Take-Two Interactive Software, Inc. (TTWO) Earnings Call Transcript & Summary

We have Take-Two Interactive, and we have the company's Chairman and CEO, Strauss Zelnick, here this morning. Strauss, thank you very much for taking the time to be with us.

Thanks for having me.

So let's start off with the big picture. We have now entered into a new console cycle. As you look out into this console cycle, do you see anything to suggest this cycle is likely going to be evolutionary or revolutionary? And what might that mean for Take-Two?

It's always hard to know. I mean we're really excited about what the new technology allows our developers to do. Any time that we have a better and more robust set of tools on which to work, our teams push as far forward as they can, and they can deliver amazing things. So for both the Xbox and the Sony PlayStation platform as well as for PC, we think that this next generation will provide great opportunity. I think when you say revolutionary, I'm not sure what that implies. The days of the sort of sine-curve console cycle are long gone. We didn't have that historical effect the last time around or the time before. We don't expect to have it this time around either. And that is where hardware is launched. There are massive software sales for a period of time. Hardware peaks, software peaks, software declines, there's a big trough. A couple of competitors go bankrupt and you start all over again. Those days are long gone. And in the last 2 transitions, our catalog remained very strong, our new releases remained very strong, we were able to launch titles in both systems, and we continue to grow the business. And I expect that will -- that's what will happen this time as well.

And when you see -- when you think about the various ways people can access your games, there's been a lot of hype around streaming. And while you guys have always been platform-agnostic, does streaming change the business model at all?

Not necessarily. Streaming is just a technology.

Okay. Looking now specifically more towards Take-Two, when I look at your numbers this year and Take-Two has been -- has seen a great engagement year, much better than originally expected, your guidance for this year suggests an operating margin of about 23%, which is roughly in line with the last 2 years. I know you guys have been talking for a while about getting greater scale. But what needs to happen to get that operating margin from 23% to 30% and more in line with the bigger players in the industry?

Our gross margins are highly competitive. So that sort of answers the question. If the gross -- if your gross margins are sort of top of the field, which ours are because that reflects our ability to create hits and therefore, hit ratio, then the only thing standing in the way of our competitive operating margin would be scale. And we've mostly grown our scale organically. We've guided to $3.15 billion to $3.25 billion in net bookings this year, for example, which will set a record for us. And most of the growth from where we were 14 years ago has indeed been organic. We've done a couple of acquisitions: most recently, Playdots; before that, Social Point. However, the preponderance of the growth has been organic. And in order to have truly competitive operating margins, we have to operate at the same scale as the biggest players. And we expect to do that through continued organic growth and potentially through inorganic growth, if we're able to complete accretive acquisitions along the way. And there are some benefits that we expect to accrue to us as well as our competitors, not the least, the continued transition to digital distribution, which will grow margins.

Understood. And so let's look at your organic growth right now. I mean the company -- you've been building out a number of internal studios under the 2K umbrella in recent years. Can you maybe highlight some of those investments and maybe talk about your development pipeline?

Well, I mean starting with the pipeline. So in reverse order, we've already said that over the next 5 years, we expect to deliver something like 93 titles, which is about double the size of our pipeline a few years ago. And that's obviously come about through the launch of Private Division; the purchase of Social Point; and more recently, the purchase of Playdots; as well as growth in our core businesses, Rockstar and 2K. At 2K, we have Cloud Chamber, the studio that's working on the next iteration of the BioShock franchise. BioShock Infinite sold-in 14 million units. So we're really excited about what Cloud Chamber will do. Michael Condrey's studio, 31st Union, is working on new intellectual property. Hangar 13 is working on new intellectual property. Ken Levine's studio, Ghost Story, is working on new intellectual property. Private Division, obviously, signed up a number of great independent developers. Social Point has 10 new games in development. And the list continues. So I answered the question more broadly than 2K. We have a lot going on at the company.

Okay. When you look at Rockstar, who's actually been generating phenomenal amounts of revenue with its 2 big properties, Grand Theft Auto and Red Dead Online, we've now seen Red Dead Online being untethered from Red Dead Redemption 2 as of December 1. You have a similar plan occurring for GTA Online and GTA V at some point in 2021 with the new consoles. Can you maybe discuss this strategy and how you see the platforms evolving in the coming years ahead of their next respective premium game launches?

It's an exciting time for us to take this step. Obviously, both titles have been out for some time. They've been immensely successful. Grand Theft Auto V has sold-in over 135 million units. Red Dead Redemption 2 has sold-in over 35 million units. Grand Theft Auto Online is expected to set another record this year, 7 years after its initial launch. Red Dead Online had enormous success in the second quarter, growing about 100% year-over-year. And we think there's an opportunity by making the online versions of these 2 beloved titles available stand alone to attract more consumers, some of which will actually go back and buy the original title, some may not. And hopefully, all will get engaged with the franchise that will continue to build both brands and build our user base and these worlds will continue to be living, thriving and growing.

And how do you think -- when you look at your franchises, what do you need to have happened in terms of engagement to be able to develop something like the open worlds of Red Dead Online and GTA Online versus thinking about standard types of add-on content or -- where you can then develop a recurrent consumer spending model?

I'm not sure I understand the question.

Are there other games within your portfolio that do you -- that you think are capable of handling an open world situation like you have with GTA Online and Red Dead Online? Or is that something that just has to happen over time as you build the audiences of those games? As you think about there's a lot of new IP being developed, is it possible to even start planning something like a GTA Online or Red Dead Online for somebody's as-yet unreleased games?

Well, nothing at our company or anyone else's company approaches the scale of the worlds of Grand Theft Auto and Red Dead Redemption. These are massive open world experiences, and Rockstar is the most expert organization on earth at creating massive open world experiences. So could someone else inside or outside of our company do the same thing? So far, the answer has been no. I mean it would be very, very hard for someone to do that. We do have titles where there's plenty of opportunity for engagement. And in many ways, NBA 2K21 is a bigger and bigger world that you can explore in the city, which is an evolution of the park. And NBA 2K used to be a great basketball simulation game. Now there's still a great basketball simulation game, but you can engage with other players throughout the game, and you can engage with music or other forms of basketball or culture. And you can have experiences in NBA 2K that are really -- that really have almost nothing to do with the simulation basketball game. Now the breadth of that world is obviously not in the same realm as Grand Theft Auto or Red Dead Redemption. However, it's certainly a lot bigger than it was years ago when it was very much a basketball experience. And I think you will see many of our titles aspiring to keep consumers happily engaged on an ongoing basis. In order to do that, we have to give them plenty of exciting entertainment. But I don't expect that we'll be trying to do what Rockstar has done with their open world games. I think that's a very bespoke activity that Rockstar really has nailed.

And with regards to NBA 2K, I mean the game continues to set new records with unit sales and recurrent consumer spending. Where do you see the biggest opportunity to keep revenue rising with this game, specifically in terms of widening the funnel of players, adding new play modes? What keeps this game growing so that you don't hit a ceiling?

We still think there's great opportunity. A lot of the opportunity exists outside of the United States. We're already the biggest sports title in the U.S., and we'll continue to grow, we believe. But we have plenty of opportunity for growth. We are certainly not the biggest sports title and the NBA itself is growing outside of the U.S. So of course, the big win is to bring in new players. And we've sold-in over 5 million units of NBA 2K21. As you said, we've had great year-over-year growth. We've sold-in over 105 million units in the franchise to date. So I think growth will come from expansion of the market, expansion of the titles, success within the markets. And then, of course, there are more and more opportunities to engage and, therefore, more opportunities to spend, and that should increase the value of the title as well.

And then in terms of your U.S. versus international mix, where is that now and how has that evolved in recent years?

I think it's still -- the majority of our basketball sales still come from the U.S. I think it's about 60-40. I think we've built up the international business. I think years ago, it used to be 65-35 in favor of the U.S. So we're making good progress, but it's still more U.S.-weighted business.

And as you think of the business models to expand NBA 2K globally, you do have a free-to-play game in China with NBA 2K Online. At what point do you think maybe to increase your players or widen the funnel that type of game should be distributed globally?

It's a great question. We haven't contemplated that yet. We're -- we have a partnership with Tencent in China. It's a stand-alone title. It's the #1 PC sports title in China with 50 million registered users. So obviously, it's a big business by itself. So we've not ruled out anything in particular. However, NBA 2K continues to grow its own open, broad, big multiplayer experience. So I think right now, our core title is answering the question from our point of view, and there's plenty of opportunity for growth with the core title without launching something else to stand by it.

So to that end, I mean where does sort of this free-to-play model for consoles fit within your framework? Does it even fit in the framework?

Well, we -- you sort of used the word before so I'll use it as well. We have now sort of tethered free-to-play, right? We have -- you buy Grand Theft Auto V, and you have access to this huge open world that looks a lot multiplayer open world, that looks an awful lot like a free-to-play game except better, frankly, and bigger. And in the case of Red Dead, we have this tethered free-to-play or now stand-alone multiplayer online game for $4.99 at least until February 15, 75% off. So the entry barriers are very, very low, but it's not quite free-to-play. In terms of console free-to-play, we are definitely open-minded. We're not unaware of the fact that free-to-play titles have much lower hit ratios. You have to take that into account as you invest in titles. And that's true for all of our competitors as well as ourselves. And yet, we think there's opportunity, and we are working on numerous free-to-play titles in the portfolio of titles I referenced earlier and expect to bring a number of them to market in the next 5 years. And not all of them are casual or hyper casual.

Let's talk a little bit about Private Division for a second. How would you characterize the productivity of the Private Division Studio, its output and its pipeline? And how should we be thinking about those games in terms of size and scale?

They've done a great job attracting the best independent developers, developers who historically would not want to be part of major systems. And they've done so by making sure that these independent teams have an enormous amount of creative autonomy and that we supply financial support and publishing support, marketing support in a way that fits with their brands and their DNA. Private Division has been very selective. Their hit ratio is very high. So far, the Outer Worlds, for example, has sold-in over 3 million units. We've also had success with other titles, Ancestors. Most recently, we launched Disintegration. And of course, we bought Kerbal Space Program, and we have Kerbal Space Program 2 coming in fiscal '23. Delivered by a stand-alone studio, the Private Division established in Seattle Intercept. So they're doing great. They've signed up a number of ongoing agreements. It's still a very disciplined, focused organization. They're not launching 20 titles a year, they're launching a couple of titles a year. I think with success, that will continue to grow a bit. But it will still be a very disciplined activity and which, frankly, is what we try to do across the board at our company.

Okay. Let's talk a little bit about M&A, and I realize you are restricted about what you can say at Codemasters at this point due to U.K. regulations. But you did acquire Playdots, a mobile studio, this year. How robust of a pipeline do you think there is of companies that meet your M&A criteria? And what is your M&A criteria?

Well, our M&A criteria would be, of course, the opportunity to acquire great intellectual property and great teams to turn that intellectual property into successful entertainment products and terms that mean that the deal can be accretive for us because we do focus on that. And so far, we haven't had a failed transaction in 14 years. And we haven't done all that many, but the ones that we've done have all penciled out, which is important to us. Most corporate M&A fails because people overpay or undisciplined about what they're buying or not focused on a cultural fit. So we are disciplined. We focus heavily on a cultural fit. We really get to know companies before we acquire them. And then once they're in the Take-Two system, they usually maintain enormous creative autonomy, often maintain their own brands, depending on what they do. We've also done some tuck-ins where they were absorbed into the organization intentionally. That's typically more the technology acquisitions that go in that direction. We're fortunate. We have a great balance sheet with $2.4 billion in cash, no debt. We generate a lot of cash. We're expecting to generate $650 million in unrestricted operating cash flow. So we certainly have the wherewithal to pursue large transactions. Some -- the deals we've done have actually been quite small. You alluded to Playdots, that was $196 million deal, a significant amount of which was in stock. So we have a lot of wherewithal to pursue deals that make sense to us. However, we'll remain highly disciplined as we approach that market. We think that has served us well and will continue to serve us well.

Do you think the industry is at a point right now where it's ripe for consolidation and timing-wise, it just makes sense for the industry to merge? Or is this just business as usual?

Well, I think my track record of making predictions about what will happen in M&A has been pretty terrible. I think years ago, I said there was going to be a big wave of consolidation and didn't occur. And now there really are a lot of deals going on with Microsoft's purchase of Bethesda, for example, our own activity and some of our competitors' activity. But I don't think the phase of consolidation that you're seeing now and you -- I think you will continue to see deals happen is a reflection of maturity in the business. I still think the business has enormous growth ahead of us as the cohort [ ages ] and still plays video games and new people enter the cohort. I think what you're seeing is the phase of consolidation you always see in hit-driven entertainment businesses, which is they reached the first phase of success and scale, which a few of us have. And thankfully, we're in that rarefied group. In success, the companies in that group generate a lot of value and a lot of cash flow, pretty strong, if not very strong balance sheets. And all have a desire for ongoing scale, which I mentioned earlier. And there's a particular emphasis on that in our shop because we are a bit smaller than our -- meaningfully smaller than our biggest competitors. That will lead people to make acquisitions where they have confidence they can maintain the success of the organization purchase or grow that success, thereby generating a gross margin and enhance their operating margin and create a return for shareholders. That's sort of best case scenario. And I think that's what's driving acquisitions now. True consolidation, the sort of end-of-life like the music business where a business is really compromised and consolidation occurs, that's really focused on cost cutting, that tends to occur when catalog sales form a very significant portion of the business, and you can look at a catalog and say, there's not much I need to do except to own this to generate value and I'll kind of have duplicative overhead. So that's happened in the book business. That's happened in the record business. That's not the stage that we are in the entertainment business nor the stage that I expect will be in anytime soon.

Okay. Let's talk about your mobile business for a little while, your -- like 1.5 years ago, you acquired Social Point. Now you have Playdots. You've had good success with WWE SuperCard. And all these businesses have seen a strong uplift during the pandemic. How do you sort of look at mobile's growth prospects in the coming year for you guys? And one of the things that's been debated among many companies is you try to leverage your existing, let's say, console or PC franchise within your portfolio and take them to mobile. What's your view there?

Well, look, we're now in a position where mobile revenue -- mobile net bookings represents about 10% of our business, which is still too small, but it's at least meaningful. We're excited about what the Playdots acquisition will mean. We're excited that Nir Efrat is leading Social Point and Playdots for us. And we have great confidence in our ability to grow the net bookings associated with mobile. Social Point has 10 titles in development, Playdots has numerous titles in development, 2K has titles in development for mobile. So I think there's great opportunity here, as you mentioned. In the second quarter, Social Point was up about 55%, equaling a new record. So it continues to perform really well. We'll see how that performance evolves as the pandemic comes to a close, which I'm certainly hopeful, along with everyone else, it will relatively soon. But we feel quite optimistic. In terms of bringing core console properties to mobile, and I'm often asked that question, obviously, the folks at Activision did it quite successfully with Call of Duty. So there is an opportunity. The biggest hits in mobile still remain titles that are native to the platform, and that's really our primary focus where we're creating IP specifically for mobile that -- we think that that's the biggest opportunity. I wouldn't rule out the possibility of taking some of our core console titles and bringing them to mobile, but that has to be done in an incredibly high-quality way. And obviously, we have to have the right expertise to achieve that. We have brought, of course, some of our core properties to tablets, also a mobile device, in pretty much their pure form. There's been a number of titles over the years, and those have largely done quite well. But I don't think that's a question you're asking. I think you're talking about smartphone titles and on the casual side, if not the hyper casual side.

Does 5G change anything?

Well, I mean it changes things in that we're going to have better connectivity for people who have 5G and therefore, the ability to bring more high-quality content to people when they're mobile. I don't think it changes much more than that, but that's potentially a meaningful change.

Okay. Before we go, we do have a question from the audience. And the question is, the time frame it takes to make a game now and now that you have add-on content above and beyond what's in the core game, how long should it take for a game to reach the market these days in terms of development?

It all depends on the type of game and the studio making -- in the case of a mobile title, it could be a year; in the case of a core console title, it could be many years. We're kind of unique in that we've been saying forever, we don't believe in annualizing nonsports titles, and we don't. And we make sure to give all of our studios the time needed to create something that's absolutely extraordinary. That approach has served us well. We now have 11 franchises that have each had at least one 5 million unit release. We have 67 million that have had 2 million unit release. I think we have the best collection of owned intellectual property in the business. The only reason that's the case is because we have the most talented creative folks. We not only allow them to, but we insist that they pursue their passions. And we give them plenty of resources to put out something that is as close to perfection as possible. So we really, really can't make predictions. One of the reasons that we've increased our pipeline to the extent that we have is because we do want to have a powerful frontline release schedule year in, year out in addition to our ongoing live ops businesses and in addition to our very powerful catalog. We want to be able to have robust frontline release schedule every year coming from a multiplicity of studios as opposed to putting pressure on any given team to get to market quicker. We have more teams working on more IP at their own pace to create perfection and then we'll bring it to market. And for that to really work, we've been pursuing the strategy for a long time. Sometimes, it's worked out, sometimes it hasn't worked out as well in terms of what actually we were able to release in a given year. But we have said we would like to have a handful of great titles every year on the frontline in addition to our annualized titles and our live ops businesses under catalog, and that remains the goal. And we can do that while still giving our teams the latitude to spend a lot of time and a lot of resources making great games as long as we have enough teams working simultaneously.

Great. And then in our final seconds, the -- one of the questions asked is, now that we are sort of getting close to the light at the end of the tunnel with the pandemic, the industry has benefited tremendously from the engagement. Do you think that this is a permanent shift? Or do you think we have to sort of normalize a little bit from here?

Well, in terms of our actual financial projections, we have not really adjusted our fourth quarter projections based on believing that the sheltering at home levels will continue. So where it really matters, we voted and said, we're not going to bet that this increase in demand will be permanent. That said, as things did appear to be returning to normal during the summer, even during the summer, we saw continued strong demand. So it's very hard to know, Activate, a media consultancy, expects that post-pandemic consumption levels for interactive entertainment will be about 14% higher than pre-pandemic levels. I think we probably have somewhat more optimistic expectations based on the titles that we deliver and our belief that we can continue to make really great content. But that remains to be seen, that will be the ongoing challenge.

Great. Well, Strauss, we are out of time. Thank you as always for knowledge...

Thanks for having me.

And have a great new year.

Thank you.

Thank you.