The "Interactive" Part of Take-Two Interactive Is Where Its Big Wins Are Coming From

In this segment from the Market Foolery podcast, host Chris Hill and Motley Fool analyst David Kretzmann consider the fourth-quarter earnings report from popular video game publisher Take-Two Interactive (NASDAQ: TTWO), which solidly beat expectations on earnings. But sales were tepid, and guidance indicates they'll remain so, until it finally gets Red Dead Redemption 2 ready for prime time and ships it.

These Fools talk about the vital "recurrent consumer spending" metric, the true impact of competition from Epic's huge hit Fortnite Battle Royale, the impressive staying power of a hit franchise like Grand Theft Auto, and more.

A full transcript follows the video.

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This video was recorded on May 17, 2018.

Chris Hill: Let's move on to Take-Two Interactive. Fourth quarter profits solidly beat expectations. Shares are up about 3% this morning. I'm assuming they would be up even more if the overall sales for Take-Two Interactive were stronger. They kind of struggled this quarter, and their guidance for the current quarter was essentially, "Yeah, this current quarter, it's going to look a lot like the one we just reported," meaning --

David Kretzmann: Not ideal.

Hill: -- tepid, sales will be tepid.

Kretzmann: With any video game company, whether you're looking at Electronic Arts or Activision Blizzard, which are much bigger than Take-Two Interactive, you will see similar dynamics, where quarter-to-quarter results will be very lumpy, because this is very much a hits and franchise-driven business. In this case, you might remember that last year, Take-Two Interactive was planning on launching Red Dead Redemption II in the fall of 2017. They delayed that to the spring of this year, and then they delayed it again to October this year. That was a big release that initially would have been lumped into this quarter's results, but they've continued to push that back. Really, I think they're doing it for good reasons. They're basically saying, "We really want to make sure we have this game right."

In the meantime, their digital side of the business is helping prop up the company and bringing in a lot of cash. It's a terrible phrase, but their metric "recurrent consumer spending," which is basically all the money that gamers spend on virtual currency, add-on content, in-game purchases, essentially, purchases that gamers make after they've bought the initial game, that spending was up 42% in the quarter. It now makes up almost half of their total revenue. And that's high-margin money coming in the door. It's dropping, essentially, straight to the bottom line.

So, right now, you look at Take-Two Interactive, they're producing over $300 million in free cash flow each year. They have $1.4 billion in net cash on their balance sheet. It's a very cash-rich business. If they can continue to churn out hits with their current franchises like Grand Theft Auto, NBA 2K, WWE, and hopefully get some other hits in the meantime, and develop some new hits, the company should be on a nice trajectory longer-term. But in the meantime, these quarter-to-quarter results will be a bit lumpy.

Hill: You're right, that is a terrible phrase for what is -- as you point out -- a great metric, and something that points to, among other things, the fact that these are well-made games. If they're that sticky, that people are, after they bought the game, they're like, "I like this game so much, I'm going to spend even more money within the game itself," for whatever you're buying.

Fortnite. is Fortnite just going to hurt every game maker right now because of its popularity?

Kretzmann: Well, Fortnite was mentioned 17 times on their conference call.

Hill: [laughs] That sounds like a yes.

Kretzmann: A lot of analysts were interested in it. Really, the response from Take-Two was similar to the response we heard from EA a couple of weeks ago. They essentially see it as, this is a new-ish development in the gaming world, especially here in the U.S., where you have these battle royale games, where you have essentially 100 people competing live at once. I think they see it as something that's, in general, an opportunity. Anecdotally, this seems to be bringing in a lot of newer gamers into the online gaming category. Ideally, for Take-Two, this might raise interest in new gamers for new games. And down the road, perhaps, they look to develop games more in the Fortnite model.

So, I don't think they see it as a threat. I'd say, at this point, all these video game companies, whether it's EA, Take-Two Interactive, or Activision, are probably looking at what's happening with Fortnite as an opportunity, just that there is a growing interest in interactive gaming. And that's where these companies have largely been spending a lot of their time as they develop and expand their existing titles. I mean, you look at Grand Theft Auto V -- which, by almost any measure, might be the most successful media franchise in a long time, if not ever -- that's sold over 95 million units. So, you think, if there's an average selling price of, say, $60 -- and that might not necessarily even include the money people are spending after the fact, once they buy the game -- that would mean that Grand Theft Auto V alone has brought in over $6 billion.

And it's probably even more than that. And that title was released in 2013, and still continues to be the primary revenue generator and earnings generator for Take-Two. So, the power of having a hit title, developing that online experience. I think Take-Two already has a lot of know-how, and they recognize that that's really what you're shooting for. If you can hit one of those, they can just keep milking that for a long time.

Chris Hill has no position in any of the stocks mentioned. David Kretzmann owns shares of Activision Blizzard, Electronic Arts, and Take-Two Interactive. The Motley Fool owns shares of and recommends Activision Blizzard and Take-Two Interactive. The Motley Fool recommends Electronic Arts. The Motley Fool has a disclosure policy.