Take-Two Title Is Scrolling Up Shares

Strong sales of its role-playing game lift the stock, but management issues still weigh.
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Is it time to take another look at

Take-Two Interactive

(TTWO) - Get Report

?

Despite all of the turmoil surrounding the video-game publisher over the last year, some investors and analysts say it is.

What they see is a company that has some of the top titles on the market right now, and in

Grand Theft Auto

it has the top franchise in the industry. But it's a company undervalued relative to its peers.

"In the grand scheme of things ... if you've got good content, people are going to show up in stores and buy it," says one buy-side analyst whose firm is long Take-Two.

"People that have bulled up on

Take-Two see a stock that has the potential of doubling right in front of everybody," says the analyst, who asked not to be named.

On Monday, the market seemed to clue into some of Take-Two's potential, as Piper Jaffray analyst Anthony Gikas raised his earnings estimates, citing strong sales of one of Take-Two's recent titles. The stock closed the regular session up 4.6% to $18.57, a price the stock hadn't reached since late last month and had not stayed at consistently since January. It was making further gains Tuesday morning, trading recently at $19.13.

But not everyone is buying the bulls' argument. Several investors say they are steering clear. Not only do they see a company that is overly dependent on one franchise, but they also see a company with seemingly no end of management and governance problems.

"It's just not a quality business," says Steve Monticelli, who as president of San Francisco-based Mosaic investments follows the video-game sector but does not have a position in Take-Two. "Aside from the potential for a take-out, I don't see any reason to own the stock."

What helped boost Take-Two on Monday -- and prompted Gikas' note -- was the performance of one of its non-

Grand Theft Auto

titles,

The Elder Scrolls IV: Oblivion

, a game for PCs and

Microsoft's

(MSFT) - Get Report

Xbox 360.

Take-Two says it has shipped more than 1.7 million units of the game worldwide. At that rate, Take-Two is now on track to sell twice as many copies of the game as projected, Gikas said.

Although he maintained his market perform rating and $18 price target on the stock, the analyst upped his full-year earnings estimate from break-even to 6 cents a share, based on the news.

"We think there is significant inherent value to the company, but the lack of earnings visibility, a challenging

near-term retail environment and a history of one-off issues will continue to dampen the company's multiple," wrote Gikas, whose firm has not done recent investment banking for Take-Two. "Overall, we do maintain a

long-term positive bias toward the

company."

Take-Two's announcement about sales of

Elder Scrolls

-- what Gikas alluded to -- was among the first positive news for the company in a while.

In recent months, the company's stock has been

rocked by concerns about the company's corporate governance and operating results.

Last week, for instance, the company announced that it was changing auditors, a move that can often raise a red flag with investors, especially in cases where questions have already been raised about a company's accounting. In Take-Two's case, the change of auditors came after the company's disclosure earlier this year of problems in its internal controls, a system of checks and balances designed to prevent corporate fraud that auditors are now required to assess.

The auditing change also postdated the

resignation in January of Barbara Kaczynski as the chairman of the company's audit committee.

In her resignation letter, Kaczynski charged that there was an "unhealthy relationship" between the company's board and its senior management that was "characterized by a lack of cooperation and respect."

Meanwhile, Take-Two's

sales and earnings have slumped in recent quarters. Like its rivals in the video-game business, Take-Two has been affected by an industrywide downturn.

But the company has also suffered from its own mistakes. Last year, the company

pulled the latest version of its

Grand Theft Auto

series off store shelves after an industry ratings board forced the company to place a more restrictive rating on the game after an explicit -- and previously undisclosed -- sex scene was discovered within it.

Even with all the problems Take-Two has faced recently, the company is a bargain, bulls argue.

Over the last year, Take-Two's shares have fallen 33%. In contrast, rivals

Electronic Arts

(ERTS)

and

Activision

(ATVI) - Get Report

have seen their shares appreciate modestly, at 6% and 15%, respectively. Over the same period, shares of

THQ

(THQI)

have jumped 36%.

Those stock gains have come despite similarly disappointing financial results at Take-Two's rivals. The divergence in stock prices shows up in valuations. Based on projected current-year sales, Take-Two is trading at an enterprise value-to-sales ratio of about 1, THQ at about 1.6, Activison at about 2.7 and Electronic Arts at about whopping 4.8.

Take-Two's corporate governance has been poor, and that has held back the stock, acknowledges Toan Tran, an equity strategist at Morningstar who covers the video-game sector. Also, the company has a lot of eggs in the basket of its

Grand Theft Auto

franchise, says Tran, who does not hold individual shares of the companies he covers and whose company does not do investment banking.

"But then again, it's a very good basket. It's very valuable," he says. Take-Two's fair value is about $23 a share, he says.

Some investors see a lot more to Take-Two other than

Grand Theft Auto

and governance problems. Not only is

Elder Scrolls

selling well, but also the company likely will have another big hit on the Xbox 360 with its

Major League Baseball 2K6

title, the only such game for the platform, says the anonymous buy-side analyst who's long the stock. An upcoming table-tennis game could also be a surprise hit, the analyst says.

"To me it seems like they're doing a pretty damn good job of diversifying way beyond what anybody's expectations were," says the analyst. "There is a value that is kind of hidden in this business."

But other investors are much more skeptical. Brightleaf Partners has been both long and short Take-Two in the past, but managing partner Evan Jones doesn't see a good position right now.

The stock isn't expensive enough to short, says Jones, whose Durham, N.C.-based firm has about $50 million under management. And if someone were to step in and buy the company -- and replace its current management -- the stock could soar, he says.

But given all governance concerns, the stock is too pricey to go long now, he says.

"It's kind of in no-man's land," he says.