025. For comparison, the company generated $5.3 billion in net books for its fiscal 2023.
Moreover, Take-Two recently signed a partnership with Netflix to release previous Grand Theft Auto titles to its users on mobile, which not only boosts revenue for the video game publisher, but should also build further anticipation for next year's release.
5. Take-Two trades at a high valuation
Before making any investment, it's essential to consider a stock's valuation beyond its stock price. For most mature, profitable companies, the price-to-earnings (P/E) ratio is a standard valuation metric that is useful for comparing similar companies or a stock's historical average. Because Take-Two is currently unprofitable, we'll need to use its forward P/E ratio, which compares a company's current stock price to its estimated future earnings per share over the next 12 months.
Take-Two's stock currently trades at nearly 51 times forward earnings, significantly higher than competitor Electronic Arts, which trades at 19 times forward earnings. When you consider the Grand Theft Auto VI release is more than 12 months out, you might be able to squint your eyes for a rosier valuation. Still, when looking at Take-Two's stock price and the company's current lack of earnings, it appears to be overvalued.
TTWO PE Ratio (Forward) data by YCharts
Is Take-Two Interactive stock a buy?
Take-Two is a difficult stock to evaluate due to its recent acquisition of Zynga and future growth possibilities. For any dividend-seeking or value investor, the stock has no place in a portfolio. The only portfolio in which Take-Two's stock currently fits is a long-term growth investor's, and even then, it looks expensive. While there is high anticipation for Take-Two's potential, prospective investors should wait for the company to start moving toward profitability before buying into the long-term vision.
