Although many of the points raised by Take-Two's Board are entirely true, we are somewhat amused that they are raised as negotiating points. Our point-by-point thoughts:
1. EA's offer represented over a 50% premium to Take-Two's closing price, and to its 200 day moving average share price. Take-Two shares have not traded at or near $26 since its new management took office in April 2007, and the company has consistently lost money for the last two years.
2. We are not in a position to comment on Bear Stearns' or Lehman's opinions without reading them in full.
3. Take-Two's directors and executive officers own less than 3% of the company's fully diluted shares, and over 2/3 of this amount is in the form of options and restricted stock that has not yet vested.
4. We think that the Board has virtually no chance of finding a better offer. The EA offer has been public for 31 days, and we believe the company is not in discussions with any other party. This deal, in our opinion, makes more sense for EA than for any other company, primarily because of the synergies from consolidation of the two companies' sports businesses. No other company is in the position to realize those synergies, which we believe are substantial.
5. We agree that EA is being opportunistic, and completely accept as true that EA's offer was predicated on acquiring Take-Two before the shipment of Grand Theft Auto IV. To the extent that EA is forced to wait until after the game ships, we believe that EA will perceive Take-Two to be less valuable, and believe that its offer will be lowered, if made at all.
6. We disagree with Take-Two management about the extent to which the offer reflects its revitalization efforts. EA's offer represents more than a $600 million premium to Take-Two's enterprise value immediately before the offer, or a multiple of 24x the expected annual cost savings. In our view, EA's offer more than compensates for the cost savings. Further, since EA is likely to substantially reduce (if not eliminate) Take-Two's overhead, the revitalization efforts are essentially meaningless.
7. We completely agree with Take-Two's Board that EA's offer does not reflect the synergies that will be realized, and are flattered that our $210 million estimate was cited. However, we are somewhat dismayed by the Take-Two Board's sense of entitlement. It is not customary to pass the synergies to be gained from operating efficiencies on to the selling shareholders. Further, EA's offer includes at least $600 million in premium, or a very fair multiple of the low end ($50 million) of the synergy benefits cited by Take-Two's Board. We think that the Board's logic is flawed on this point.
8. We completely disagree about whether EA's offer adequately reflects Take-Two's financial condition, strategy and future prospects. Prior to the offer, Take-Two's shareholders valued the company at $17. The premium offered by EA fully reflects Take-Two's prospects.
9. We agree that the offer is taxable, and are baffled as to how Take-Two's Board proposes to offer its shareholders a tax-free exit plan. As a tax lawyer (California Bar number 102110), I'm supposed to be an expert on these matters, and in my 26 years as a lawyer, I am unfamiliar with how a shareholder can sell stock on a tax-free basis.
10. EA's offer is conditional on due diligence. We cannot envision a competing offer that does not include the same conditions.
In our view, Take-Two's Board has made a mistake. We believe that the company was positioned to extract a higher offer from EA by offering a friendly transaction, and its Board chose to continue its adversarial posture. We do not mean to suggest that EA's offer was intended as a friendly one, but note that it started out as such, and EA turned hostile only after its first two friendly offers were summarily rejected. We think that Take-Two's position that the company will have greater value after the release of Grand Theft Auto IV is naive at best, and disingenuous at worst. It is inconceivable to us that there are any Take-Two shareholders (current or prospective) who are not aware of the upcoming release of the game, and we do not believe that the game's reviews or first week's sales will ultimately impact the company's valuation in any meaningful way. In our view, Take-Two's share price prior to EA's offer fully reflected the success of the game, and we don't believe that EA's $26 offer was made without an assessment of the potential of the game. The absence of other offers in the interim suggests to us that EA values Take-Two more highly than any other interested party, and we are confounded that Take-Two's Board believes that other parties will be willing to pay more than $26 after the release of the game.
We think that the strategy adopted by Take-Two's Board was ill-advised. Had they offered an olive branch, we think that EA may have increased its offer by $1 or more. Instead, the Board chose to reject EA's offer. Once the tender expires, we expect that EA will receive tenders of more than 50% of Take-Two shares, mooting today's recommendation. If the company does not receive majority control through a tender, we expect it to withdraw its offer, and we expect Take-Two shares to decline by 20% or so. This presumes that the market will expect EA to come back at a later date, which is not assured.
We will comment after April 11 about the impact of the poison pill adopted by Take-Two's Board. Without a review of the company's charter and by-laws, we are not in a position to comment upon whether this provision requires shareholder approval.
Maintaining our HOLD rating on Take-Two, and $26 price target based on the proposed offer price for the shares of Take-Two. Should EA withdraw its offer, we will re-evaluate our rating and price target.
Risks to our investment thesis include weaker performance of the company's games, unexpected deterioration of the average selling price (ASP) for game software, levels of competition, changing macroeconomic factors, and changes in consumer demand for video game hardware.