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#1: Take-Two Earnings Signal Weakness Until FY 2025

Take-Two Interactive stock rose to its highest level since April 2022 after the company reported results for FY 2023 that surpassed expectations. Net bookings rose from $846 million in FY Q4 2022 to $1.39 billion in Q4 2023, a 65% gain. This growth was due to two factors: the inclusion of Zynga in Take-Two’s financial results, and a recovery in GTA Online and Red Dead Redemption 2 spending from the same quarter last year. These results exceeded last quarter’s guidance of $1.34 billion in bookings at the midpoint. The stock jumped 11.7% on May 18th, the first trading session following the release.

For the entire fiscal year, net bookings of $5.28 billion marginally exceeded the high end of guidance. The company issued a very cautious outlook for FY 2024 at $5.45-$5.55 billion, well below the consensus of around $6.2 billion. At the midpoint, this would mean Take-Two only expects bookings to grow by 4% year-over-year despite the inclusion of Zynga, which should also see a continued recovery in its mobile portfolio. 

The company recorded two impairment charges that contributed to GAAP net losses of -$610 million for the fiscal year, well below the forecasted -$214 million. The first was a $54.2 million impairment charge, resulting from the cancellation of “several unannounced titles in development” during the quarter. Take-Two announced an aggressive games pipeline in its FY 2022 earnings presentation last year that would have seen it launch 69 titles between FY 2023 and FY 2025, or April 2022 to March 2024. The second impairment was a $465.3 million charge related to the acquisition of Zynga’s assets.

Management sees both impairments as one-off expenses, and these losses are added back to adjusted EBITDA. However, they may pose an ongoing concern not limited to this quarter. Large developers like EA, Take-Two, and Ubisoft have struggled with game development since the pandemic and have frequently pushed back new titles or canceled them outright. Even small losses in efficiency can cause significant disruptions to a game’s launch window, which can, in turn, lead to financial losses. Game development costs have swelled as mainstream consumers demand substantial amounts of content from new AAA titles, and a delay or cancelation can materially affect net bookings.  

Secondly, the Zynga impairment charge calls into question just how successfully the business is being integrated into Take-Two’s broader portfolio. Prior to Zynga, mobile contributed about 12% of Take-Two’s top-line, with $405 million out of the $3.41 billion in FY 2022 net bookings. Now in FY 2023, mobile contributes 47% of net bookings — backing out last year’s sum for mobile, this means that Zynga is about 40% of bookings.

Development staff headcount also jumped from 6,042 to 8,894. This 47% increase is almost all attributable to Zynga, given the challenging hiring conditions present at the other studios throughout the year. This makes the Zynga workforce about one-third of the headcount of the overall business. The lack of disclosure on what the impairment entails is concerning, given mobile has gone from a relative afterthought for Take-Two to a mission critical part of the operation.

Investors ignored the quarter’s GAAP losses and the low growth rate projected for next year as they looked to FY 2025 and beyond. Enthusiasm surrounded CEO Strauss Zelnick’s comments that the period from April 2024 to March 2025 would be marked by "several groundbreaking titles” that would push the company “toward $8 billion in bookings and $1 billion in adjusted cash flow.” These bookings would represent a 45% increase over guidance for FY 2024. Such an ambitious forecast would not be issued for new AAA IP and must  instead be due to the new planned installment in the Grand Theft Auto franchise. 

Assuming a launch during Holiday 2024, this would place the gap between GTA V and GTA VI at 11 years, by far the longest time period between installments. GTA V’s online multiplayer and live service is delivered via GTA Online, which launched a couple of weeks after the main game in 2013. There is still no discussion over whether the next GTA game will have a separate multiplayer mode, and if so, what the timeline for its debut will look like. What is more certain is that Rockstar will publish the game at a $70 price point, which already appears to be the norm for AAA titles this year. This will lead to a 17% increase in unit sales revenue, though the impact on services will depend on content offerings.

Live service growth is a source of optimism for Take-Two stock, which is trading at 4.8x EV/Sales, its highest valuation since last November. The company disclosed that “recurrent consumer spending” now makes up 78% of net bookings, up from 64% in FY 2022. Note that some of this is due to the Zynga acquisition, while another portion is due to waning GTA V/RDR 2 unit sales while content spending remains strong. Take-Two’s EV/Sales ratio is higher than its peers, including Nintendo at 3.1x, EA at 4.5x, and Ubisoft at 1.6x. Activision is trading at 6.5x, though this is distorted by its deal premium due to the ongoing acquisition.

Take-Two’s results for the next three or four quarters will not be very impactful for the medium to longer term thesis of the company. What will be important for the next year is commentary surrounding GTA VI, the launch of which cannot afford to come any later than FY 2025. It is remarkable that Take-Two and Rockstar North have created a product that continues to sell well more than a decade later, but a well-executed launch of GTA VI within the next year and a half is mission critical for the type of revenue growth and margin profile Zelnick is envisioning. 

Even at $1 billion in FCF for FY 2025 though, Take-Two stock looks rich at 25x EV/FCF. Continued integration of the Zynga portfolio, successful execution of GTA VI, and an adherence to the new, leaner FY 24-26 pipeline are all integral to support the company at its current valuation and to facilitate market-beating growth going forward. 

#2: Ubisoft’s Problems Will Take Years to Resolve (If Ever)

Ubisoft shares slid after the French video game publisher reported lackluster results for FY 2023. Net bookings of €1.74 billion were down more than 18% from a year prior, and were lower for a second consecutive year. Bookings are now lower than five years prior in FY 2019, when the company first started reporting the metric in addition to IFRS sales. IFRS operating income plunged into loss territory for the first time since FY 2020, though at -€586 million was by far the widest loss ever reported. Adjusted operating income was slightly better at -€500 million, which adds back €62 million of stock-based compensation among various other items.

Ubisoft is focused on shoring up profitability via cost cutting measures. The company’s website still shows 21,000 employees across the business, but CFO Frédérick Duguet stated in the press release that total headcount dropped below 20,000 during the quarter. This amounts to a reduction of around 5%, which appears to have been executed without much fanfare. There is also a cost reduction plan of at least €200 million underway, which is expected to be realized by FY 2025. 

In an e-mail to employees in January, CEO Yves Guillemot instructed workers to brace for the dismal full-year results and improve their efficiency. With morale already low due to allegations of misconduct, sexual harassment, and toxic behavior within the company, employees at the Ubisoft Paris office went on strike. 

Employees, gamers, and investors alike have been dissuaded by numerous canceled projects since last year. In July 2022, Ubisoft canceled Ghost Recon Frontline, Splinter Cell VR, and two other unannounced projects. Guillemot’s e-mail on January 11th came concurrently with a press release indicating three additional cancellations, none of which were yet made public. 

In terms of other new IP, Ubisoft Singapore’s action-adventure game Skull & Bones has been delayed at least six times, and was originally set to be released in Q3 or Q4 2018. The game was supposed to rival Rare’s Sea of Thieves, which is Microsoft’s most successful exclusive of the eighth console generation. Guillemot lamented recently that Ubisoft has not yet integrated live services successfully in with its IP. Skull & Bones, which is confirmed to feature microtransactions, appeared to be the best shot of accomplishing that goal. But five years after the game was initially promised, excitement for it has waned and player engagement is likely to underperform. 

At €24.46 a share as of May 19th, UBI is trading at October 2007 prices. Since then, revenue has nearly doubled from €928 million, while margins have completely vanished. The revenue comparison looks much less impressive when translated to USD, with FY 2008 revenue of $1.46 billion versus $1.96 billion in FY 2023.

Seven titles are slated to be released by FY 2024, including an unannounced title. The company is projecting “strong growth” in net bookings and €400 million in adjusted operating income. Both of these targets seem ambitious, given one or more of them is likely to see delays. In addition, the Q1 FY24 forecast of €240 million in bookings would be 18% lower than the same quarter in FY23, indicating extremely low sell-through in the back-catalog, given the implied lack of new releases. It would also mark the worst first quarter for net bookings since FY 18, when the back-catalog comprised 94.3% of total sales.

In its earnings report, Ubisoft released details about its plans for the Assassin’s Creed franchise. The company plans on fueling an “ambitious expansion” of the franchise by increasing the series’ staffing by 40% over the coming years. Ubisoft notes Assassin’s Creed is one of its “biggest growth opportunities,” and talent will be reallocated to its development from elsewhere in the business. 

It does not appear that the next Assassin’s Creed will be a live service title, as developers have called Assassin’s Creed Mirage smaller and more focused. Main-line installments in the series typically have a one- to two-year gap between releases (Valhalla to Mirage will be three years). The type of live service game that Ubisoft is envisioning will probably take a minimum of three years of development, which would be in FY 2027 at the earliest.

To Ubisoft’s credit, the Assassin’s Creed franchise continues to sell well 16 years after the first installment appeared on the PS3, Xbox 360, and Windows. The company disclosed that Valhalla “has 44% more players life-to-date than Assassin’s Creed Origins and 19 percent more than Assassin’s Creed Odyssey on a comparable basis.” Valhalla also has “materially higher revenue per player,” leading to much higher net bookings for the game. 

In addition to its dearth of live service games, one of Ubisoft’s biggest challenges has been cracking mobile. According to data.ai, Ubisoft generated $46.2 million in mobile revenue between April 2022 and March 2023, corresponding with the last fiscal year. This amounts to about €43 million, or 2-3% of total IFRS revenue for the year. A recent partnership with Tencent aims to boost its standing in mobile games, which saw the Chinese technology giant purchase a $297.2 million minority stake in the Guillemot Brothers’ investment vehicle that owns 29.9% of Ubisoft.

With a market cap of just over €3 billion and a sizable back catalog that continues to sell relatively well, the company on paper seems like a prime acquisition target. But the Guillemot Brothers are hesitant to give up control, and scrutiny over acquisitions in the video games industry has never been higher. These two factors have sapped any sort of deal premium embedded in Ubisoft’s stock, which may return were there a change in developments. In terms of Tencent as a suitor, its recent stake only gave the company 5% voting rights in Guillemot Bros, and while it has the option to increase its direct stake in Ubisoft to 9.99%, it cannot increase it further for a period of eight years. 

Ubisoft has gone from a seasoned cash-flowing game publisher behind multiple popular franchises to a turnaround story in under two years. Its rock-bottom valuation among its peers is justified given the lack of a clear pathway towards sustained profitability. Delays and cancellations continue to plague the company’s various studios, and a cessation of these should represent the very first step for Ubisoft to get back on track. 

Top Movers

• For the week ending May 19th, 2023: the average return for gaming companies tracked by Naavik with a market capitalization exceeding $500 million was 0.7%. The S&P 500 returned 1.7% and the Nasdaq-100 returned 3.5%.
• Markets were led by mega cap tech stocks last week as the Nasdaq-100 surged to 52-week highs. Sentiment has improved around debt ceiling discussions in Congress, which are pressing given the Treasury is expected to run out of funds by June 1st. Treasury yields rose sharply as weekly jobless claims continued to beat expectations, though the correlation between technology stocks and bond yields appears to have dissipated. 
• AppLovin (APP) continued to trend higher, gaining 16.8% last week, following an increase of 25.4% the week prior after reporting earnings that beat expectations. Shares rallied after BofA analyst Omar Dessouky upgraded the stock to buy and increased his price target, citing the release of Axon 2, the company’s machine-learning engine which connects app users with relevant advertising content.
• Take-Two Interactive rose by 9.7% after beating bookings guidance in the current quarter and issuing an optimistic forecast for FY 2025. While reporting cautious guidance for the upcoming fiscal year, management stated that net bookings would be 45% higher in FY 2025 over 2024, a factor almost certainly attributable to the release of GTA VI. 
• Embracer Group plunged -20.9% after the company revised their EBIT forecast for FY 2023 from SEK 8.0 - 10 billion to 6.35 billion. The reason cited was Embracer’s press release from March 27th, which pushed back the closure of several “transformative partnership and licensing deals” from FY Q4 2023 to Q1 2024. 
• Sea Limited and IGG fell -18.1% and -16.5% respectively after reporting results that missed estimates. Sea’s gaming segment Garena extended its slide, with bookings falling to $462 million as compared to $544 million for the previous quarter. IGG fell for a second week following its multi-week surge which saw shares more than double year-to-date through the first week of May.

Other News

• Saudi Arabia’s Public Investment Fund filed its quarterly 13-F, covering investments for the first quarter of 2023. The fund increased its stakes in EA and Sea, and now owns 8.4% of EA, up from 6.3% previously reported. This amounts to 8.8 million shares bought in Q1, or between $959 million and $1.13 billion depending on the purchase dates. Its holdings of other video game companies like Nintendo, Activision Blizzard, and Take-Two Interactive were unchanged. (Link)
• FaZe Clan laid off 40% of its remaining staff in May, after terminating 20% of its employees just three months ago. The company has faced both financial turmoil and internal dissatisfaction since its SPAC last July, after which shares plunged by over 90%. Since February 7th, its stock has traded below $1, and FAZE risks delisting from the Nasdaq if it does not fall into compliance by September 19th. (Link)
• Microsoft’s acquisition of Activision Blizzard received two major approvals. The first was from the EU’s European Commission, which found Microsoft’s numerous 10-year cloud gaming licensing deals with its competitors to be sufficient remedies. Later in the week, China’s State Administration for Market Regulation (SAMR) approved the deal unconditionally, despite the ongoing lawsuit filed by NetEase against Blizzard surrounding breached licensing agreements. (Link)
• Blizzard scrapped Overwatch 2’s PvE Hero Mode, which was supposed to launch at a later date following the multiplayer release. In a blog, game director Aaron Keller said the Overwatch team could not fulfill the “ambitious” vision that was shared at Blizzcon 2019, which would have “allowed players to upgrade individual heroes through talent trees” in a replayable experience. The team is continuing to move forward with Story Missions, which are focused on co-op gameplay in a linear narrative. (Link)

A big thanks to Mario Stefanidis, CFA for writing this update! If Naavik can be of help as you build or fund games, please reach out.