Analysts: EA 'overpaying' for Take-Two

Industry watchers boggle over Madden NFL publisher's $2 billion bid for GTA maker, agree stockholders will acquiesce to the deal sooner rather than later; TTWO stock skyrockets 54 percent.

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Yesterday, EA decided to put the screws on Take-Two management by making public its erstwhile private $2 billion acquisition offer that would yield an at-the-time princely 64 percent premium to shareholders. Take-Two formerly rejected the proposal on February 19, saying the offer "substantially undervalues" its franchises, creative talent, and consumer loyalty. The publisher also called the proposal's timing opportunistic due to the impending release of surefire hit Grand Theft Auto IV, reasons which have all been formally rebuffed by EA kingpin John Riccitiello. EA has also set up an official Web site to provide a FAQ and other updates on the deal.

Today, industry analysts continue to scratch their heads over why Take-Two's board would turn the offer down, as well as question EA's willingness to drop so much cash on the transitioning publisher. In a company update today, Goldman Sachs analyst Mark Wienkes said that despite popular belief that EA will soon enact a hostile takeover of Take-Two by buying up a majority of outstanding stocks, the publisher will at least raise its bid once more.

"Given all of the moving parts with respect to the assets that may or may not be included in any potential transaction, the relatively small impact to the aggregate offer for each $1 increment to the bid, we think it's rational to expect a higher bid," said Wienkes. EA's initial offer, made in a private letter to Take-Two chairman Strauss Zelnick on February 6 and formally rejected on February 15, offered shareholders a buyout offer of $25 per share. However, Wienkes also cautioned Take-Two with a carpe diem warning, saying "the more protracted this process becomes...the less desirable the target would become, in our view."

In a note titled "Take-Two Declines EA's Offer to Overpay," Pacific Crest Securities analyst Evan Wilson believes that even though EA isn't afraid to reach deep into its pockets, the publisher is squandering its cash by offering so much for Take-Two. "Given that Take-Two's business overlaps EA's in many areas, the uncertainty in the future of the GTA developers, and Take-Two's ongoing legal issues, we believe that EA is willing to pay too high of a price."

To justify the purchase price, Wilson notes that GTAIV must live up to expectations. "For the acquisition to make any financial sense, it needs to be closed in time for EA to realize GTA profits. Without GTA, Take-Two is certainly not worth $2 billion and there is no certainty that the talent behind GTA will stay for the next installment." Wilson also notes that knocking Take-Two out of the sports market would certainly be a boon for the Madden NFL publisher, but "eliminating a competitor in sports brings only a modest benefit."

On the other side of the table, Wilson says that Take-Two shareholders should get behind EA's takeover bid. "EA's $26 offer is more than fair, in our view. [Earnings] of 19x in a GTA year is a significant premium to the historical trading range of second-tier publishers, especially given its struggle to achieve profitability. Given lackluster success outside of GTA, even under current management, the offer exceeds our expectations for TTWO over the next year." Wilson also notes that there are few other publishers in a position to capitalize on what Take-Two can offer, and by dallying, Take-Two's stock outlook has "turned negative since the potential for EA to walk away from its bid is far more significant than the potential upside from a higher bid."

While Wilson feels Take-Two's lack of action is cause for a stock downgrade from "Outperform" to "Sector Perform," Wedbush Morgan Securities analyst Michael Pachter upgraded his stock advisement from "Sell" to "Hold" in a research note this morning. Pachter, who last year outright dismissed speculation of EA offering to buyout Take-Two due to a perceived conflict in corporate culture, unreservedly redressed prior guidance.

"We were shocked and awed by the offer, and our Sell recommendation was wrong," Pachter remarked. "After numerous rumors over the past several years surrounding an acquisition of Take-Two that have been dispelled, a bona fide serious offer has been made. We believe EA fully intends to complete this acquisition, and believe that Take-Two's investors will decide that a sale is the best option for them."

While Pachter laid out the bulk of his reaction to GameSpot yesterday, the verbose analyst lent further insight into the buyout offer today. Rationalizing the deal from Take-Two's perspective, Pachter notes that the deal EA has extended is far better than they'd get from any other media company.

"In our view, the offer is more than adequate," said Pachter. "We agree that Take-Two has several game franchises that have great potential, and acknowledge that its creative talent is as good as any in the industry. However, the company has failed to make a profit for over two years, and although its turnaround efforts are sincere, they have as yet to yield significant results. We believe that EA's offer is significantly higher than the amount that would be paid by a major media company, and think that the company is uniquely positioned to derive synergies from a combination with Take-Two. Other prospective bidders are simply not in the same position to value Take-Two as is EA."

Addressing the likelihood of overlapping products and redundancies created by the merger, Pachter believes some franchises will benefit, while others will invariably follow a more spaced-out release schedule. While Take-Two titles such as Civilization, BioShock, Max Payne, Bully, Manhunt, and Red Dead Revolver will see a bump from the superior marketing and distribution capabilities of EA, titles such as Burnout, Need for Speed, and Midnight Club would necessitate "a more leisurely release of all three franchises."

Pachter also once again addressed the possibility of change-of-control clauses in top developers' contracts. "We found it interesting that EA's offer was not predicated on successfully retaining the Rockstar North studio personnel, nor upon renewing the contracts of Rockstar's founders, Sam and Dan Houser. We believe that this negotiation will necessarily fall outside the terms of the acquisition, as it will likely entail either a significant increase in the compensation paid to the Housers and to Rockstar North, or will entail a separation agreement."

Echoing the sentiments of other analysts, Pachter reiterates that EA is unlikely to tarry in its buyout bid. "We envision this deal playing out over the next few weeks. Although we think that Take-Two management will posture and seek to delay a deal, we think that EA management will make a 'take it or leave it' offer, and expect EA to lose patience in a month or so. Ultimately, we think that Take-Two shareholders will embrace a deal, as virtually all of them will profit immensely and immediately."

As of the end of trading hours on Monday, Electronic Arts was trading down on the New York Stock Exchange by 5.2 percent to $47.14. Take-Two stockholders, on the other hand, have cause to rejoice, as the publisher's stock has spiked an astounding 54.9 percent to close out the day at $26.89.

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