Now that talks between Electronic Arts and Take-Two have concluded with no agreement, what now? Analysts had generally agreed that the proposal would turn out to be a huge value add for both companies and their investors -- so why couldn't they work it out?
The major dispute, both Cowen Group's Doug Creutz and Wedbush Morgan's Michael Pachter agree, is on the valuation of the company. Although Take-Two has had impressive financial results month after month since the release of Grand Theft Auto IV, giving board chairman Strauss Zelnick plenty of ammo to angle for a higher price, Wedbush Morgan analyst Michael Pachter has doubts about the sustainability of this performance.
"Take-Two’s earnings were outstanding, but several balance sheet items cause us to expect a reversal of fortune next year," says Pachter. "At the same time, key Rockstar employees Sam and Dan Houser are free agents in February 2009; we question whether Take-Two can retain them, and if so, at what cost?"
Cowen Group analyst Doug Creutz has a different view; "We believe the fundamental outlook for sustained growth and more consistent profitability at Take-Two continues to strengthen," he says. Creutz surmises the two companies could've gotten a deal done in the $28-$30 price range, and guesses that what happened here was that EA didn't want to pay that much.
Though Pachter admits that one can only speculate on the reason why the companies broke off negotiations, he disagrees that EA undervalued Take-Two, as Take-Two board chairman Strauss Zelnick had always maintained it did.
"In our view, EA’s late February offer was too high from the beginning, representing a premium of around 50 percent to the closing price of TTWO shares immediately prior to the offer," he says.
"We believe that EA recognized that it had overplayed its hand in making an offer for Take-Two," Pachter adds. "We also think that Take-Two management overplayed its hand in warding off the unwanted offer from EA."
Part of Take-Two's "hand" had included several comments by Zelnick that said that Take-Two was entertaining interest from other interested parties. So did they play a role here?
"Despite its repeated comments about other interested parties, it appears that none were serious enough to make a firm offer," says Pachter.
Pachter says that Activision and Ubisoft, the only other independent publishers large enough to afford Take-Two, can't offer the same synergies as EA, given their lack of a strong sports portfolio. And for different reasons, neither of them is in the right spot for a merger right now, Pachter adds -- for its part, Activision just completed its own major merger with Vivendi.
So analysts agree the dissolution of talks between EA and Take-Two had nothing to do with a third party, and Creutz and Pachter also agree that EA wasn't willing to raise its bid to match what Take-Two thinks it's worth, although they disagree on whether or not it's worth more. Pachter seems to think Take-Two's the one who lost out here, while Creutz doubts EA can make its $1.5 billion fiscal year 2011 target without the value add it would have gotten from a deal, even at a higher price.
Says Creutz, "We think EA's decision to walk was motivated by some combination of the following: a desire to appear fiscally responsible after several years of capital misallocation; concern about EA's ability to retain the development talent at Rockstar; personality conflicts between the management teams of the two companies, and skepticism about Take-Two's multiyear release lineup."