Take Two Intercactive

8/17/23, 10:45 AM Take-Two Interactive: GTA and NBA 2K | Colossus®
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Introduction
Matt: [00:00:50] This is Matt Reustle and today, we are breaking down Take-Two
Interactive. If you listen to our business breakdown on Electronic Arts, Take-Two is
another giant in the video game publishing space. They are best known for their Grand
Theft Auto and 2K franchises. To break down Take-Two, I'm joined by Eric Kress,
Principal at Gossamer Consulting.

Eric spent multiple decades inside the video game market, both as an investor and as
an operator, and we tap into his perspective from both sides of the table. We drilled into
historic IP, the strategy behind new releases and what mobile means for the market and
specifically for Take-Two. Please enjoy this breakdown of Take-Two.

All right, Eric. I'm excited for this one. You bring a very unique background to this
business breakdown. You spend basically after your career in industry, after your
career in the investment world, you're still involved in both worlds, which I think is ideal
for these types of conversations.

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https://www.joincolossus.com/episodes/44983717/reustle-take-two-interactive-gta-and-nba-2k 1/21
Overview of Take-Two and the Broader Gaming

Ecosystem
So as we're talking about Take-Two, we're basically going to jump back and forth in
terms of inside the industry perspective and an investment perspective. Maybe we
could just start out with a simple introduction of Take-Two. We know they're a video
game publisher, but what would you say they're best known for and what differentiates
them?

Eric: [00:02:04] Fundamentally, Take-Two has some of the marquee current franchises, which
include Grand Theft Auto from the Rockstar division and NBA 2K, which is an annual
basketball game. I think that's what they're most well-known for, and then they have a bunch
of other franchises that I think have been a bit nascent over the past 10 years, actually. And
their recent acquisition of Zynga adds the mobile layer, but that's kind of a new thing for them.

Matt: [00:02:29] Yes, we can get into that. We covered EA on a separate breakdown and
introduce the idea of what it means to be a video game publisher. We also did this
industry overview on mobile gaming. Maybe you could talk a little bit about where Take-
Two fits into that ecosystem. It sounds like they have some historical IP, these
franchises that have been associated with console games.

The recent acquisition of Zynga, is this a bigger push for them into mobile when you
think about the company? And what they'll be looked at in the next 5 to 10 years, how
big of a piece is mobile going to be?

Eric: [00:03:05] Yes. I mean I think there's been a lot of pressure for getting into mobile
because mobile has become a much bigger part of the overall gaming industry. Almost 50% of
the revenue worldwide is from mobile. And maybe it's like 25% or 30% for the West, which is
an important distinction, frankly.

So I think Strauss has been really trying to push into mobile, and they've done a lot of smaller
acquisitions that were literally too rinky-dink to really make any type of meaningful impact. And
then ultimately, he ended up acquiring Zynga, which I think was really a dumb acquisition. But
he ended up acquiring Zynga, which was one of the bigger independent publishers and
publicly traded, obviously.

And that's launched them into a business, which, frankly, I don't think Strauss really
understands because the fact is no one wanted to acquire Zynga at that valuation, at that level
given all the headwinds for mobile that are showing their ugly face right now. But going
forward, it is going to be a big part of their business, but I think it's going to be a declining
asset for them, which will be an albatross on them going forward.

Matt: [00:04:01] Can you elaborate on it a little bit in terms of headwinds that mobile
󰍡 versus what exists in console and PC that differentiates it?
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faces

Eric: [00:04:12] Basically, mobile games have been driven by user acquisition for the last
decade. People have been optimizing around that since my Kabam days figuring out ways of
UA arbitrage in which you buy users for a certain amount, and you earn something back.
Apple became completely hostile against these type of user acquisition tactics and targeting
and removing IDFA has removed the ability for them to target the audiences that they need in
order to continue to grow the business.

So last year, after a decade of almost 20% growth year-on-year, the business was down 10%.
You can attributed some of that to a tough COVID comp, but a lot of it had to do with the fact
that Apple just completely screwed over the ecosystem with their IDFA, removal of the ability
to target. And that's the biggest headwind, and these changes are not over. They are
removing fingerprinting. Google is changing their processes, which will make identifying and
targeting more challenging.

And so there's just absolute crazy headwinds. Now the market this year is actually only
declining around 3% so far because of new titles, but we will see the impact of removing
fingerprinting towards the end of the year, and so we should still see 5% to 10% declines in
the mobile business over the next two years, which is impacting basically everybody in the
industry.

Matt: [00:05:35] Yes. It doesn't seem like privacy and all of the changes that happened
around privacy are going anywhere or moving in a direction that would be more freeing
for the mobile game publishers.

Eric: [00:05:47] That's my main point on this podcast and talking to investors is that Apple
could give a s*** about mobile publishers. They don't care at all about that. Their goal is to sell
phones.

But having this privacy message, I think it's very much differentiated them from their biggest
competitor, which is Google or Samsung, et cetera, is that Apple has the most secure phones
because they are moving the ability to target individuals. And so it's really, really, really good
for Apple, but it's absolutely terrible for the mobile publishers and the mobile industry in
general. But Apple doesn't care. That's not their business.

Actually, there's a lot of reasons why they do care that there are a lot of publishers that were
getting way too much control over their store because they were manipulating the algorithm to
get people into there, like the super casual games, the hypercasual industry, social casino, all
these people were leveraging the abilities on their platform, that's something that they wanted
to fight. And this has been the big challenge is that Apple is just rolling over them with these
crazy privacy things for literally a marketing message.

Matt: [00:06:49] So Take-Two has stepped into the mobile world recently and stepped in
is probably an understatement. They dove into the mobile world with that acquisition.
But maybe we could start at the beginning. I know it was founded in the early '90s. Can
you talk about how they've evolved since those early days? They obviously have some
󰍡 big important franchises that are a big piece of this. How did those come
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really
together? And any major milestones that you would point to over the history of Take-
Two and basically how that's coincided with the industry as well?

Eric: [00:07:19] The way I look at it from an investment perspective is there's been three
fundamental shifts in the industry, all of which have been adopted and taken on by the big
publishers in the business. Initially, the game business was PC and console. PC, console
drove most of the industry.

And that's when we see the rise of like Sony, Nintendo, Activision, EA, Ubisoft and Take-Two,
obviously, in part of that. And from a Japanese perspective, you see Konami, Sega, Capcom.
So those are the publicly traded companies, and they were primarily in packaged goods, PC
and console. So selling games and Midnight Club and all the old franchises that Take-Two
has. That was their thing. And then GTA, Red Dead Redemption, all that was all part of that
era.

Mobile really started to impact the industry in 2011 and 2012. And again, as I said earlier, it's
grown to almost 50% of the business worldwide, and that included like Zynga, Glu, Playtika,
AppLovin, King, which was acquired by Activision. And then Unity, ironSource and Stillfront are
the other ones from the mobile space. Again, importantly, in Asia, then mobile became
absolutely massive, and then we have Tencent, NetEase, Nexon and Netmarble.

And that created a whole other group of gaming companies to be part of this industry. For the
last 10 years, and this is the part in which Take-Two has benefited probably the most over the
years has been the rise of micro transactions and Software-as-a-Service in the video game
space, making these games more like SaaS businesses as opposed to hit-driven packaged
goods businesses.

So games like Call of Duty, and FIFA, and Madden, and NBA 2K from Take-Two as well as
GTA, they now are like ongoing revenue streams in which the revenue per user has gone up
absolutely dramatically. That has helped fuel the last couple of cycles of this industry with a
bigger portion of it as digital Software-as-a-Service compared to full game packaged goods
sales. And now new companies are emerging from this like Roblox and Epic, which Epic
should go public in the next few years.

And then finally, moving forward, what's to come. We have VR and AR and cloud gaming and
blockchain, which I think are part of nascent platforms. I don't think these will have that much
of an impact in the next 5 to 10 years, but I'm of the minority on that opinion, I think. But you
take all the hype away from the VC and the investments by big tech companies, and you see
that these platforms are really not really all that viable.

Matt: [00:09:45] And in terms of just what differentiates console and PC versus mobile, I
would imagine it's something like compute capacity and what you're actually able to do
in terms of graphics. But what else would you point to in terms of it having staying
power versus something like mobile continuing to take share or some of these new
products coming in and actually getting proper product market fit adoption, all of that
󰍡starting to eat into share?
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and
Eric: [00:10:11] I think the fundamental thing you have to think about from the console space
is that it is all focused on AAA game development. And it all is focused on the West, and it is
primarily being driven by 18- to 44-year-old males. That is a very distinct market. And in some
ways, it's a limited market. And these games that Take-Two 2K, Basketball, GTA, these are
boys that have become men that play these games.

And what's great about that market is that they're willing to spend whatever it takes. Buying
console is nothing to them for their entertainment. They have a lot of dispensable income that
they're willing to spend insane amounts of money for these IPs and these game experiences.
Mobile on the other hand, has that same market to some degree, but it expands it much more
beyond that.

It's a much bigger market. More women, obviously, a lot bigger in terms of the age
demographics. So it's almost unlimited, but it's also not that premium. So there are far less
people that are -- as a percentage that are spending a significant amount of money in that
space. In some sense, the conversion is the limiting factor on mobile. That's what limits the
ability for them to proceed. Not to mention, obviously, it's not AAA. A lot of the content on
mobile, although some of it is very AAA.

The majority of the content that makes money on mobile is not AAA. It's actually 95%, I would
estimate is driven by non-AAA production value. When I was at Kabam, everyone was talking
about how mobile was going to just take over and destroy console, but that was never going to
happen because you're going to basically have to pull the PS5 out of the cold dead hands of
those loyal fan base and to remove that type of experience from them and mobile is not going
to satisfy that at all for that audience.

The Success of Take-Two's Flagship IP and Challenges
Associated with Creating New IP
Matt: [00:11:53] You mentioned some of these titles, Call of Duty, Madden, Grand Theft
Auto. These have been around for years since I was a teenager or even a young boy,
and they're still around. It seems like a lot of the titles that have become the biggest
that are these iconic forms of IP had been around for a while.

I'm just curious, is it incredibly difficult to launch new IP that will become iconic? Am I
just noticing that and attributing it to me and missing some of these new titles that
have launched more recently that have gained a lot of market share? I'm just curious,
when you think about IP and how valuable it is to have those franchises versus the
ability for someone to come up and create a new franchise that's actually going to
compete with that. What does that landscape look like? And what does that actually
entail?

Eric: [00:12:36] It's almost impossible. That's the sad truth. We are at a AAA gaming space.
󰍡AA, there's not much market for AA anymore. I've been doing strategy consulting around
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So
game development and strategy for Warner Bros and others, and that's what it comes down
to, is these budgets are over $100 million to $200 million even $300 million for games to be
competitive even. Something like GTA is probably like $400 million or 500 million, maybe even
$600 million just to bring it to market. So there's no one that really competes with that at all.
Period.

Matt: [00:13:09] James Cameron competes with that with his movies.

Eric: [00:13:12] Yes, exactly. But that's the type of investment that's required to be
competitive. Now having said that, there have been a few games that have come out of the
woodwork, miHoYo, with their games. But they are spending $200 million, $300 million to build
these games, Genshin Impact and they have a new game recently. And those are somewhat
competing at the same level as AAA.

But again, these investments are made, and they're spending rumored like $300 million, $400
million on marketing. Now again, there are some surprise hits that come out of nowhere that
gets lots of traction, but they are fewer and far in between because the expectation of the
customer is so high that it's just impossible to be competitive against the entrenched
competitors. So that is more of a challenge. And that actually is an advantage for the big
publishers that have these huge IPs that continue to deliver year after year. It creates quite a
moat for the big game developers.

Matt: [00:14:06] And you've been in the system, so you've seen how this works. When I
hear something like $300 million of that budget is marketing. It is a little bit of a self-
fulfilling prophecy such that it's historical IP, it's going to get that marketing budget. No
smaller game is going to get something or anywhere close to that marketing budget.

So naturally, those big IP names are going to continue to hold the top of the charts. I'm
just curious in the earlier days, what drove the winners? Obviously, there's just sales
and Grand Theft Auto was a hit almost immediately, something I heard of. But there
were other games and maybe it's in my imagination, but games like Metal Gear Solid,
which felt like it was a huge hit at the time, but fell on its way side, and I haven't heard
much about it recently. So what differentiated some of those names in terms of those
that lasted and persisted versus those that fell off?

Eric: [00:14:58] A lot of times, historically, back when I was at EA in the 2000s, I think '98 was
when I started at EA. God, I'm getting old. But it was all about publishing. It was all about
distribution. It was all a retail-driven business. It was about what relationships you had with the
retailers in North America and particularly Europe, which is much more complicated in terms of
distribution because you had to had local people on the ground for every of the major
countries, U.K., Germany, France, Spain, et cetera. So EA, and Take-Two, and Activision all
differentiated themselves on being able to reach all the different retail sites.

Matt: [00:15:32] So where we stand today with Take-Two. You mentioned you have these
two marquee franchises, Grand Theft Auto, NBA 2K. What percentage of the overall
business do you think they represent?
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Eric: [00:15:45] That's a good question. Now with Zynga, it changes the calculus a little bit,
but it is a very significant portion if not their revenue is certainly of their profit. And I don't think
they report it that way, so it'd have to be an estimate, but it is very, very significant.

Basically, the only thing that's profitable from my perspective on the business is those two
franchises. Take-Two's business is very simple in that way because all you really need to do is
track what 2K is doing and GTA and you'll probably get 80%, 90% of the story.

Matt: [00:16:04] Yes. Usually, businesses come down to a few simple things. It certainly
seems like the case here. What does Zynga represent now that it's consolidated? We
can start out with the top line because it sounds like there may be a different story
between top line and bottom line impact.

Eric: [00:16:24] I think that they're, what, $2 billion out of the $5.3 billion. So that's about 40%
of the business on a revenue basis. Now of course, their profitability is a lot lower.

Matt: [00:16:37] And you talked a little bit about the improved visibility or the adjusted
business model, which is basically resembling SaaS and something that you can sell
almost like software with updates and that's almost a free-to-play model where you can
monetize that user over and over again without them having to go to a store, whether
that's digital or physical. How much visibility is there year-to-year?

If you're an investor trying to model this business out, how much visibility do you have
one year out, two years out in terms of depending on those historical games to deliver
numbers?

Eric: [00:17:13] For the sports games, it's pretty much almost 100% guarantee that you're
going to get a significant amount of revenue for both the packaged goods as well as the digital
sales. It will fluctuate over time. The one thing great about basketball in general, is that the
popularity of that franchise continues to grow worldwide.

So while the U.S. is probably still growing to some degree because the popularity is better for
NBA versus baseball, for instance, or hockey, et cetera. But in Eastern Europe, it's a big
growth vector. In LatAm, there's more interest in basketball. And then Asia, of course, there's
getting more and more interested in China and other places. That keeps the tailwind going.

So you can almost anticipate perpetual growth for the foreseeable future for that franchise. For
something like GTA, obviously, it ebbs and flows with the content cadence of how they release
content. Also, they're bigger content releases, whether it's content patches. And then
obviously, if new game came out, which is a big anticipation over the next year or so and the
reason the stock is doing extremely well. That's going to drive huge levels of adoption.

But
󰍡there's also complexity and issues around that. Like how much does that cannibalize the
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existing game? How big is that market? How well do they monetize the audience? Those are
the questions that need to be answered or have to have an opinion on as an analyst.

The Economics of GTA, the Rockstar Acquisition, and
Designing for Consoles
Matt: [00:18:34] Bring us in the room a little bit for that. Because I imagine with
something like 2K, it's an annual release similar to something like Madden. But for
something like Grand Theft Auto, it's a much trickier situation. I think there was a
historical release schedule way back when in the early 2000s, late '90s when I was
around, and it was often related to new console systems being released. But how do
they think through the release of a new game, whether it's the fifth version, the sixth
version and all the moving parts that go into that?

Eric: [00:19:05] Okay. That's a very complicated question. So Rockstar used to have multiple
teams but it feels nowadays, they have one team, and they basically are iterating against Red
Dead Redemption and GTA. So Red Dead Redemption came out a few years ago, and it did
very well on the packaged goods side, but the services side did not do well. And part of the
reason is because no one wants to own a new saddle or build a cart that versus you look at
GTA and you have a McLaren or a Bugatti or a Porsche and you're collecting that.

The differences between those two is pretty dramatic. So there's no real chase for the
customer in the Red Dead Redemption world on the flip side, owning an amazing crib and
amazing cars and boats and stuff like that makes a lot of sense on the GTA side. So the Red
Dead did extremely well. But now the last five or six years, they've been developing GTA, and
so that game is imminent.

And they still have not announced that game for the record. But Strauss in all his wisdom and
him managing Wall Street, he basically intimated that it is coming out next year because
they're going to grow revenue from $5.3 billion to $8.3 billion or $8 billion next year, somehow,
so magically something is going to happen. That game is coming out next year.

And so what will have to happen is they will have to figure out a way of transitioning existing
GTA users to the new GTA and/or bring old players back to the new GTA. But what we do
know for almost absolute certainty is that it will sell a gazillion units, like probably between 25
million and 30 million units just by coming out.

It can be the worst game ever, but that game is so hotly anticipated and they will build up the
hype so much that that's almost a guarantee that they will sell that many units. But the
question is, what happens afterwards, that could be actually a little bit more debated.

Matt: [00:20:52] Five to six years feels like a long time to me. Is that the norm? Or is it
on the longer side of things?

󰍡 [00:21:01] That's on the shorter side. You have to imagine, these games are absolutely
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Eric:
massive in scope and scale. No one could actually recreate building a GTA in the world,
except for maybe the Chinese, like miHoYo, people have talked about that a little bit out there
is that probably they could throw like thousands of Chinese developers to build something like
GTA. It still would not have probably the gravitas of a world created by Rockstar. They are
very, very good at making these type of worlds. And that differentiates this product from any
other product that comes out.

Matt: [00:21:37] I have to ask the question, why not just announce the game? If you're
going to put that in the estimates, it's maybe a silly question. You might not know the
answer. But if you're going to have to lower the estimates because the game is not
coming out, you're going to have to lower the estimates. So why do you think?

Eric: [00:21:48] Part of it is that Strauss has absolutely no control over Rockstar, zero.
Absolutely zero. He has no control about when they come out with games, when they release
stuff. He gave up that control long ago because that's the type of deal that they did with the
Houser Brothers is that they own -- he doesn't know really.

And so in some ways, there's no 100% guarantee the game comes out next year and actually
gun to my head, I don't think it's coming next year. I think likely it will come out in May of '25.
That's when it will come out, their next fiscal year. So they'll miss it most likely because I think
they will have some issues that they have to iron out. And Rockstar is going to do it when it's
ready. They don't give a c*** about earnings releases or quarterly.

So this is just Strauss managing Wall Street. Full stop. And they've done it a million times, and
he's really, really, really good at. He's not so good at acquisitions, but he's very, very good at
managing Wall Street. So yes, Rockstar will announce it when they're ready to announce it.
That's the answer to your question. And we haven't seen an announcement from them yet. I
actually thought that it was going to come out like at this time frame in the summer But maybe
it's not until next year. No one knows. It's really hard to get a read on what Rockstar is doing.

Matt: [00:22:58] And what about the deal that they made, the Rockstar acquisition?
What about that acquisition was set up in a way where Strauss does not have the
visibility over that business?

Eric: [00:23:09] They have complete autonomy, 100%. A lot of these deals were made that
way. Even when Blizzard was first acquired by Activision, they had that autonomy for a long
time until they didn't. But Rockstar, given their success and their prowess in building hit after
hit, and being very successful with what they do, they've maintained that autonomy forever.

And so they are locked away in New York City in a high-rise right now and no one comes in
and out of that stuff with information about what's going on out there. That leak that happened
maybe six months or eight months ago was unprecedented for Rockstar in which they actually
got video out. That just doesn't happen with that company. Period.

Matt: [00:23:43] Super interesting, yes, just to see the different dynamics because when
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you do own multiple creators, publishers, studios under one brand, they can each have
their own individual approach and culture and all of that. And I think from the outside,
at least from the cheap seats over here, you didn't fully appreciate it until you learn
more about it.

Eric: [00:24:02] And they also get significant rev share, too. They're optimizing around their
rev share as well to give to their team. So they get a percentage of every dollar profit. So
that's very hard to replicate across the entire portfolio of studios. So it's very unique for
Rockstar.

Matt: [00:24:23] Is there a risk that a new console is introduced? How much visibility do
they have over new consoles coming and just aligning things with console
introduction?

Eric: [00:24:33] This is the big risk, I guess, in terms of expectations for this next game. Is that
what you're alluding to? Because when GTA V came out, it was at the tail end of the last cycle.
So it's the biggest possible installed base of hardware. You're selling one of the best games
for that generation. So the adoption rate is absolutely massive. So they sell 30 million, 40
million units in the first 12 months. I can't remember exactly what it was, but it's something
along those lines.

And then on top of that, you've got the next-gen release coming out. And so the next gen was
coming out basically at the same time. And so you double-dip. So certain customers bought
multiple copies, one for the PS4 and then one for the PS5 within 12 months of each other. And
then you come out with a PC version and then you get triple dipping potentially. So it was
actually a perfect storm and a perfect time to release this type of game.

Not to mention they were releasing their online services over that time and perfecting it and
getting more -- getting reengaged people coming in to try it out again and get hooked on it.
This time, it's a little bit different because we're kind of mid-cycle and so the installed base is a
lot lower than it would have been that GTA IV release.

And so they only have a certain amount of hardware units out there to sell into because it's
going to be a PS5 and Xbox Series X exclusive. And so the initial sales are probably in the
$25 million to $30 million range. And what I worry about is that people get way too high in their
expectations. And we won't see another next-gen console for another three years, maybe
even four.

And so they only have this basically installed base to work with until those next-gen consoles
come out. And the PC SKU, obviously, we don't know. But that likely will be delayed at least a
year after the console SKU, which is the typical thing. Anyway, so I think people don't want to
get ahead of themselves in terms of expectations on the unit sell-through. There's only a
certain amount of attach rate, maybe 30%, 40% of the existing installed base that will buy
GTA. Not everyone is going to buy GTA that has a console, so.

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Matt: [00:26:26] But if I do the math and that it does come out in two years that there's a
new console in three years, it wouldn't be the worst setup in terms of replicating what
they did before, obviously, with a much lower installed base overall with consoles.

Eric: [00:26:41] If I'm right in my delay of the game, you may be right. You're off by a year,
maybe. Not as ideal, but yes, it's possible that they could wait until a better opportunity to
double dip the way they did with the original one.

Matt: [00:26:54] With GTA IV, is there a substantial cost involved with updating the title
for the different consoles?

Eric: [00:27:01] Yes and no. It used to be far more complicated because they were on
different architectures. But now that everything is basically a PC, both Microsoft and Sony
have come out with consoles that are PC architecture. I don't want to be diminalist on this
because it is very complicated, but it's not as complicated as it used to be. And then the PC
SKU itself allows them the flexibility of building the game for different levels of hardware. And
so that helps as well in terms of engagement and then to iterate on the game itself.

Matt: [00:27:29] When you look at the most recent GTA, just in terms of the upfront
sales that they have and now the revenue associated with in-game purchases. What do
you think that looks like in terms of the total that they earn from selling the actual title
versus the total that they've earned from in-game over time?

Eric: [00:27:49] The amount of money that they've made on selling the game is far higher
over the years. But the recurring revenue, if I were to guess, I would say it's like 70-30, maybe
60-40, that's typical.

Matt: [00:27:56] Yes, you answered my question as to why they don't just give away the
game for free and generate the...

Eric: [00:28:02] Oh, wow. That has been a huge source of angst for me, people talking about
free-to-play on console like it's going to be the next thing. It's the wrong market to do free-to-
play. This is a premium market, and you have to compete against premium games. And so
yes, they have given away for free over the years, but only after they've sold gazillion units.

Matt: [00:28:22] It's interesting that the unit price per sale has not gone up substantially.
The title would cost in the $60 to $70 range now?

Eric: [00:28:29] The new price being set now is $70. But with something like GTA, they'll have
premium SKUs that go for $80, $90, even $100 and people will buy it.

󰍡 [00:28:40] And is there any bull case for seeing that number go even higher? As
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Matt:
you start to mention those numbers, it's substantially higher than the $50 that I
remember paying back in my day, as I'll say. But I would have expected it could
possibly be over $100 at this point, given everything that's happened. Where do you
think that could be over time? Is it any bit of a catalyst from a revenue perspective?

Eric: [00:29:01] Yes and no. When you're talking about premium plus type things where you're
buying the game basically, in essence, for $60 or $70, and then you're adding in a layer of
DLC, of currency, et cetera, people that are going to be really engaged with the GTA online
because it's only a small portion of the actual audience that buys GTA is involved and
engaged in GTA online.

Again, the free-to-play business model is very small group of people that are actually spending
insane amounts of money. So you have to keep that in mind. So those type of SKUs will do
well with that audience, but it's a smaller percentage of that audience. What I'm hoping --
again, from a design perspective, what I'm hoping for GTA this time is, first of all, they learn a
lot from their last GTA in terms of how to monetize what the content cadence is supposed to
be, how to monetize the audience and optimize against the spenders.

And then also the technology behind GTA IV was so bad in terms of load times and all the
issues around matchmaking, and it was horrific. The fact that they've made so much money is
remarkable. So the new technology with the better hard drive, the SSDs and better load times,
hopefully, they'll be able to optimize and make it a much better experience and have more
mechanics to monetize.

And again, what I'm really hoping for, which I don't think will happen, this would be really
bullish for them is they start to do more pay-to-win, pay-to-progress type mechanics, which will
send the spend depth much higher, and that will really leverage the core players to spend
more, and that would be a huge boom for them in terms of revenue per user.

Matt: [00:30:30] I know in mobile, a lot of the advertising actually is just the closed loop
system. So it's not necessarily advertising for products, it's advertising for other
games. I always wondered if the advertising market could exist in the console industry
as well, whether it's product placement or something else, GTA feels like one of those
games where you could actually see those things show up, putting aside the mature
rating and all the dynamics that go into that. But I'm just curious if that's a business
line or a segment that they've ever tapped into.

Eric: [00:30:59] You mentioned why most likely that won't happen because of the mature
content. And I don't think Coca-Cola would be really interested in branding with GTA. So those
brand placements, probably not. Maybe certain brands.

Matt: [00:31:12] Yes, there's brands for everything, but fair enough. That makes sense.

Eric: [00:31:15] Advertising actually within console games is something that we've been
looking at for decades when I was at EA, and we actually tried it a few times, massive, I think,
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was acquired by Microsoft ages ago to try to take advantage of that. It went away, but now it's
coming back in full force. So there's a couple of companies that are actually working on
building that within games to do banner advertising and other like much more better placed
advertising. So we'll see.

GTA, I don't know if it's a really great fit. Because the one thing about GTA is you want to be
immersed in the world and by any type of advertising within the game that pulls you out of the
immersion and what's the call to action. But anyway, there are people much smarter than me
working on this type of thing, and we'll see it more and more. But again, the mature nature of
GTA makes it a little bit tough.

NBA 2K and Take-Two's Portfolio of PC Games
Matt: [00:31:56] Shifting gears to 2K. I think you've outlined the bull case for why that
franchise could continue to do well. I'm curious in terms of the license itself with the
NBA, is there anything unique there in terms of what that contract costs them, whether
it comes up for renewal, how often it comes up for renewal? What are the dynamics
behind that?

Eric: [00:32:15] Basketball is an open license, it's not an exclusive with 2K, like the NFL was
for a while with EA and then FIFA was, but ultimately, that went away for EA. There's no
competition out there. EA has been trying to make a new game. And actually, I don't know
what is happening with that because supposedly, it was supposedly coming out this year, and
they'd said to investors and clients in mind that they're not giving up on it, but it seems like
they're giving up on it.

So I'm not too worried. I will say this is one thing that people don't really quite understand
about these licenses that even though the Take-Two is the licensed store and NBA's licensee,
the reality of it is, is that 2K actually does a lot for the brand of NBA, similarly that did a lot
from the FIFA brand in terms of making it as popular as it is. It's more of a partnership than a
licensee-licensor relationship. Now that's not to say that NBA could come out then with insane
terms. That's possible. But I think there is a partnership there and I think that's less of a risk.

Matt: [00:33:15] Makes sense. If we just compare those two titles from a margin
perspective, profit perspective, however you would think about it. Do you think there's
drastic differences between those two? And then we can talk about the rest of the
catalog after that.

Eric: [00:33:34] I actually don't think so. And the reason I say that is because the type of
license or 15% to 20% that you're giving to the NBA and the Players Association is probably
very similar to the percentage you're giving way to Rockstar. So at the end of the day, from an
EBIT perspective, I bet they're very, very similar.

Matt: [00:33:52] And what is an ideal EBIT margin for a title? Obviously, there's a lot of
moving parts, and I know it's difficult when you have the beginning of the life with the
title sales versus the in-game purchases. But how would you even think through that in
󰍡 of any type of return metrics, profitability metrics, margin metrics for a title?
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Eric: [00:34:09] I would say like 40% -- 30% to 40% for these type of businesses. But over the
life, it gets complicated because the dev costs are so front-loaded, capitalized, et cetera, et
cetera. But it's probably higher margin ongoing, but lower margin, if you look at it holistically,
so 30% to 40%.

Matt: [00:34:30] And then the rest of the console PC portfolio of titles. Is there anything
else in there that you think is an attractive name that could emerge as a third horse in
the race?

Eric: [00:34:39] This is part of my risk with Take-Two as a whole is that Activision and Take-
Two in particular, just did not do a good job of investing in other studios. Whether it's different
Rockstar teams or other studios. And so they really don't have much at all other than GTA and
2K at Take-Two.

There are other games in the portfolio that are coming, but they're just not going to be
profitable, not nearly as profitable as GTA and 2K. If they make money, it will be surprising like
Judas is the game from Levine that's coming out. And then finally, we have the Gearbox guys
who had make Borderlands, and Borderlands has been one of the bigger franchises from
Take-Two, but they don't own it.

They're only a distributor of record. It's really the Gearbox guys, which were acquired by a
terrible, terrible, terrible acquisition by Embracer. And so they own that team, but not that
franchise. So it's very unclear and Embracer's collapsing as we speak. So I don't know what
the guys at Gearbox are going to do, et cetera, but that could be an interesting game going
forward.

But other than that, everything that they're doing doesn't make any sense. They came out with
some casual sports strategy, which is some fever dream of some guy in Marin that wanted to
make casual sports. That's not the business that we're in. We're in a AAA business. It never
made sense. They have some success with the LEGO racing game, but other than that,
making a tennis game or making an arcade basketball game, none of this makes any sense.
This is not the business that we're in.

And then the company will keep saying the same b******* over and over again that they have
52 games planned for the next three years, including 17 immersive core games, it is just
nonsense that they keep pushing this narrative, but they don't have the teams to do what
they're suggesting. It is just a narrative. That's all it is. And I guess you should keep track of it,
but don't expect much contribution from it is the way I would look at it or the way I talk to my
clients about it.

Matt: [00:36:31] Putting aside the casual sports games, which it sounds like there's an
obvious issue there. But do you think there's other AAA titles that exist within the
portfolio that just don't have the marketing budget? What do you think stops them from
having another hit game?

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Eric: [00:36:44] They don't have any teams. That's it. They have not built the teams that can
build contemporary AAA. They just did not invest in building new game teams that can create
contemporary games. That's just full stop.

Matt: [00:36:55] I know with EA, they have a software or some type of design studio
that's in-house that can be used by all the different teams. And you could tell me how
quality that is versus just pure marketing language.

Eric: [00:37:06] EA did the smart thing. They bought Respawn. And they bought that
management team and that group. And Vince Zampella, he's an amazing operator and studio
leader, which is the hardest roles to fill within these type of organizations. It's really hard to
manage creatives. But he has that credibility. He's been down the block a bunch of times.

And he's created like four or five studios under him that are actually creating AAA content,
including the Star Wars game, including the Black Panther game and the Iron Man game.
They're working on a Medal of Honor game. That's what Take-Two should've done ages ago.
But it's too late now. It's really hard to build these type of teams there.

So I think EA has been really smart in reinvesting some of their revenue and earnings into
building out these teams to build more content. They just don't have the capability that I see
within Take-Two to actually do anything. The other thing, which again, they have no control is
that Rockstar creates a second team to help build something with Midnight Club, some with
their older IPs, Max Payne or whatever, but that's not happened. They've consolidated to one
team as well, like I said earlier.

Matt: [00:38:10] And what does the team look like in terms of size? I'm just curious.

Eric: [00:38:16] Early concept is like 10 to 20, but pre-pros is 50 to 60 and then you go up to
full production at like 200. So it evolves over time. But those teams need to be built up and
have experience working together and working on games, which takes a long time.

Changing Industry Dynamics, Mobile Gaming Economics
& The Zynga Acquisition
Matt: [00:38:27] So with something like film, we've actually seen the number of titles that
are released each year come down quite a bit and you've seen a removal of a lot of
those mid-budget films that used to be made that are no longer made by the studios,
and there's various different reasons for that. It sounds like, in your view, from an
investment perspective, that's what would make more sense to do here. Do you think
that's specific to Take-Two because of the teams? Or do you think that's a broader
industry dynamic?

Eric: [00:38:54] Historically, when I was the first at EA, we were building like 30 games a year.
󰍡 if they do six games, that's a lot. And again, the focus has been on revenue per user as
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opposed to tons of games trying to expand the audience. The market matured. Media matures
in that way until new platforms emerge. Gaming is no different than even movies and
television, which consolidated to a few studios or to a few networks until Netflix came out and
then that changed the game.

New platform came and created much more opportunity. But for games, again, it's been like
these 200 million users that continue to buy consoles that is the target market and the game
makers have just consolidated to fewer and fewer franchises. And mobile is evolving in that
way, too, where it is almost a winner-take-all type thing where certain types of genres are the
main revenue drivers of the business, and that's been the way it's been since almost 2014.

Matt: [00:39:52] In mobile, does the margin profile look similar to those 40% EBIT
margins?

Eric: [00:39:56] Unfortunately not, particularly for Zynga, which was acquired by Take-Two. So
for individual products that scale, absolutely. So for something like King's Candy Crush, I think
they are at 40% margins and certain big games do scale in that way. The problem with Zynga,
and I think we'll get into it a little bit is that, yes, they bought this company with the gazillion
products that some are more profitable than others for sure. But overall, the business, I think,
was like a 15% margin business at best.

Matt: [00:40:21] Talk a little bit about the titles there. Do they have any core IP or crown
jewels that sit within that portfolio? And in your mind, how similar will mobile be to
console where it is core IP? Or is it a different market where you'll just see recycling
and new games tested out more frequently?

Eric: [00:40:42] Well, because game development costs a lot less in mobile, I think there's a
lot more opportunities to experiment and throw out there and see what sticks. But my opinion
on mobile has changed now is that user acquisition cost is so expensive. Game development
is getting more and more expensive. But you spend more on user acquisition than you do on
game development, which is not the case for console.

So it is consolidating amongst the big publishers and the big games. And Zynga does have
some amazing games that they've acquired over the years. And so those are the cornerstones
of their business in terms of what's generating all the profit and the revenue for that matter.
The problem is that all those core businesses are falling apart right now because IDFA and all
these privacy issues and Take-Two bought this company at the peak.

It was like the most idiotic acquisition in terms of timing I've ever seen in my career. It was so
bad. People in the industry were just like, what is he doing? Why would he ever acquire this
company? And I've been covering Zynga since the beginning, and I was really content with
what Frank did with the business, but it was clear eight months before the acquisition that they
were looking down the barrel of gun of no growth in the next three or four years. And then they
get acquired for a premium, made no sense at the time.

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But back to your question, the big franchises that matter for them is Merge Dragons!, Empires
& Puzzles and Toon Blast and Toy Blast and Golf Rival to some degree. These are all the
acquisitions Zynga made over the years that drive the majority of their revenue. And if you
look at all of them, they're all down 15% to 20% year-on-year after a s***** year last year. It is
Armageddon over at Zynga.

The fundamental problem with this is as revenue declines in order to maintain the profitability,
which was s***** to begin with, you start cutting costs. And when you start cutting costs, the
only thing that you really can cut, once you cut a lot of the people is cutting UA. And the
minute you start cutting UA and this is UA-driven business, then revenue suffers. And then
revenue goes down. And then you get in this death spiral.

Now having said all that, I think a lot of that is priced into the stock. If you had listened to me a
year ago, when this acquisition was announced, I would have told you all of this then and then
exactly what I said actually happened. But I think everyone's realizing that and no one gives a
F. All they care about is GTA and rightfully so, to some degree. Hopefully, they can stabilize
this business, but it's not looking good.

Matt: [00:43:05] I'm curious just in terms of the acquisition. Obviously, the price was
way out of bounds. Is it still a valuable asset? You described the death spiral there,
which can be incredibly destructive in almost negative value. And you can argue that
just the attention that it requires could detract a lot of value. But in your mind, is there
value somewhere in that Zynga asset once it stabilizes?

Eric: [00:43:29] No, they gave up 40% of their company, 40%. Whoever was doing
spreadsheets and PowerPoints on this thing clearly had no idea what was going on in the
mobile game market. There was a reason why it was at $6 before this acquisition. If they had
waited three to six months, they would have gotten it for half as much. Majority of the analysts
in this space could have told you that. So I don't know what they were thinking. Really, I have
no idea.

So is there value? No, it's a declining business. You have to compare this to King. And I hate
to bring up King on this because King was bought for like 10x EBIT, while Activision was
trading at 20x EBIT. And at that time, Bobby did this absolutely massive multiple arbitrage, and
it was a genius acquisition at the time. But even after that, the business actually flatlined. It
wasn't doing much, but it maintained its profitability.

So it was this cash cow that they kept on reining in. And then on top of that, they end up
growing by doing better live ops and advertising, all this stuff. This business has been --
Bobby is a freaking genius when it came to this sort of thing Strauss did the exact opposite.
They bought a declining asset with less profitability than their core business and a continually
declining revenue.

So I'm imagining in my head with these McKinsey and JPMorgan guys creating these
spreadsheets and these beautiful PowerPoints talking about how this is going to be multiple
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expanding arbitrage, whatever, and putting all these fancy graphs up there, but they don't
understand the core business. Apple destroyed it overnight, and it's getting worse and worse.
And all these core franchises are never going to be able to grow again.

And the key thing here is they have absolutely no capability of building new games within
Zynga. And this is the critical point is that they do not have extra teams building new stuff, they
have no pipeline whatsoever to offset the weaknesses in their core businesses. And so this
was all known. It's so obvious. It just kills me. So no, I think this is the biggest problem with the
story is that Zynga is going to be this constant albatross around the neck of this company from
a profitability and revenue perspective once they consolidate all their P&Ls.

Matt: [00:45:26] Do you think it makes sense for mobile and console PC publishers to be
combined? Are there many synergies that exist between the two?

Eric: [00:45:39] Very, very little. No. I think Strauss had a lot of pressure to get into mobile.
And as I said earlier, mobile has become 50% of the interactive business, and they really had
no mobile presence. So I think he was pushed into it without really understanding it. And if you
actually listen to Strauss talk all the time, he's always talking about AAA. He doesn't really like
these free-to-play mechanics and he doesn't like mobile all that much. Similar to the way EA,
the CEO of EA hates mobile, generally speaking.

So anyway, I think he was pressured into building it. And I think a lot of it had to do with the
ego. Strauss always, in my opinion, or people that I talk to say that he always wants to be as
big as EA and Activision. And without a mobile presence, it's going to be impossible to be at
the scale that EA and Activision are. Both of which have mobile. This was a way of almost
overnight getting into mobile, but it was just the wrong acquisition at the wrong time.

What Industry Consolidation Means for Take-Two

Matt: [00:46:31] Qualitatively, checking a box of mobile exposure, makes sense.
Everything else beyond that, the reality of the situation point made for sure. Keeping on
the consolidation topic, the acquisitions topic, Microsoft-Activision, obviously, big
headlines. What does that mean for Take-Two? My immediate assumption is it makes
them a potential target. How real do you think that is? And in five years from now, will
EA and Take-Two be independent?

Eric: [00:46:58] It's really, really hard to think that EA and Activision will be independent in the
next five years. I have to imagine that as -- I don't want to go down this rabbit hole of this
Microsoft-Activision acquisition, but if that deal actually goes through, which it looks like it's
going to get through, that is open -- everything is open for acquisition, at least locally.

One clear thing is that the Chinese will not likely be able to acquire big publishers in the West
for obvious reasons. But for people like Amazon, Comcast, Netflix, Apple, Disney potentially,
not probably in the short term, it's open season on gaming companies. Now they're expensive,
but could be a strategic pillar for any of these companies. Right now, I think Amazon and
󰍡 are the ones that are the most potential to do something in this space.
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Comcast
I think Amazon is not giving up and Take-Two makes a lot of sense for Amazon, and Comcast
has some interest there as well. Savvy Group is probably the other potential that has deep
coffers to buy something like that. And that's a Saudi sovereign wealth fund that acquired
Scopely recently. And they're still looking for a traditional publisher for console PC, which
could be something like Ubisoft or Take-Two. EA is a little bit different in the sense that
majority of their content is licensed, most of their biggest content. So it's a little bit harder.
Disney would make a lot of sense for them or Amazon.

Matt: [00:48:20] And the strategic benefit to those buyers, I think with Microsoft-
Activision, I know it hasn't necessarily been for the strategy, which you would initially
think in terms of the Xbox and maybe holding games hostage. It's quite the opposite,
but would be a buyer strategy, someone like an Amazon or a Comcast in terms of
acquiring a Take-Two?

Eric: [00:48:37] First of all, getting into the interactive space, which is one of the fastest-
growing areas of media, generally speaking. It's also leveraging the existing IP from that
acquisition to do cross media, which movies and television, which has become more and more
popular with the success of Last of Us, and The Witcher and numerous others that have done
extremely well. And Take-Two has some great IP. Red Dead Redemption would be a great IP
for movies and television, Max Payne, BioShock. So there's tons of stuff that they could
leverage.

Matt: [00:49:11] You've mentioned that valuations are extremely high in terms of
potentially impeding a potential acquisition. How do you go about valuing these
businesses? And what is industry norm from the investment world in terms of looking
at these? Is it traditional PE? Is there anything unique that they use to come up with
valuations?

Eric: [00:49:30] I mean it's more or less traditional PE stuff. It used to be more of a hit-driven
business, so you would take peak earnings, et cetera, and then do some discount on it. And
that's what Take-Two has to some degree because next year, again, if GTA comes out, you
consider that one of their peak earnings years. And so that's what the multiple is based upon
right now or how some of the investors are looking at it.

On the flip side, Activision and EA have much more stable earnings and so they traded at an
ongoing multiple and I think that makes the most sense or you could take an average over the
next three or four years for Take-Two, but they seem to think that they can actually grow after
the release of GTA through GTA catalog and online sales and other products in the pipeline.
Anyway, that makes it even potentially more valuable. And I think there's actually a method
that, that could happen.

Matt: [00:50:19] I guess, relative to the market, we said like average market multiple
normalized of 15x earnings. Have these businesses historically basically normalized off
of that? Has the evolution of mobile or maybe not mobile, but in-game purchases
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Eric: [00:50:37] I alluded to that earlier. Historically, the multiple was a lot lower because of
the hits-driven business. But now that they are a SaaS business to some degree, their multiple
definitely expanded to the 20% to 25% range. And they should. I mean a lot of this stuff is very
predictable. EA has grown FIFA over the last decade, every year. Some higher than others,
but it's still like this ongoing business. They have this core group of people that are continuing
to spend and have complete loyalty. 2K is the same thing.

Matt: [00:51:04] I think we've talked about the risks quite a bit, Zynga being in the death
spiral and just being in a constant strain on the business being one of those things.
Anything else that you would point to in terms of key risks here for Take-Two?

Eric: [00:51:20] My biggest worry is that people's expectations on GTA get ahead of
themselves. People have to keep in mind that the installed base is a lot lower that they're
selling into. The total addressable market is smaller. And then there's always the Software-as-
a-Service risk, there could be burn out. People may not be as interested in going into GTA like
they did before or get all bent out of shape because all the content that they've purchased.

You have to imagine people have collections hundreds of cars, hundreds of boats, hundreds
of motorcycles that they've collected and spent thousands and thousands and thousands of
dollars and thousands and thousands of hours collecting. And so now you're asking them to
stop, get rid of all of that. And I know it's digital, but it's still considered an asset for these
people and start over. That's a tall order. They have to manage that well.

The final thing I would just say is that in order to really see an increase of revenue per user,
they have to do a better job of managing the service, the online service. And that's what I'll be
watching to see how well and what they do, what mechanics they have, what kind of things
that they're doing in order to monetize the audience better so that they get more revenue per
user because they're going to have to do that to offset the big installed base of GTA IV.

Matt: [00:52:36] We close these conversations out with lessons or things you could take
away from looking at this business and maybe apply to other businesses. It seems like
there's quite a bit here, actually, just in terms of lessons about capital allocation and
acquisitions and getting pressured into making those deals. But what would you point
to in terms of main lessons that you think you might be able to apply elsewhere?

Eric: [00:52:56] Clearly, you have to focus on the businesses that make up the majority of
their earnings. So keep an eye on the big titles, GTA and 2K, similar EA, similar Activision, et
cetera. And then also, you got to keep an eye on the potential downsides of businesses that
aren't doing well like Zynga. And I think you can do that for all of these publishers that are out
there.

And then finally, this is still a hit-driven business. Regardless of how mature it gets, there are
still things that can surprise you. And so that's what makes this business really interesting from
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an investment perspective is because things can come out of nowhere and do extremely well.
I mean something like Fortnite was after two really failed games from Epic. Epic hadn't
created a good game, a successful game for like 15 years, 15 years they haven't created a
game.

And all of a sudden, they have the biggest game in the world. That's still possible in this world,
and that's what makes this industry really interesting for both mobile and console for that
matter. Always keep that in mind that you have to be keeping track of the buzz and interest
along new games that are coming out.

Matt: [00:53:58] Well, all right, this was a pleasure. Appreciate all of your insights on
Take-Two specifically and the industry. Thanks for joining us.

Eric: [00:54:05] Thank you.
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8/17/23, 10:45 AM Take-Two Interactive: GTA and NBA 2K | Colossus®

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RECOMMENDED CONTENT TRANSCRIPT SHOW NOTES

Overview of Take-Two and the Broader Gaming

the questions that need to be answered or have to have an opinion on as an analyst.

What Industry Consolidation Means for Take-Two

Eric: [00:54:05] Thank you.

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