Krause Fund Research Fall 2020 November 17th, 2020 Take -Two Interactive Software, Inc.(NASDAQ: TTWO) Stock Rating: BUY Interactive Home Entertainment Analysts Target Price $200-$210 Daniel Poncer Adam Topping Stock Values [email protected] [email protected] DCF/EP $206.76 Connor Hoeft Hieu Nguyen DDM $144.26 [email protected] [email protected] Relative Valuation (2020 P/S) $181.28 Investment Thesis We recommend a buy rating for Take Two Interactive Stock Performance Highlights WeSoftware, recommend Inc. a We buy believe rating on Take-Two Interactive Software, Inc. We believe the company is currently undervalued considering the projected growth of the industry as a 52 Week High $180.61 result of COVID-19. We expect Take-Two to continue to drive growth through largely 52 Week Low $100.00 successful titles while also expanding its mobile gaming presence and portfolio of games Current Price $162.39 with the release of Madden 2K and the purchase of Codemasters. Share Highlights Investment Drivers: • Take-Two is well positioned to continue to capitalize on pandemic video game Market Cap(M) $18,678.35 buyers. Recurrent consumer spending accounts for roughly 64% of revenue and is Shares Outstanding(M) 115.021 core to their business model. As players continue to engage in Take-Two’s games, Beta 0.66 they are more likely to purchase digital content like virtual currency past the EPS(2021E) $3.14 pandemic. P/E Forward 48.60 • Their continued focus on the mobile gaming space opens avenues to drive revenue growth as category is projected to grow at an annualized rate at 25.3% Company Performance Metrics over the next five years. ROE 17.7% Investment Risks: ROA 8.8% • Dependency on the Grand Theft Auto series leaves Take-Two vulnerable to declining revenues as consumer preferences may change. Financial Ratios • Smaller cash balances relative to its peers could hinder ability to acquire software Debt/Assets 3.08% licensing rights and bid on potential acquisitions targets, stunting future growth. Cash Ratio 1.25 12 Month Performance Company Description Take-Two Interactive Software, Inc. is a Data from leading developer, publisher and 12 Month Return Compared to the S&P Yahoo Finance marketer of interactive entertainment for 50% Take-Two Interactive Software, Inc. S&P 500 consumers around the globe. We 40% develop and publish products through 30% our labels Rockstar Games, 2K, and 20% Private Division, as well as Social Point, 10% a leading developer of mobile games. 0% Our products are designed for console systems and personal computers, -10% including smartphones and tablets, and -20% are delivered through physical retail, -30% digital download, online platforms and 12/1/2019 2/1/2020 4/1/2020 6/1/2020 8/1/2020 10/1/2020 cloud streaming services. 1 Economic Outlook reduced hours are not factored into this calculation regardless of their underutilization. As a result of the pandemic, businesses nationwide have reduced their U.S. Real Gross Domestic Product (GDP) hours of operation affecting many employees. Due to Real GDP represents the market value of goods and this we believe the true unemployment rate to 7.3%, services produced within a given year on an inflation 0.4% points above the Bureau of Labor Statistics most adjusted basis. Therefore, steady gains in real GDP are a recently reported figure. positive indicator of the overall strength of the economy and suggests increased consumer spending and The unemployment rate has continued to steadily decline personal consumption expenditures (PCE). As real GDP from April’s all-time record unemployment rate of declined in the first and second quarters of 2020 due to 14.7% as millions of Americans were laid off as the COVID-19 shutdowns, third quarter real GDP businesses were forced to close. However, with recent increased by 33.1% from the preceding quarter.1 The news regarding positive test results of a COVID-19 rebound in the latest quarter is attributable to second vaccine, we expect this rate to decline slightly into the quarter’s decrease of 31.4% being the largest end of the year and drop to roughly 4% in 2021 Q1 as an quarterly contraction of real GDP in 75 years.2 effective vaccine becomes widely available The increase in third quarter real GDP reflects the for distribution and jobs in the hardest hit industries such continued attempts to reopen businesses that have been as hospitality are able loosen social distancing restricted due to the coronavirus pandemic.3 requirements. Take-Two Interactive has benefitted from stay-at- home orders; however, an extended shutdown will greatly hurt consumer spending on home entertainment. We anticipate uncertainty of coronavirus related news to continue to elongate the recovery of GDP. As cases have seen a resurgence in the recent weeks and restrictions have been reinstated, a slow recovery is imminent. We forecast that GDP will not return to pre-pandemic levels until early 2022. Consumer Confidence The Consumer Confidence Index is the leading indicator in predicting consumer consumption and gives detail on how consumers view the overall economy and their individual financial situations. The University of Michigan puts out a monthly report detailing the index reading and is one of the leading economic indicators in predicting the performance of the American economy 4 as consumer spending accounts for roughly 68% of GDP.6 The most recent report in October gave us a Current Employment Statistics reading of 81.8, a 14.3% YoY decline from 95.5 and much lower than the pre-pandemic reading of 101 in Unemployment rates are still heightened above usual February of this year.7 These results indicate that levels as a direct result of the COVID-19 pandemic. The consumers are less likely to consume as much as they most recent unemployment statistics released by the Bureau of Labor Statistics for October indicated that had prior to this pandemic, and feel more sensitive in nonfarm payroll employment rose by 638,000. The their financial situation. However, due to the release of unemployment rate in October fell to 6.9% but is still positive vaccine results, we believe that this does not nearly double what the unemployment rate had been pre- accurately the true confidence of consumers in the pandemic.5 Due to the way unemployment is calculated, economy. As positive vaccine results indicate a return to many employees that are still employed but working normalcy in the near term, we believe many consumers 2 negatively affected financially by the COVID-19 pandemic will look more favorably upon the economy in the near term and their financial situations going forward. As a result of this, we estimate that the true Consumer Confidence Index to be 89. Industry Analysis Industry Description Inflation The interactive home entertainment is a specific The Consumer Price Index is a measure of the average subset of the media and entertainment industry within change over time that consumers pay for a basket of the communications sector. Companies within the market goods and services and is the most widely interactive home media companies primarily develop, used index to measure price inflation. As a result of the publish, and produce video game software. These companies may internally develop, design, and publish, COVID-19 pandemic, trillions of dollars have been or may exclusively publish titles. A growing operation in pushed into the system to help support capital markets the industry is sale of virtual in-game currency, in-game and to help consumers support themselves as many find add-ons, or other additional content. themselves still unemployed. An influx of cash like this has never been seen before, not even during the financial Recently, the industry has outperformed previous crisis of 2008. This influx in cash has caused the price of expected forecasts as consumers search common goods across the board to raise YoY by for entertainment during widespread lockdowns because 1.4%.8 Without factoring energy costs into the CPI, of the COVID-19 pandemic. Technological advances which has seen cost decreases as global consumption of will continue to drive growth for the industry as oil has decreased, consumer goods such as food has seen consumers online presence continues to increase, YoY price increases of 3.9%. Certain food items such as especially in mobile gaming. As mobile connectivity meat and poultry have seen larger price increases of improves, the smartphone game market will expand rapidly. IBIS World projects that over the next five years roughly 6.3%, used car prices have risen 10.3%, and the the mobile gaming market will grow at an annualized cost to eat out has roughly increased 3.8%. rate of 25.3%. Emerging technologies and high Due to the deflationary effects that energy costs have on consumer spending will drive revenue growth by an the overall CPI, we believe the true CPI has been much annualized rate of 10.1% over the next five years. We higher than reported throughout the pandemic. anticipate continued expansion of online users and therefore, a wider market for video game publishers. As Disregarding the deflationary effects that oil prices have well as a shift from physical manufacturing and had on the overall CPI basket of consumer goods, we wholesaling requirements to online based believe the true CPI to be closer to 3.1%. Higher sales which will contribute to lower future expenses.9 inflation rates harm consumers as their purchasing power is negatively affected as consumer goods prices Industry Trends rise. COVID-19 Impact As a result of COVID-19 shelter in place orders were instituted across the country and internationally. This positively affected the video game industry as 3 consumers restricted to their homes sought other forms of entertainment.