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Morningstar | Take-Two Reports Mixed End to Fiscal 2019; Recurring Revenue Remains a Key Driver

Take-Two ended its fiscal 2019 on a mixed note as fourth-quarter revenue came in just under Street estimates and EBITDA slightly beat expectations. Results continue to be driven by NBA 2K19, Red Dead Redemption 2, and GTA V. The company issued weaker-than-expected guidance for fiscal 2020, particularly for revenue, but came in ahead of our below-consensus estimates. We are maintaining our narrow moat rating but are raising our fair value estimate to $118 from $114 as we have increased our fiscal 2020 estimates in light of the new guidance. While we continue to believe RDR2 will have a shorter revenue tail than GTA V, the implied growth and continued strength for both GTA V and NBA 2K are impressive, especially given the age of the fifth installment of GTA. With shares trading in 4-star territory versus our updated fair value, the current levels may provide an attractive entry point for investors.

Non-GAAP net bookings of $488 million (up 19% year over year) were driven by recurrent revenue spending (up 27% year over year and 62% of total net bookings) in NBA 2K19, GTA Online, and RDR 2. Digitally delivered net bookings in the quarter expanded by 26% to $419 million and made up 86% of non-GAAP net bookings, up from 81% a year ago. Digital full-game sales for current titles increased to 57% of sales, up from 44% a year ago, well ahead of the firm’s full-year fiscal 2019 target of 37% which Take-Two just beat at 38% for the year. Non-GAAP EBITDA was roughly flat at $112 million, but EBITDA margin declined sharply year over year to 22.9% from 27.4%. The margin decline was due in part to increases in royalties and marketing expense attached to RDR 2 more than offsetting the growth in high margin recurrent revenue.

As we noted last quarter, the strong launch of RDR2 with sales over 24 million demonstrates the strength of Rockstar Games beyond the GTA franchise. While RDR2 has already handily outsold its prior installment, we continue to believe that the game will not have as long of a tail in terms of lifetime sales or recurrent revenue as GTA V which is admittedly a high bar. RDR Online will exit its beta phase before the end of the current quarter. We expect that Rockstar already has a large amount of content ready to be released when the beta test ends and for the months following. The question remains if gamers will continue to play and enjoy the relatively slower pace and turn of the 20th century Western setting of RDR. Additionally, the title is vying for player time and attention in a much more competitive landscape than GTA Online faced. Not only does the game need to compete for attention against Fortnite, but also with Apex Legends, Call of Duty, League of Legends, Overwatch, and numerous other video games. Also, new games like Apex Legends can seemingly pop up out of nowhere and grab the attention of gamers everywhere.

One of the upcoming titles vying for gamer attention will be Borderlands 3 which will be published by 2K Games in September. The game is the fourth title in the Borderlands franchise with the most recent title, Borderlands: The Pre-Sequel, released in 2014. While the five-year gap could be an issue, the announcement of the Borderlands 3 along with a remastered version of the first game and free 4K texture packs for the last two installments, have helped the older games spike in popularity over the last few months on both the PC and consoles. Despite being developed by an outside firm (Gearbox), Take-Two will earn similar gross and EBIT margin on Borderlands 3 as it does on its internally developed titles. Management expects the newest installment to outsell Borderlands 2 which sold 7.5 million units in its first year and almost 20 million over its lifetime. We believe similar to RDR 2, Borderlands 3 will outsell its predecessor over a much shorter time frame than the six years it took Borderlands sell 20 million units.