The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.
Take-Two Interactive Software (NASDAQ:TTWO) earnings revealed Borderlands 2, catalog, and digital drive top-line beat, with EPS beat from cost control. Revenue was $288 million, compared with consensus of $240 million, and guidance of $200 – 250 million. EPS was $0.11, compared with our estimate of $(0.21), consensus of $(0.18), and guidance of $(0.30) – (0.15).
Full year guidance and our estimates are lowered to reflect the Grand Theft Auto V delay. The company decreased FY:13 guidance for revenue to $1.10 –1.20 billion from $1.70 – 1.80 billion and for EPS to $0.00 – 0.20 from $1.75 – 2.00. We are decreasing our FY:13 estimates for revenue to $1.21 billion from $1.80 billion, and for EPS to $0.30 from $2.00. We are increasing our FY:14 estimates for revenue to $2.10 billion from $1.90 billion, and for EPS to $3.00 from $2.00.
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Lack of visibility into game releases makes modeling Take-Two’s financial performance nearly impossible and increases volatility. FY:13 EPS guidance was slashed by $1.75 to $0.00 – 0.20, and the trading reaction to the beat and “certainty” that GTA V is finally coming reflects investor skepticism about the“spring” release. We can make an educated guess at how FY:14 may play out, but modeling it close to accurately is nearly impossible, particularly as the company has provided little detail about the bulk of its release slate. Investor confidence in Take-Two (NASDAQ:TTWO) is low, given repeatedly unexpected swings in profit and loss.
Long game development cycles limit profitability. Many of Take-Two’s games were under development for five or more years, including Max Payne (more than eight years), Mafia (six years), Red Dead Redemption (six years) L.A. Noire (six years), Grand Theft Auto (five years) and BioShock (over four years). Long cycles create risk of an eroding fan base. Also, with longer development time comes higher overall development cost, and higher cost requires greater sales to achieve breakeven. Finally, long cycles make the timing of releases unpredictable and earnings volatile, limiting the multiple investors are willing to pay.
Maintaining our OUTPERFORM rating and lowering our 12-month price target to $15.50 from $19, which reflects a forward multiple of 12x estimated sustainable EPS of $1.20 (fully taxed) plus an estimated $1/share in net cash. Our multiple is in line with the historical range, and reflects improving execution.
Michael Pachter is an analyst at Wedbush Securities.