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From earnings to sell offs, lawsuits to forecasts:The EA and Take Two Deal Diary

ea ttwo deal diaryEarnings are down but forecasts are up.  The pipeline is good but some big shareholders are selling. Some small shareholders are suing. There are new severance packages but nothing to fear.  “All is well” is the tagline. 

Such is the ongoing saga of Take Two Interactive as they sort through their own issues with the added monkey of Electronic Arts$2 billion takeover offer on their backs.  It’s a story with more twists and turns than an installment of their popular Grand Theft Auto gaming franchise.   Here’s the plot summary for the latest news:

Take two released earnings for the holiday quarter on Tuesday. The numbers were mixed, beating many revenue estimates but coming up short on earnings. 

For the quarter ended January 31st the company posted a loss of $38m (52c/share) versus a loss of $21.5m (30c/share) last year.  (Less option expenses and legal fees they lost 41c/share).  Revenue was off 13% year over year to $240.4m ($277.3m last year).   Consensus analyst expectations (Thompson) had called for a loss of 51 cents a share on sales of $211.7m (less one time charges). The company had guided for losses in the range of 50 cents to 60 cents a share on sales of $175 to $225m.

IMPACT ON THE EA BID: None.  It would have taken a surprising and dramatic result, positive or negative, to cast any suspicion on the fairness of EA’s offer and have an impact.  Hitting the number range adds little to arguments EA’s offer is undervaluing the company.

The positive note in Tuesday’s analyst call was with what lies ahead.  On the strength of pre-orders and increasing demand for Grand Theft Auto IV, which is expected in stores April 29 after several delays, the company raised year ahead guidance.  For the fiscal year ending in October they’re forecasting a range a $1.35 to $1.55 a share from sales of $1.25 to $1.4b.  For Q2, with the bulk of the result coming from the game’s release, they’re expecting a range of $1 to $1.10 a share on sales of $450 to $500.

IMPACT ON THE EA BID: Many analysts have already built the performance of GTA IV in to their models for the remainder of the fiscal year.  As it stood, the consensus forecast was for sales of $1.36b. While that is now on the lower side of the range, it’s still in the spectrum.   Additionally, at a 64% premium to February 15th closing price, EA’s bid of $26 a share arguably priced for this as well.   

The wildcard comes into play only if the game dramatically outperforms at retail.  If that happens and the game exceeds early sales forecasts, it could add firepower to the argument EA’s offer isn’t sweet enough.   

Take Two has a number of major title releases planned for 2008 and 2009.  In addition to the release of Grand Theft Auto IV in April, other efforts in the pipeline:
° Q3 2008 will feature a multi-platform release of tennis game “Top  Spin 3”, boxing title “Don King Presents: Prize Fighter”  and a Nintendo DS version of popular Wii title Carnival games.
° Q4 2008 will see a second installment of Carnival Games built around mini golf for the Wii.  Driving game Midnight Club: LA and sports titles NBA 2k9 and NHL 2k9 are also in the cue.
° 2009, Rockstar, the studio behind GTA, will deliver at least one major sequel.  Bioshock 2, a sequel to this past year’s popular new introduction is also planned.

IMPACT ON THE EA BID: Speculation about the strength of the pipeline will likely be used to argue that the company is worth more than the current offer.  Whether that has any impact is debatable.

According to Schedule 13 insider selling documents filed with the SEC on Monday, the two largest of Take Two’s  shareholders substantially cut their holdings (and with it there exposure to the deal).

Oppenheimer Funds, Take Two’s largest shareholder, cut their stake in half, slimming down from a 23% stake to just  11.5 percent (8.8m shares). 

FMR LLC, the parent company of Fidelity Mutual Funds, and the second largest shareholder, sold off 16 percent of their holdings.

IMPACT ON THE EA BID:  It’s safe to assume if either fund believed a higher offer was coming from EA, or if management could squeeze more money out of the company to justify a higher valuation, they’d have held on to their positions.  Instead, by selling off such sizable positions  they’ve effectively issued a vote of “no confidence” all around. That’s no confidence the deal will close soon and no confidence more money is coming.

On Friday,  Prickett, Jones and Elliot filed a class action suit in Delaware on behalf of Take Two shareholder Patrick Solomon.  The complaint alleges Take Two executives failed to complete their fiduciary duties to the shareholders when they chose to neither discuss the original EA offer (EA made a silent offer before going public with an increased bid) nor negotiate. 

The suit also questions the decisions made by Take Two’s board on February  15th to increase Zelnick Media’s management fees and bonus structure and fortify the change of control provisions that provide payout in the event the company is acquired.    

Both Strauss Zelnick and CEO Ben Feder are named among defendants in the suit.

IMPACT ON THE EA BID:  Class action suits are almost a certainty in any contested acquisition.  The company likely carries D&O (Director and Officer) insurance to cover these issues in the event of a loss or settlement.  In the meantime, they’ll go through the process of defending themselves.  It will take some cash off the table from legal expenses but there’s no obvious immediate impact.

As part of a standard takeover defense package, Take Two approved a new severance plan for employees (SEC Filing here).  Under the new guidelines  it sets, executive staff will receive up to 1.5x salary and bonuses for up to 18months if they lose their jobs as a result of a buyout.  The remainder of the staff will be eligible for payment of up to six months’ salary.   The severance plan will not apply to Strauss Zelnick, Ben Feder and other executives from Zelnick Media.  Their compensation is provided for under a separate management agreement.

IMPACT ON THE EA BID: Hidden cost maneuvers that make it more expensive to acquire a company are common tactics to defend against an unsolicited buyout.  Similar tactics have recently been used by Yahoo in their defense against Microsoft’s buyout offer.  The negative consequence of this approach, however, is that it means money EA might have used to increase their bid will more likely be set aside to cover the onetime charges due during a post merger integration.

The deal officially escalated to hostile March 13th with EA taking its tender offer to Take Two’s shareholders. The move will also put management’s pay in the crosshairs.  In the tender offer documents filed with the SEC today (Summary Term Sheet is here), EA added an aggressive price reduction trigger to their offer.  Now, in the event that the new management agreement terms are approved, EA will reduce their offer to $25.74 net per share (that is a reduction equal to the payment Zelnnick Media will get if their shares are vested).   To the shareholder’s it was a simple ultimatum: “Pay yourselves or pay the company’s management. You Decide.”

IMPACT ON THE EA BID: Substantial. Take Two will ask for ten days to review the offer but the aggressive shift will put this deal on the clock. The official tender means there is now a set date, a fixed time, for a decision. One way or another, shareholders are going to have to make a call soon.

[More info on the management pay issues can be found in this related article]


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