Despite a burgeoning video game market backdrop, shares of video game publisher Take-Two Interactive Software, Inc (NASDAQ:TTWO) have struggled recently.
The struggles started back in early February when TTWO reported mixed third quarter numbers. The guide was strong, but revenues missed expectations in the quarter. TTWO stock dropped.
And it hasn’t recovered since, partially due to broader market volatility but mainly due to the mainstream emergence of Fortnite: Battle Royale.
Fortnite is a sandbox survival game that looks fairly similar to TTWO’s most important game franchise, Grand Theft Auto. As such, investors have been concerned that the emergence of Fortnite will dilute Grand Theft Auto participation and thereby significantly hurt TTWO’s financial results.
Analysts have been quick to point out that Fortnite‘s core demographic doesn’t have heavy overlap with Grand Theft Auto‘s core demographic. GTA skews more toward an older audience, while Fortnite skews toward a younger audience (the mid-teens crowd). While this may be largely true, there is considerable spillover from the core Fortnite crowd into the core GTA crowd.
NFL players, NBA players and other high-profile celebrities like Drake have publicly commented on playing Fortnite. Those players aren’t in the mid-teens crowd, and their followers aren’t all in the mid-teens crowd, either. Thus, Fortnite does present considerable risk to GTA participation and Take-Two stock.
But TTWO stock has lost nearly a fourth of its value since early February, making this selloff seem overdone. The valuation at current levels look compelling. And there is a huge catalyst on the horizon which could materially alter the momentum of the stock in the back half of 2018.
That is why I’m a buyer on this big dip. Here’s a deeper look.
Four Big Reasons to Buy Take-Two Stock
The first reason that TTWO stock looks good on this dip is the company’s robust and durable content portfolio. Consumer demand for Take-Two’s suite of games hasn’t shown any signs of wavering despite those games being around for a long time.
The NBA 2K franchise, which debuted nearly 20 years ago, just had its most successful game launch ever. Meanwhile, GTA Online V was the number three video game title last year, and it launched four years ago.
This durability sets TTWO up well for the current and still-accelerating digital transformation. Because consumers never tire of TTWO’s games, they will pay up for exclusive content and other things that the company can lock behind a pay wall.
Thus, Take-Two can succeed even without any new major video game launches because its core portfolio will generate large of amounts of high-margin, annually recurring revenue.
The second reason to buy TTWO stock on this dip is the stock’s now-depressed valuation. Fiscal 2019 is expected to be a major year for the company thanks to some headline releases, and earnings are expected to shoot up to nearly $5 per share. That means Take-Two stock is trading at essentially 20 times forward earnings.
That is dirt cheap for a video game stock. Activision Blizzard, Inc. (NASDAQ:ATVI) trades at 25 times forward earnings. Electronic Arts Inc. (NASDAQ:EA) trades at 24 times forward earnings. If TTWO normalized to those valuation levels, then the stock would be back around $120 highs.
The third reason to buy TTWO stock now is the October 2018 launch of Red Dead Redemption 2. This catalyst has been pushed back multiple times, but I think that has only increased pent-up demand for this much-awaited and super-popular video game. Results will get super-charged next year. The numbers will look really good. Sentiment will be strong, and the valuation will look anemic.
The fourth reason to buy TTWO stock is the company’s strong balance sheet. Take-Two has a bunch of cash on its balance sheet that it can weaponize at any point to supercharge growth via acquisitions.
The company is already pioneering its Private Division, which is focused on bringing titles from top independent developers to market. In other words, TTWO’s content portfolio is only widening.
Bottom Line on TTWO Stock
Despite what analysts may say, Fortnite risks are real. Just look at Google Trends. Grand Theft Auto is dropping in popularity, and Fortnite is rising in popularity.
But Take-Two stock has lost a fourth of its value in two months. That sizable of a selloff seems to overplay the magnitude of Fortnite risks.
Under $100, TTWO stock looks materially undervalued relative to peers. But sentiment needs to change in order for this stock to head higher. That sentiment shift will happen as we get closer to the October 2018 launch of Red Dead Redemption 2.
Consequently, now looks like a good time to start taking nibbles at the stock. Near-term weakness may persist. But that weakness will fade by the back-half of 2018, at which point TTWO stock could head significantly higher.
As of this writing, Luke Lango was long TTWO.
