Just when it looked like video game stocks were in a lull after the surge in growth in 2020, Interactive Take-Two (NASDAQ: TWO) made waves with the announced acquisition of the top mobile game maker Zynga (NASDAQ:ZNGA) for $12.7 billion.
The deal is a reminder of the opportunities for top video game companies. The $175 billion video game industry is highly fragmented, where the combined revenues of ActivisionBlizzard (NASDAQ: ATVI), Take-Two, Zynga and electronic arts (NASDAQ:EA) represents only 12% of an industry that has been growing for decades. This is an opportunity for major game makers to strike more bottom-line accretive deals over the next few years, which could improve shareholder returns. This is one of the reasons to consider buying Take-Two this year.
1. Cheaper recovery
Take-Two has the most to gain from industry consolidation and new game releases, given its relatively smaller size compared to Activision Blizzard and Electronic Arts. On a 12-month basis, Take-Two generated $3.3 billion in revenue, compared to $6.4 billion at Electronic Arts and $9 billion at Activision Blizzard.
Take-Two also grew its revenue faster than its peers. This has led to much better returns for investors, with Take-Two shares returning 206% over the past five years, compared to 67% for Electronic Arts and 64% for Activision Blizzard.
The deal with Zynga won’t close until the end of June quarter, but Take-Two appears to be the best value in video games based on price versus sales. The combined company generated pro forma net bookings — a non-GAAP (adjusted) measure of revenue — of $6.1 billion on a 12-month basis through September 2021.
Take-Two plans to issue between 50 million and 58 million shares to help fund the acquisition. Assuming the deal is already closed, Take-Two’s market capitalization (share price times outstanding shares) would be $26.7 billion at the current share price of $157.
This brings Take-Two’s price/sales (P/S) multiple to 4.4 with the addition of Zynga, based on last 12 months pro forma bookings. Even without Zynga, Take-Two has been the best value based on P/S over the past few years, which should lay the groundwork for further outperformance against its peers.
2. Growth catalysts
Analysts were already expecting Take-Two to grow earnings per share at an annualized rate of 13% per year over the next five years. Following the agreement with Zynga, Take-Two expects bookings to grow at a compound annual rate of 14% per year through fiscal year 2024.
However, the forecast does not include the development of new mobile titles based on Take-Two’s intellectual property, and the resulting growth in recurring consumer spending (eg, spending on games). It also excludes growth in monthly active users by leveraging Zynga’s Chartboost adtech platform and penetration into new geographies, such as India and the Middle East. These opportunities are expected to contribute up to $500 million in annual bookings that are not included in management’s 14% annualized growth forecast.
3. Take-Two builds a monster
There has been a flurry of trading activity in the video game industry over the past few years. Remember, Microsoft acquired Bethesda studio operator ZeniMax Media in 2020 for $7.5 billion, while Electronic Arts acquired Glu Mobile and Codemasters last year for more than a few billion combined. One of the benefits is to increase the number of monthly active users, increase scale, and spread development costs over a wider player base to improve returns, especially when games get more expensive to manufacture.
The transaction with Zynga is expected to close in the first quarter of fiscal 2023 ending in June. The agreement will be accretive to Take-Two’s cash flow upon closing. The company will maintain a “fortress-like balance sheet with very little debt,” Take-Two CEO Strauss Zelnick told analysts on a call.
Pro forma adjusted operating cash flow for the trailing 12-month period was $769 million for both companies through the quarter ending September. As a result, Take-Two will have more money to pursue new opportunities. Regarding acquisitions, Zelnick told analysts on a call that they are looking for “great teams, great intellectual property and accretive deals.”
The growth of the video game industry offers long-term benefits for patient investors, and Take-Two’s relatively low valuation and growth catalysts make it one of the best gaming stocks to hold for the next five years. and beyond.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.