It's the hot coffee that keeps on burning. Shares of videogame maker Take-Two Interactive (TTWO) fell out of bed on June 27, a day after the company disclosed the New York County District Attorney is investigating its inclusion of hidden sex scenes, commonly referred to as "hot coffee," in a best-selling game.
Take-Two said on June 26 that it had received grand jury subpoenas from the New York County District Attorney's office, just weeks after settling with the Federal Trade Commission on charges arising from the Grand Theft Auto: San Andreas scandal. The company's stock plunged 16% the following day, closing at $10.85, the lowest in four years.
Rx NEEDED. It's been more than a year since Take-Two landed in hot water over the embedded minigame. Sales of Grand Theft Auto: San Andreas plummeted after the Entertainment Software Ratings Board gave it an Adults Only designation. Afterward, retailers swiped it from shelves, and the FTC launched an investigation (see BusinessWeek.com, 9/8/05, "Take-Two Is Off Its Game").
Now the New York County District Attorney's office wants to get in on the act. It has requested company documents from as far back as 2001 concerning Take-Two management's knowledge of the racy minigame as well as a host of other matters, from acquisitions to the company's decision to switch accounting firms.
Take-Two said it "had not been advised that it or any specific individual is presently a target of the investigation." Still, the renewed scrutiny and the prospect of indictments have investors jittery and raise questions anew over how soon Take-Two can rebound.
WII WORRIES. In a research note after the announcement, Citigroup's (C) Liz Osur cut her 12-month target for Take-Two's share price to $9—from $12—and stuck to a June 8 recommendation that investors sell the stock. Having key Take-Two executives engulfed in legal battles could delay game development and compound losses, Osur wrote.
It's not helping matters that Take-Two has yet to announce software for Nintendo's planned next-generation gaming console, the Wii. Take-Two essentially ignored the predecessor GameCube console, but analysts expect the Wii to be a much bigger seller. A Take-Two spokesman declined to comment on Wii developments, although BMO Capital Markets' Edward Williams says that, down the road, Take-Two is likely to announce some titles, mainly sports-themed, for the Wii.
There's plenty more bear-case building material. Take the abrupt January resignation of Take-Two's chief operating officer, Gary Lewis, and board member Barbara Kaczynski. "There was something definitely there for those guys to head for the exits," says Sterne, Agee & Leach analyst Arvind Bhatia, who also has a sell rating on Take-Two.
In a research note, Wedbush Morgan's Michael Pachter said the investigation could probably last up to two years and keep investors skittish through the release of the highly anticipated Grant Theft Auto IV, which Take-Two says it will debut on Oct. 16, 2007. Pachter has Take-Two on a "hold," and suspended his 12-month target price.
PICKED CLEAN? Williams of BMO Capital Markets says Take-Two's troubles are magnified because the gaming industry's state of flux as console makers—Microsoft (MSFT), Sony (SNE), and Nintendo—all introduce next-generation playing machines. Hence, many buyers temporarily defer purchases. "Their woes are exaggerated by the industry's melees as you transition from one console to the next," he says.
Even after the stock's recent plunge, Williams ranks Take-Two at "outperform," holding a 12-month price target of $16. In light of the recently completed FTC investigation and the 2005 conclusion of a multiyear Securities and Exchange Comission accounting probe, he says there probably isn't much left for the New York District Attorney to uncover.
In addition, Williams says Take-Two's acquisitions should pay off with some solid titles, and the company's success may come down to how well it can follow through with big efforts like next year's installment of the Grand Theft Auto series. "The bigger question is, can these guys actually execute in a reasonably flawless manner?" he says.
Still, even Williams isn't sure Take-Two will remain independent. He says the dropping share price makes it an attractive takeover target. Buyers may first want to ensure it’s no longer an investigation target.
Bergfeld is an intern for BusinessWeek.com in Silicon Valley
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