MT Insider: Calculating the Impact from TTWO's Grand Theft Auto Sales, 40% Earnings Upside - Potential $35 TP


Take-Two Interactive's ( TTWO ) 5th version of Grand Theft Auto 5 (GTA 5) sold $800M in world-wide retail sales on its first day, September 17. This is well known across media, but what does it mean with regards to potential earnings upside?

First, let's take a step back and put this into perspective. GTA 5's $800M in sales on day 1 compares to $310M of sales on day 1 for the 4th version of GTA and $500M on day 1 for Activision's ( ATVI ) Call of Duty "Black Ops 2."

GTA 5 is the highest-rated game of all time on Microsoft's ( MSFT ) xBox 360, according to Metacritic, and the second highest-rated game on Sony's ( SNE ) PS3.

Let's get to the numbers. Back of the envelope, using the average selling price of $90 for GTA 4, would equate to 9 million units sold ($800M/$90) on the first day.

This is significant given that 8.5 million units were sold for GTA 4 in its first month, yes, the first month. GTA 5 was launched on September 17, which means there are still more than 10 days left until the end of Q2 (September 31).

Obviously, the high run rate in unit sales from Day 1 will not continue. In the past, similar games have sold between 1.6-1.8x the number of sales on the 1st day in its 1st week, according to Bank of America.

Using the mid point of the range at 1.7x would imply an additional 5M units sold (9M units/1.7). Adding in 1-2M units for inventory build, GTA 5 could ship upwards of 16M units in fiscal Q2 alone (9M units + 5M units + 2M units).

Now we need to estimate what the street was expecting, as the stock will react based on the differential from consensus (and not just on the headline alone).

Consensus is currently at $820M in revenues for Q2. Console revenues are typically 75% of total revenues (the rest would be PC and handheld). Thus, assuming 75% was the forecast for GTA 5 would imply $620M in console revenues ($820M multiplied by 0.75). Applying this to an ASP of $90 would indicate that the street was guessing approximately 7M units would be sold in the quarter.

At a retail price of ~$90 and the wholesale (or cost) at ~$70, the delta would equate to pure profits, which is around $20/unit. Based on the estimate of 7M already baked into consensus, it is fair to assume an additional 9M units were sold that the street had not expected (16M estimate - 7M street). Multiplying this by $20/unit is equal to an additional $180M in profits.

The next step is calculating the earnings impact. Assuming a 35% tax rate would imply $117M in after tax profits. On 121M shares outstanding (which is the street's estimate for Q2), would be equivalent to ~$1.00 earnings in upside for Q2 alone ($117M/121M shares outstanding).

This compares to the current estimate of $1.41 for Q2 and $2.50 for FY14 on the street. Adding in $1.00 in earnings power is equal to $3.50 in earnings for FY14 (40% earnings upside from consensus).

On valuation, TTWO is trading at 10x forward earnings versus its 5 year average of 8x. This compares to Electronic Arts ( EA ) at 20x and Activision ( ATVI ) at 15x, respectively.

Assuming no multiple expansion, $3.50 per share on a 10x multiple would equate to a $35 target price (versus the company's closing price of $17). Thus, the risk/reward ratio is extremely compelling at these levels.

It is worth noting that there are still risks given intense competition from EA's Madden 25. That said, GTA 5 unit sales have set a record, suggesting that a focus on specific titles such as Madden and Grand Theft Auto is critical to the gaming sector.

Similar to movie franchises such as Walt Disney's (DIS) Avengers (trading at 17x forward earnings), and Lions Gate Entertainment's (LGF) Hunger Games (trading at 25x forward earnings), this a net positive for the entire industry and thus, should likely warrant higher multiples.

Perhaps, content is also king in gaming.

TTWO 17.48 +0.05 +0.29

ATVI 17.12 +0.02 +0.11

EA 26.99 +0.01 +0.06

DIS 65.65 -0.07 -0.11

LGF 35.60 +0.15 +0.42

MSFT 33.65 +0.01 +0.03

SNE 21.63 0.00 0.00

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

Copyright (C) 2014 All rights reserved. Unauthorized reproduction is strictly prohibited.

This article appears in: Investing , Commodities

Referenced Stocks: ATVI , EA , MSFT , SNE , TTWO

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