At first glance, Take-Two Interactive Software Inc (NASDAQ:TTWO) highlights the challenges of investing in the gaming space. TTWO stock trades at 36x estimated TTWO earnings for fiscal year 2018 (ending March 31). That seems an expensive multiple, to be sure.
And as quickly as gaming is growing both in the U.S. and globally, there simply isn’t a “cheap” way to play it. Nvidia Corporation (NASDAQ:NVDA), which gets the majority of its profits from gaming chips, trades at over 40x forward earnings. Hardware manufacturers overall aren’t great gaming-related plays. Sony Corp (ADR) (NYSE:SNE) gets more profit from insurance than the PlayStation, and the Xbox is a minor contributor to Microsoft Corporation (NASDAQ:MSFT) results.
Take-Two’s rivals in development admittedly appear more reasonably priced. Activision Blizzard, Inc. (NASDAQ:ATVI) and Electronic Arts Inc. (NASDAQ:EA) trade at 25x and 21x forward earnings per share, respectively. But ATVI has a major franchise in decline in World of Warcraft, and EA is dealing with missteps on its in-game mechanics.
Growth in the gaming industry is coming — but there doesn’t seem a good way to capitalize on it. But, looking closer, TTWO stock is exactly that play.
After more than doubling this year, it would appear TTWO stock is set for a pullback. But even with those gains, TTWO isn’t necessarily that expensive.
For one, Take-Two has over $11 per share in cash, and almost no debt. Backing out that net cash, the forward multiple comes down to a more reasonable, if still high, 32x.
But there’s also more growth coming in FY19. Red Dead Redemption 2 launches in fiscal quarter 1 (calendar Q2), and a typical release there could add as much as $0.75 in extra EPS, according to an analyst. FY19 consensus already is at $4.76; again, backing out the cash, and suddenly TTWO is trading at about 21x EPS, in line with EA’s current multiple.
It may take a bit of patience, but the point is that soon enough, Take-Two stock won’t be that expensive, even if TTWO news is roughly as expected.
And at a similar multiple, I’d rather have Take-Two than either of its larger rivals, even though I do like EA stock at the current price. Take-Two has a much narrower portfolio than larger Activision and EA — which gives it more focus on developing and marketing big launches like RDR 2.
It also helps Take-Two avoid mistakes. Activision saw Call of Duty:Infinite Warfare disappoint. EA has run into troubles with micro-transactions. Take-Two’s focus on Grand Theft Auto, NBA 2K, and RDR has allowed it to avoid those potholes.
That aside, Take-Two’s portfolio is performing better. Revenue has grown nearly 80% over the past five years. For Activision, the figure is just 44%, despite a big bump from its acquisition of King Digital. EA’s top line has increased just 29%.
So while the narrower portfolio might be seen as a risk, so far it’s worked well for TTWO — whose stock has outperformed those rivals as well. And I don’t think that outperformance is ready to come to an end.
After a recent pullback despite strong Q3 earnings, TTWO looks set for upside in 2018. Earlier this month, James Brumley highlighted a potentially concerning technical picture, but fundamentally there’s good news coming. The RDR 2 launch should attract attention to the stock and drive strong results in fiscal Q1 and fiscal Q2. Recurring revenue grew 66% in Q2 and now accounts for almost half of sales, which should drive impressive growth in fiscal Q3 and Q4 results.
There’s a lot to like when it comes to Take-Two — and its strengths should be on display during calendar 2018. The recent pullback looks like an opportunity, and the valuation is much more attractive than headline multiples might suggest. With gaming growth likely to continue for years at least, TTWO stock looks the best way to play the trend.
As of this writing, Vince Martin has no positions in any securities mentioned.