Electronic Arts plays risky game in bid for Take-Two

As a devout video game player for the majority of his 28 years, Mario Perri says he does not feel completely comfortable with Electronic Arts Inc.'s (ERTS/NASDAQ) US$2-billion hostile takeover offer for Take-Two Interactive Software Inc. (TTWO/NASDAQ).

"I don't think it's going to create better games," said Mr. Perri, owner of Xtreme Games Interactive, an independent video game retail store in Toronto. "Usually [it's better] with a little competition between developing companies, but they often get lazy once they merge."

Mr. Perri's concerns are echoed within the investor community. In what is widely being viewed as an attempt by Electronic Arts to revitalize itself from its current status as a major video game publisher suffering from what one analyst calls "sequelitis," acquiring Take-Two and its infamous Grand Theft Auto franchise presents a number of risks that investors should be aware of.

While the offer, valued at about US$26 a share, makes complete strategic sense for Electronic Arts, Take-Two's chief executive, Strauss Zelnick, has already rebuffed the proposal, calling it undervalued. Electronic Arts replied it would go directly to Take-Two's shareholders and launch a proxy battle to gain ownership of the publisher.

News of the offer pushed Take-Two's stock upward by US$9.53, to close at US$26.89, a clear indication that investors believe the offer will be raised later. Electronic Arts traded down more than 5%, to close at US$47.14.

Indeed, the focal point of the takeover offer is Take-Two's Grand Theft Auto franchise. Developed by Rockstar Games, a development division of Take-Two, the game has drawn the ire of family-friendly organizations for its graphic depictions of crime and a lurid sex scene that was hidden within the previous version of the game.

Mr. Zelnick said he is willing to enter discussions with Electronic Arts after the next version of the franchise is released in April, a release that is expected to see more than nine million copies sold.

That alone might force Electronic Arts to raise its offer for Take-Two substantially, said Daniel Ernst, a New York-based equity analyst with Soleil Securities Corp.

"This offer price is a substantial discount below publicly trading companies," Mr. Ernst said. "Our view is that this offer price undervalues the company and our own price target [on Take-Two, prior to Electronic Arts' bid] was US$30."

Tying itself to a video game rife with negative publicity presents an enormous risk, even though the franchise has sold more than 65 million copies, said Gartner research vice-president Van Baker.

"The groups that rally against these kind of games like GTA may bring a lot of baggage to Electronic Arts," he said, later adding that GTA's popularity could show Take-Two as a "one-trick pony," making the company worth substantially less than US$2-billion.

Even if Electronic Arts weathers the bad PR storm that came with the release of GTA IV, it could potentially lose the franchise if the licensing agreement between the two companies is allowed to lapse next year.

"A potential transaction would likely offer significant-scale benefits in both distribution and publishing and segment market share by aggregating an impressive array of IP [intellectual property], but also introduce a greater amount of title risk, key developer/studio risk and require a healthy level of synergies to deliver a fair return on the capital deployed," Goldman Sachs analyst Mark Wienkes said in a research note to clients yesterday.

In an industry that has grown more than 50% in the past year, consolidation among the major video game publishers is being viewed as a troubling harbinger that may affect future titles.

Citigroup Capital Markets equity analyst Brent Thill cautioned clients in a research note that if a merger were to take place, it might also postpone the release of some of Electronic Arts' popular and lucrative titles including Need For Speed and Madden NFL.

via National Post

No comments: