Diversification Drives Take-Two - TheStreet

Shares of

Take-Two Interactive

(TTWO) - Get Report

got a shot in the arm Friday after a strong first-quarter earnings report, as analysts excused the company's soft guidance as a necessary evil to building a broader game portfolio.

Monarch Research analyst Garrett Edson, for instance, upgraded his rating on Take-Two's stock to buy from a hold. He and other analysts also upped their earnings estimates and price targets on the company's stock.

"After the last earnings call, we stated that management needed to 'show us' and exceed expectations after several lackluster quarters. With

its first-quarter report, management has done just that," Edson said in his report Friday.

(Kevin Dann & Partners, Monarch Research's parent company, has not done investment banking for Take-Two, and Edson does not hold shares in Take-Two.)

Apparently in response to bullish comments such as Edson's, investors bid up shares of Take-Two on Friday. In recent trading, the stock was up 91 cents, or 2.4%, to $38.33. Earlier in the day, it traded as high as $39.25.

Take-Two topped analysts' estimates on Thursday by

reporting first-quarter earnings of $55.23 million, or $1.19 a share, on $502.47 million in sales. The consensus expectation among sell-side analysts was for a profit of $1.09 a share on $452.6 million in sales.

But the company drew cheers from analysts Friday not only for beating their forecasts. The company has taken significant steps to diversify beyond its blockbuster

Grand Theft Auto

, the sell-siders noted.

The knock on Take-Two has long been that the company is a "one-hit wonder," meaning that it has little success outside of

Grand Theft Auto

. But over the last year, the company has focused on trying to develop or buy new titles. The company made a big push in sports last year, for instance, with its ESPN line of sports titles. In recent months, the company

bought the studio behind the ESPN sports games, secured a long-term

license from Major League Baseball and

bought the rights to the

Civilization

series of simulation games.

The company has a couple of promising titles in an upcoming game based on the movie

The Warriors

and in

Midnight Club 3: DUB Edition

, the latest game in its racing series, analysts said. Additionally, the company said on its Thursday call that it is close to signing a long-term, nonexclusive licensing deal with the National Basketball Association, a move that should shore up its sport efforts, analysts said.

"TTWO proved that it can again deliver with

Grand Theft Auto: San Andreas

, and is gradually building a portfolio of other dependable franchises," said American Technology Research analyst P.J. McNealy in his own report Friday.

(American Technology does not do investment banking and McNealy does not own Take-Two shares.)

The diversification effort is proving to be costly, some analysts noted. The company projected, for instance, that its earnings the next two quarters will come in far below analysts' previous expectations, due largely to increased development costs.

"It is clear that this is an investment year for the company," said Bear Stearns analyst R. Glen Reid, in a report Friday, in which he reiterated his outperform rating on Take-Two shares. "With investment we believe that TTWO continues to chip away at the sentiment that it is an undiversified company. As a result,

fiscal 2006 looks to be a year of growth for the company."

(Take-Two has not been a recent investment banking client of Bear Stearns.)

Other analysts found more reasons to be bullish. The company is coming out with a new

Grand Theft Auto

title for

Sony's

(SNE) - Get Report

PlayStation Portable (PSP) handheld game machine and also plans to release the new

Midnight Club

title for the device. Those games could help boost revenue if sales of the device take off after it is released later this month.

"Given Take-Two's leverage to the PSP, its strengthening product portfolio and attractive valuation, we believe Take-Two remains one of the most attractive risk-reward situations in the entertainment software space," said Credit Suisse First Boston analyst Heath Terry, in his report Friday. Terry reiterated his outperform rating on Take-Two shares.

(CSFB has provided both investment banking and noninvestment banking services to Take-Two in the last year.)

A further reason for optimism, analysts said, was that a long-running

investigation by the

Securities and Exchange Commission

into Take-Two, which has served as a drag on the company's stock, appears to be drawing to a close. In November, the company submitted a proposal to settle the matter, and the SEC staff agreed to recommend the settlement to the commission, the company said in its annual report filed in December.

Once the matter is resolved, it will "eliminate a major risk for the firm and open up the company to potentially repurchasing shares," said Monarch's Edson.

However, not everyone cheered the company's results. A change in the company's tax rate boosted its bottom line by about 12 cents a share, noted Colin Sebastian, an analyst with Thomas Weisel Partners, in his own report Friday. Without that boost, the company actually would have fallen short of expectations, because its operating expenses were larger than projected.

That tax change is likely to continue to boost Take-Two's results for the rest of the year, Sebastian noted. Because the company didn't change the top end of its earnings outlook for the year, its operating results likely will be worse than previously expected, again due to the increased expenses.

And while the company has taken steps to diversify its revenues, it still is largely dependent on

Grand Theft Auto

, Sebastian said. Sales of

San Andreas

comprised 57% of its revenue in the quarter.

While other video game publishers trade at about 25 times their expected forward earnings, Take-Two trades at about 18 times its projected earnings for this year -- a justified discount, according to Sebastian.

"We believe that TTWO is likely to continue trading at a discount to its peers until the company further diversifies its publishing revenues beyond the GTA franchise, product visibility and performance of new titles improves, the portion of lower margin distribution business declines, and/or there is greater consistency in meeting financial targets," Sebastian said, reiterating his "peer perform" rating.

(Thomas Weisel has not done investment banking for Take-Two in the last year.)