We are lowering our rating on shares of Take-Two Interactive (NASDAQ:TTWO) to NEUTRAL from OUTPERFORM, and are maintaining our 12-month price target of $19. We believe that investors should be cautious about the company’s product pipeline; although Take-Two has consistently produced successful games, it has not produced a sufficient number of them to generate consistent profits. Our price target is based upon a market multiple (15x) applied to “sustainable” earnings of $0.70 plus $8.45 net cash (see last bullet). This multiple is in-line with industry peers, and reflects an improving outlook for publishers on the next-gen consoles.
Take-Two reported solid upside to Q3 guidance, and once again raised FY:14 guidance. The company reported non-GAAP EPS of $1.70 on revenue of $768 million, compared to our estimates of $1.48/$700 million, consensus of $1.37/$704 million, and guidance of $1.20 – $1.35 on revenue of $650 – $700 million. Once again, upside was driven by strong GTA V sales, helped by record sell-in of NBA 2K14.
Management provided little visibility into the company’s FY:15 line-up. To date, we are aware of only three games for next year: Evolve (next generation and PC only), NBA 2K, and WWE 2K (both multi-platform). Management committed to profitability in FY:15 and beyond, but was reticent to specify the level of profitability, suggesting to us that consensus EPS estimates of $1.08 for next year are too high.
Due to lack of visibility, we are lowering our FY:15 EPS estimate to $0.40 from $0.85. Take-Two earnings have been uneven since current management took the helm; while we think that the company has made many good decisions that will position it to be consistently profitable going forward, we note that Take-Two has generated profits in four of the eight years under this management.
We think that GTA will drive $500 million in operating profits each time it is released, and presume it is on a five-year development cycle. Now that it has generated a substantial profit, we expect Take-Two to begin paying income taxes, leading us to believe that it will generate only $375 million in net income, or $3.30 per share in fully taxed earnings, every time GTA is released. We think that profits in other years will likely fluctuate between break-even and $1.00 per share or so in fully taxed profits, but without visibility, we are unprepared to assign a guess that high to FY:15. We estimate that sustainable earnings are $0.60 from GTA and $0.10 from the rest of the lineup (the company’s average non- GTA earnings the last six years).
Michael Pachter is an analyst at Wedbush Securities.