Video-game publisher Take-Two ( TTWO) is wedged between a rock and a hard place. Take-Two has long faced criticism for its inability to produce a string of hits and its excessive dependence on a single, best-selling game series, Grand Theft Auto. Not surprisingly, the company's
new management indicated that it will strengthen its unprofitable sports division, 2K Sports. This sounds like a reasonable plan: Sports games have a strong fan base, and Take-Two has been working on building up the division as part of its diversification plan. But scratch deeper, and some analysts say that Take-Two may just be setting itself up for another big mistake. Sports games were about 20% of the company's publishing revenue and pulled in about $150 million in 2006, nearly double the previous year's take. Still, 2K Sports continues to lose money, and the road ahead seems rough. In an update to analysts and investors earlier this month, Strauss Zelnick, Take-Two's new chairman, warned that the company's sports division is unlikely to emerge from the red this calendar year as expected and that profitability may be pushed out to 2008. And even that is unclear. Instead, the company might be better off focusing on building its portfolio in other game genres, such as strategy and action.
Shares of Take-Two closed the regular session off 15 cents, or 0.8%, to $19.71 Tuesday. The stock has been up about 8% in the three months since Jan. 23, and up about 18% in a year. The sports genre of video games, while lucrative, is also a difficult business. Getting exclusive licenses to games can be expensive, and most of the top-selling categories have been cornered by Electronic Arts ( ERTS), a formidable rival in the segment. That's why Take-Two could be better off cutting 2K sports loose and instead focusing on other genres where it can actually have a shot at success, says Michael Pachter, an analyst with Wedbush Morgan, which does not own shares of Take-Two and EA or have an investment banking relationship with either company. "Take-Two is competing for a very small slice of the overall market," Pachter says. " Activision ( ATVI) has a stronger balance sheet, and it chose to pass on sports. But Take-Two took on a fight they couldn't win." Take-Two declined to comment. New York-based Take-Two has about 300 people working on its sports titles and has invested $200 million on sports titles since 2004, former CEO Paul Eibeler said during the company's quarterly earnings call on Feb. 28. Roughly $60 million has gone into the acquisition of development studios, $50 million into software development, and more than $80 million has been spent in licenses and IP for products.
That's still a fraction of what EA has doled out. EA has about 75% of the market and deep pockets, which have enabled it to sign expensive but lucrative licensing deals with sports leagues that its competitors can't afford. "By all signs, 2K Sports is a drag on
Take-Two , and it has not turned a profit yet," says Brian Sozzi, an analyst with independent research company Wall Street Strategies. "It's great that they are trying to expand market share, but there isn't anything big and worthwhile out there for grabs." The top-ranked, best-selling sports games categories are NFL football and FIFA soccer, followed by NBA basketball and Major League baseball. College basketball and NASCAR are next, with wrestling weighing in after. "If you really go through the list, NFL, FIFA,Tiger Woods, NASCAR, Formula 1 are all exclusive to EA," says Pachter. Though Take-Two has an exclusive license in Major League Baseball, that might not be enough to get a good return on the company's investment or to hold competitors at bay. The license is third-party-exclusive, which means that console manufacturers can still create games based on the franchise. And that's exactly what Sony ( SNE) is doing. Sony's game MLB 07: The Show, for the PS2, sold 164,000 units in March, eating into Take-Two's sales. Take-Two's Major League Baseball 2K7 game for the Xbox 360 sold 165,000 units during the same period, according to the NPD Group.
Meanwhile, Sony plans to release the PS3 version of the title on May 15. "Sony's game has sold really well," says Pachter. "And that's a problem for Take-Two. Their exclusive license isn't all that exclusive." Pachter says that Take-Two's new management may have its heart in the right place when thinking about diversifying the company's product portfolio through sports games, but the odds are against the company's gaining significant market share or becoming anything more than a bit player. "EA has been trying to sign a baseball exclusive for a long time, and it is going after an exclusive NBA deal, too," he says. "If it succeeds, then Take-Two can kiss its sports business goodbye." That's why Take-Two could fare better devoting its resources to developing more strategy games, a genre in which it found its biggest hit, Grand Theft Auto, or shooter games along the lines of Activision's Call of Duty, which have become megahits. Take-Two could leverage its strong development team in these areas, while at the same time avoid setting itself on a collision course with a huge competitor, says Wall Street Strategies' Sozzi. Still, it might be premature to write off 2K Sports, says Billy Pidgeon, an analyst with research firm IDC. "Their internal development team is very talented, and they do have the chops to take on EA with game design and execution," he says. "It is entirely possible to challenge EA on nontraditional sports." Pidgeon also suggests that sports leagues might be moving away from an exclusive licensing model. "There's more opportunity for them if they have several publishers bidding for their IP," he says. But that only underscores the case against 2K Sports. 2K Sports can't win at the game right now; it has a shot only if the rules change.