Video Game Champs

S&P's Jim Yin discusses his outlook for game developers Electronic Arts, Take-Two, Activision, and THQ, as well as the sector as a whole

by Jim Yin

SyndicateCategory: Investing, Mergers & Acquisitions, Software, Stock Recommendations, Technology, Video Games

While the battle rages on, video game maker Electronic Arts (ERTS) is likely to win the fight to take over Take-Two Interactive Software (TTWO), says Jim Yin, who follows entertainment software companies for Standard & Poor's Equity Research. He believes EA's $26-per-share offer for Take-Two is already high, given the company's "lumpy" earnings and reliance on one franchise: Grand Theft Auto. Still, he thinks EA will have to raise its bid before declaring victory.

On Mar. 26, Take-Two rejected EA's offer, saying it was inadequate, and adopted a poison pill—a move Yin says was expected. Then, on Mar. 28, EA extended its tender offer to Apr. 18 from Apr. 11. Last month, Yin downgraded EA shares to sell from hold, saying he thinks EA would have difficulty keeping key Take-Two employees and achieving synergy if the merger goes through. He has a hold opinion on Take-Two shares.

In the meantime, Activision (ATVI) looks like a real winner to Yin. On Mar. 28, he upgraded Activision to buy from hold. He likes the company's game franchises, and its deal to merge with Vivendi Games will boost earnings, he says.

BusinessWeek.com's Karyn McCormack spoke with Yin about his view of the video game software industry (for more, see our special report). Edited excerpts of their conversation follow.

Do you think the EA/Take-Two deal will ultimately get done?

I do think, eventually, EA will acquire Take-Two. The main reason is its offer of $26 is substantially higher than what Take-Two was trading at prior to the announcement. And I think it will be difficult for another buyer to come up with anywhere near the $26-per-share it is offering. It's a slight discount to the industry in terms of price-earnings. However, Take-Two's earnings are lumpy, because they're tied predominantly to one franchise: Grand Theft Auto.

Take-Two plans to launch the latest version—Grand Theft Auto IV—on Apr. 29. This is the best-selling game franchise, and we expect it to be very profitable. For Take-Two, I project earnings per share of 91¢ for fiscal 2008, ending in October. This fiscal year will include most of the revenue from Grand Theft Auto, but beyond that we expect earnings to drop off.

So, I think the price EA is offering for Take-Two is fair. I don't expect another company to match EA's offer. Take-Two is playing hard to get. When shareholders have a chance to vote, I think they will accept it. Without this offer, the shares could drop off to somewhere near the level before the bid—around $18.

I think Take-Two wants to extract a higher value by seeing initial sales of Grand Theft Auto IV, in hopes EA might raise its offer. EA already raised its bid by a dollar, and it could go up another dollar or two to close the deal. That's why I have a $28 price target for Take-Two.

Do you see more deals in the group?

I think THQ (THQI) could be a potential takeover target. The stock has rallied a little, to 22 from 18 earlier this year.

Activision already announced it is in process to merge with Vivendi Games, a division of Vivendi (VIV.PA). We expect this deal to close soon.

What are your favorite stocks?

I upgraded Activision to buy from hold on Mar. 28. I downgraded it to hold from buy several months ago when it announced the deal to merge with Vivendi Games, thinking that the deal will limit near-term upside potential since Vivendi will be acquiring a majority stake at $27.50 a share.