This was originally posted on Steve’s blog, Aim Assist.
The market is wrong to doubt Take-Two’s acquisition of Zynga. On Monday, Take-Two announced a deal to acquire Zynga for $12.7B. This represents a price per share of $9.86 for Zynga, a 64% premium to its closing price the prior Friday. On the day the news broke, shares of Take-Two traded down 15%.
The sticker price of $12.7B for Zynga seems aggressive at first glance. It would represent the largest gaming acquisition in history. It’s also a bit puzzling that Take-Two would pay for 60% of the deal with its own stock, just a quarter after repurchasing its own shares and describing them as being in deep value territory. But due to the sheer size of the deal, Take-Two wouldn’t have been able to pull off an acquisition with all cash. The high premium also represents Take-Two’s interest in getting the deal done. Zynga has a go shop provision until February 24 where it can solicit other bids. The gaming space has seen its fair share of M&A over the past two years. Take-Two does not want a repeat of its Codemasters bid, where they appeared to agree on a rational price before EA came in—bidding 15% above—and swiped the deal from them.
After digesting the news, it seems clear that the market is missing the opportunity. While the market is pointing to a higher EV/EBITDA that Take-Two paid relative to other historical gaming acquisitions, we frequently refer to Mouboussin’s Expectations Investing as a baseline for evaluating opportunities. At the acquisition price that Take-Two paid for Zynga, the implied future revenue growth over the next decade for Zynga as a standalone entity is essentially flat. This assumes the company can hit the free cash flow margins of 21% that the Street expects in 2023. Over the last five years, Zynga has grown revenue by a CAGR of 32%, making this target seemingly easy to beat. While this may seem puzzling given the 64% premium that Take-Two paid, it’s worth mentioning that Zynga shares are still down 25% from their 52-wk highs.
As a result of the Zynga acquisition, Take-Two believes it can generate $500m in net bookings from its existing IP on mobile platforms “in the next several years.” Given the apparent fair value of Zynga and the ability to better monetize its own IP, it begins to make sense why Take-Two paid for the acquisition with so much of its own stock despite the belief that it was cheap.
The Zynga acquisition is about so much more than simply acquiring an undervalued mobile publisher. Take-Two is the last of the three US publishers to make a major splash with a mobile acquisition. Activision-Blizzard acquired King for $5.9B in 2015 and Electronic Arts acquired Glu Mobile for $2.4B in 2021. Zynga is Take-Two’s signature mobile acquisition. It brings the company’s mobile bookings from about 10% of net bookings to 50%, diversifying its revenue base and signifying the company understands where gaming is moving.
The acquisition gives Take-Two three things:
- Opportunity to bring existing IP to mobile
- Business model evolution
- Ability to reach new demographics
Opportunity to bring existing IP to mobile
The narrative around mobile games began to change over the last few years. Historically, mobile games were thought to be mostly casual titles. Games like Candy Crush, Clash of Clans, and Pokémon Go, which had relatively simple gameplay and low graphic fidelity. The shift to high fidelity games started in the East, where most trends in gaming begin. Tencent published Honor of Kings, a MOBA title closely resembling League of Legends (after Riot declined the opportunity) to mobile in late 2015. Since then, the game has gone on to do over $13b in net bookings. Genshin Impact, published by miHoYo in 2020, was one of the first open-world RPGs to find massive success on mobile, generating over $2B in net bookings, a majority on mobile, in its first year alone. These games, among many others, proved that high-quality gameplay with high-fidelity graphics can work on mobile. The AAA publishers of the West realize this and are now racing to bring their IP to mobile before its positioning is usurped by someone else. Call of Duty is a great example. While the franchise will generate around $3b in net bookings in 2021, Call of Duty: Mobile will do somewhere close to $400m in net bookings. The game is facing intense competition from PUBG Mobile and GarenaFree Fire. If Activision had waited a year or two to bring its IP to mobile, they may not have claimed the top position among mobile battle royale titles.
Take-Two has an opportunity to bring its franchises to mobile and shouldn’t wait. Grand Theft Auto, Red Dead Redemption, and NBA 2K are the most immediate, logical choices for where to start. The company has previously released some of its older Grand Theft Auto titles to mobile and has dipped its toes with NBA 2K on mobile but has fallen short of expectations. Looking at the rest of Take-Two’s portfolio, Borderlands, Civilization, and Midnight Club represent back catalogue opportunities. Bringing Zynga on board will give Take-Two what it needs to establish a strong presence in mobile gaming.
Business model evolution
Zynga is one of the best free-to-play game publishers in the world. Take-Two has historically taken the opposite approach, releasing massive titles infrequently and charging premium prices. While Take-Two has been able to master the monetization of these player bases, it stands to benefit from exploring new business models. Activision has built an impressive ecosystem by blending free-to-play and premium versions of Call of Duty together, in large part because of its King acquisition. Zynga can deliver this for Take-Two. A free-to-play version of Grand Theft Auto Online could reach a much larger player base and potentially drive more premium title conversion and in-game monetization.
Ability to reach new demographics
Publishing on mobile gives Take-Two access to players that it currently doesn’t serve like those in Latin America, India, and Southeast Asia. In these areas, mobile games tend to perform well, as console and PC penetration is lower than in Europe and North America. Understanding how to reach these demographics is important for Take-Two. Zynga helps them reach these gamers.
Take-Two’s target of $500m in new annual net bookings feels like a layup. With Take-Two’s IP and Zynga’s publishing and monetization experience, the company could double or triple that goal in the next five years. During the call announcing the combination, Take-Two stated that the combined entity is expected to grow net bookings by 14% CAGR over the next three years. Based on our reverse DCF, the implied revenue growth of the combined entity over the next decade is low single digits. Expectations will have to come up. Take-Two isn’t a high multiple growth name that’s three years away from profitability. The company delivers solid earnings and free cash flow and should be able to maintain some pricing power in the face of inflation. Long-term, the acquisition of Zynga is a win for Take-Two and its investors.