Street's two takes on Take-Two

Recent surge, upgrades come despite wobbly past, 'disaster' quarter

Perhaps all the bad news is behind Take-Two Interactive Software. The company behind some of the most controversial video games in the industry is in the midst of a regulatory investigation, already has been through a boardroom takeover and has been chastised for hiding lurid sex scenes in its games. It also has delayed an important release and seen its stock tank.

But most of that is old news. Take-Two shares have risen 20% since March, the same month five board members were ousted and the company was taken over by chairman Strauss Zelnick and new CEO Ben Feder.

Judging by the enthusiasm of some, Take-Two's new management can do no wrong. Case in point: When the company announced its sixth consecutive quarterly loss this month — missing Wall Street estimates by a mile — shares rose and analysts were actually impressed.

JP Morgan analyst Dean Gianoukos upgraded the stock after the report from "neutral" to "overweight," guessing that all "the negative sentiment" was already priced into shares. He also called the impending launch of "Grand Theft Auto IV" a large near-term catalyst for the stock.

Likewise, Janco Partners analyst Mike Hickey recently raised his price target on Take-Two shares from $25 to $28, impressed that, while not profitable, the company at least has $109 million in cash on the books. Shares closed Wednesday at $20.42.

But what has changed at Take-Two to warrant a price surge and bullish prognostications from some analysts? Not much, more bearish Wall Street observers say.

Wedbush Morgan Securities analyst Michael Pachter, for example, says that Take-Two shares are overvalued because of persistent speculation of a takeover that he thinks isn't going to happen.

"The stock is trading on the greater fool theory," Pachter said. "Investors expect a $2 billion offer to come in, but there are other acquisitions out there that are less of a hassle."

Take-Two had a market capitalization of $1.5 billion at the close of trading Wednesday, and Pachter says any entity in the market for a video game company would do better to purchase THQ Inc., which is profitable, has no public-relations baggage and sports a market cap of $2.1 billion.

Pachter estimates that Take-Two could grow into its current market cap by increasing operating income by about $100 million annually, which could take four years, he says.

The company recently started addressing its profit-ability, though, saying it would cut costs by $25 million in part by laying off a "significant percentage" of its 2,100-person work force. The company also said that it was considering shedding its Jack of All Games and Joytech operations in order to focus on its Rockstar Games, Global Star Software, 2K and 2K Sports labels.

More immediate problems with Take-Two are that its "Manhunt 2" release recently was "temporarily suspended" after the game received an Adults Only rating, and its "Fantastic Four: Rise of the Silver Surfer" has been getting dreadful reviews.

"They only had two products this quarter, and both are a disaster," Pachter said.

If "Manhunt 2" were to be released with an AO rating, that would keep it off of the Play- Station 2 and Wii platforms and off the shelves of many large retailers. Plus, Pachter argues, the "Manhunt 2" and "Silver Surfer" situations reflect a problem that Take-Two's new management might have with its creative talent.

"Someone needs to let the children know you can't make adult-only games; instead, management defends their developers as 'artists.' But stockholders are investing in a company, not a piece of art," Pachter said. "What's the point of making an AO game? Just to prove you can? It would be like the next 'Die Hard' movie getting an X rating. Someone at Fox would get fired."

While the bulls and bears haggle about Take-Two's prospects, some are content to occupy the sidelines for now.

One manager of a private fund who invests exclusively in the video game sector says he is not short or long Take-Two for now, eager just to watch the reaction to the fall release of the latest "Grand Theft Auto," which will sell for a hefty $60 per copy.

"The industry has yet to experience a $60 title being a 5 million-plus seller for a third-party publisher, so few fully understand the potential effect," the money manager said. "A loser would kill Take-Two's valuation. A big winner could double the stock."
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