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Take-Two Interactive Software Inc Continues To Be a Winner

There’s Activision Blizzard, Inc. (NASDAQ:ATVI) and Electronic Arts Inc. (NASDAQ:EA). And then there’s video game developer Take-Two Interactive Software Inc (NASDAQ:TTWO). While EA and Activision see more success from some game franchises than others, each strives for a diversified portfolio of games. But owners of TTWO stock know the company has focused on squeezing as much life as possible out of just a small number of proven titles like its Grand Theft Auto series.

It’s not just a diversity/focus dichotomy that distinguishes Take-Two from other game-makers. Activision Blizzard and Electronic Arts both offer downloadable games. And their preference has been and remains disc-based delivery. Take-Two Interactive Software, conversely, seems to thrive on selling downloads, though it does create discs and cartridges.

It works. The company flipped the proverbial switch last year. Since the beginning of 2017, TTWO stock has rallied more than 140%.

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You can’t chalk up the stock’s amazing runup to its different strategy and delivery initiatives, however. While they certainly matter, there’s a third reason Take-Two has been and will continue to be a winner. Even if it’s a bit controversial.

Take-Two Rewards the Right Things

To be clear, most CEOs are at least partially compensated based on their company’s performance, even if only in the form of stock awards. But Take-Two Interactive Software takes the idea of incentives to an extreme.

For one, Take-Two’s CEO is not compensated directly by the company. Rather, CEO Strauss Zelnick is paid through a partner media company called ZelnickMedia. Zelnick is one of the principals of the private equity company. He receives no more than 60% of the firm’s total compensation from Take-Two.

That’s not the interesting and encouraging part of compensation structure, though. What’s curious is how the deal is structured, incentivizing EBITDA rather than mere revenue, and offering compensation based on the stock’s relative performance over the long haul.

You can bet that changes the way Zelnick leads the company. In most regards, it sets the stage for less risk and more profitability.

Yes, more digital sales is one of the outcomes of the compensation plan. Take-Two has gotten very, very good at higher-margin downloads of games and other content. As Chris Tyler explained it earlier this month, “Take Two’s ‘best-in-breed’ digital revenues have allowed the company to smooth out and monetize its hit game franchises better than ever.”

TTWO Stock Boosted by Risky Business

The structure also rewards doubling down on proven game franchises rather than developing new ones … a significant risk in the game-making business. BMO Capital Markets analyst Gerrick Johnson noted earlier this month:

“In the past, the knock against the company had always been that it was overly reliant on just a few games, most notably ‘Grand Theft Auto,’ creating a lumpy, unpredictable, and risky earnings stream. But in the digital era this is a competitive advantage. By having some of the highest-quality games, and periodically dropping additional content, Take-Two can keep its players engaged and spending in its games without having to reinvent the wheel every 3-5 years. The company’s earnings stream is now predictable, reliable, and much less risky.”

Investors aren’t looking to fix what isn’t broken (for them). But it’s worth noting not everyone may be thrilled with how the company calculates its EBITDA figure. Namely, the SEC has made it clear the way Take-Two calculates its revenue is a regulatory no-no. It’s complicated, but the simplified version is Take-Two books revenue when it gets the money. It arguably shouldn’t be booking those sales until the service or good is delivered. And it matters because had Take-Two kept books in accordance with the SEC’s standard, TTWO earnings of $1.09 last quarter would have been a loss of 3 cents per share instead. Adjusting for GAAP standards may have also crimped the company’s EBITDA, which is the key to Zelnick’s paycheck.

All the same, even though company accountants arguably shouldn’t be counting deferred revenue, in this case the non-GAAP metrics are a more meaningful picture of the company’s health.

Bottom Line for TTWO Stock

In the shadow of a 140% rally in less than eleven months, and valued at a trailing P/E of 70.4, it’s tough to step into Take-Two Interactive Software right now.

After a healthy pullback though, it’s a different story. This is a company in which management and shareholders are very much on the same page. The game portfolio is a bit scant, but for Take-Two and owners of TTWO stock, the “quality over quantity” thing is working out quite well.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter, at @jbrumley.

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