Pachter: Studio Closures, Cancellations, GTA Delay Loom At Take-Two

Ahead of Take-Two's June 11th Q2 earnings call, Wedbush Morgan's Michael Pachter says the publisher will announce announce studio closures, lease terminations, game cancellations, and push back Grand Theft Auto IV's release date as new management struggles to turn the company around. Pachter says Wedbush is maintaining Q2 sales estimates of $181 million, lower than consensus estimates of $202, with NPD sales data implying that the publisher's sales are down 23 percent from the year prior. "Shareholders apparently believe that new management has the 'magic bullet' required to reverse the company’s recent history of consistent quarterly losses," says Pachter, adding that "although we are impressed with new management and believe that they will ultimately succeed in turning Take-Two’s fortunes around, we think that the turnaround will take more than a year to complete." "Accordingly," he adds, "we continue to believe that the company is overvalued on its fundamentals, and advise shareholders to sell." He continues: "We believe that new management understands what is required to turn the company’s fortunes around, and believe that they will take prudent steps to return the company to profitability. However, we believe that there are significant structural changes required in order to control costs, and believe that these changes will take more than a year to complete. On the revenue side, new management is saddled with the decisions made by the prior management for at least another year, and we do not expect new games such as The Bigs, All-Pro Football, Fantastic Four, or The Darkness to be wildly profitable. We also think that the new management will take steps to cut costs as soon as practicable, resulting in studio closures and charge-offs for games in development." On the new management's strategy, and in particular its plans for what will surely be Take-Two's biggest title of the year, Pachter says: "In its first conference call with investors, new Take-Two management did not update its predecessors’ FY:07 guidance for revenue of $1.2 – 1.25 billion and EPS of breakeven. We did not consider this to be a reiteration; rather, we believe that the new management team was not yet prepared to reaffirm prior guidance, nor was it prepared to lower guidance. With an additional 10 weeks of experience, we expect the new management team to lower guidance for FY:07 significantly. We believe that it is possible that the company will choose to “throw in the towel” on FY:07 by shifting the release date for Grand Theft Auto IV by a few weeks, increasing the losses incurred this year and improving the company’s prospects for FY:08. We believe that a two-week delay would provide a reasonable gap between the launch of Halo 3 and the launch of GTA IV, and would actually help sales of both games. In addition, a delay of the “normal” SKU for GTA IV by two or three weeks could allow Take-Two to maximize revenues from the $89.99 Collector’s Edition of the game by shipping that SKU on October 17, and to increase overall profitability." On the studio's overall portfolio and increasing competition, he adds: "We continue to believe that at current levels, Take-Two shares are overvalued. In our view, the company faces an uphill battle in turning around its history of generating losses in a strong video game environment. We think that heightened competition from the competitors above will limit Take-Two’s ability to grow its market share, and we continue to believe that its sports experiment is misguided. While we believe that new games like The Bigs and All-Pro Football are likely to receive critical acclaim, we are not sanguine about their prospects in a competitive sports market. We expect to see increased resolve from competitor Electronic Arts in defending its sports dominance, and think that new CEO John Riccitiello is a formidable adversary determined to bury Take-Two’s sports effort." Pachter concludes, "We continue to think that the loyal Take-Two shareholder base faces a prisoner’s dilemma—choosing to stay the course and hope for a return to profitability in FY:08, or to sell their shares. Shareholders gain if everyone chooses to cooperate, but if any large shareholders choose to sell, the remaining shareholders will likely lose. We continue to believe that the company is overvalued on its fundamentals, and advise shareholders to sell."