Time's Waning for EA's Take-Two Takeout

EA is expected to ask for another extension on its bid for its smaller rival.
By Priya Ganapati ,

SAN FRANCISCO -- The countdown to video-games publisher

Electronic Arts'

(ERTS)

$2 billion hostile bid for its smaller rival

Take-Two Interactive

(TTWO) - Get Report

has begun.

After one extension, EA's tender offer to Take-Two shareholders is set to expire midnight Friday.

Many analysts and portfolio managers are betting that EA will fall far short of the majority of shares it needs to acquire Take-Two. Instead EA is likely to either extend its tender once again or announce an update to negotiations with Take-Two's management, they say.

On Feb. 24, EA said it will offer $26 a share for Take-Two, a move that was rejected by the latter's management on the belief that the price significantly undervalued Take-Two. Take-Two management has since then tried to thwart a takeover by issuing additional shares. In response, EA

dropped its bid

to $25.74, where it now stands.

On April 18, EA said that it has gathered about 9% of shares in Take-Two. It is unlikely EA could have bagged much more since then, says Darren Chervitz, director of research at Jacob Internet Fund, which has Take-Two among its top holdings.

Jacob Internet Fund hasn't tendered its shares to EA and Chervitz says he doesn't plan to for now.

"Take-Two's stock is trading two dollars above the tender offer," says Chervitz. "So why would any investor tender to EA when they might as well sell it in the open market?"

Take-Two's stock closed up 36 cents, or 1.3%, to $27.33 Thursday. Shares of EA were down $1.26, or 2.4%, to $51.52 Thursday.

Still, EA is likely to extend its tender offer yet again, say analysts.

"I don't think EA will get any more shares," says Michael Pachter, an analyst with Wedbush Morgan. "But I expect them to extend the tender another 30 days." Wedbush Morgan does not own shares or have an investment banking relationship with Take-Two.

On its earnings call with analysts earlier this week, EA said it is working with the U.S. Federal Trade Commission, which is reviewing the deal to see if it would be anti-competitive.

EA could use that review as a reason to extend its tender offer, even as the company negotiates with Take-Two's management and waits for FTC clearance on the acquisition, says Todd Greenwald, an analyst with Signal Hill Capital. Signal Hill does not own shares of EA or Take-Two, or have an investment banking relationship with them.

An FTC nod would clear the decks for the acquisition.

EA's current fiscal year guidance shows the company needs Take-Two for its stable of original game titles and creative talent, says Greenwald. EA beat analysts' estimates for the fourth quarter but

offered mixed guidance

, saying it expects profits in the first half of the current fiscal to be lower than Street expectations.

"What EA needs is owned -IP (intellectual property)," he says. "The Street is disappointed because they don't have enough operating leverage."

For the current fiscal 2009, EA has guided operating margins, excluding charges, of 12% to 14%, an increase of up to approximately 5.5%. Compare that to an operating margin of 18.4% at rival

Activision

(ATVI) - Get Report

in fiscal 2008.

EA's lower leverage stems from the fact that many of the company's biggest hits are either licensed titles or games that it co-publishes, leading to lower margins.

"EA doesn't have too many new and original IPs," says Doug Creutz, an analyst with Cowen. Cowen does not own shares of EA or Take-Two, or have an investment banking relationship with them.

That's why Take-Two, with its stable of innovative games such as the

Grand Theft Auto

franchise or last year's sleeper hit

BioShock

, makes an attractive purchase for EA.

It's also why analysts believe that EA is unlikely to walk away from the negotiating table.

"There's a lot of incentive on both sides to get a deal done," says Creutz. "They are presumably talking now."

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