What is our favourite recession-proof business?

Take-Two Interactive Software Inc. (Nasdaq: TTWO) is a developer and publisher of video game content for console systems such as the PS4, Xbox One and Nintendo’s Wii; handheld gaming systems such as Sony’s PSP; and personal computers, including smartphones and tablets. The Company is perhaps best recognized as the developer of the Grand Theft Auto franchise – one of the most popular gaming franchises ever created. GTA V, which was released in September 2013, generated $800m in sales on its first day of release and the GTA franchise has sold over 225m copies to date.

TTWO has developed a diverse stable of gaming brands over recent years, launching one new successful intellectual property per year since 2007. Historically the Company was viewed by investors as a one-hit-wonder whose fate was tied to the success or failure of the Grand Theft Auto series. In contrast, Take-Two now has 11 gaming franchises that have each sold at least 5 million units with an individual release.

Unlike virtually every other entertainment business, critic scores are positively correlated with revenues for the interactive entertainment industry and TTWO is a publisher of some of the highest-quality gaming content available. The below table highlights that TTWO has four of the top ten highest-rated titles for Xbox 360 and the PS3.Screen Shot 2016-02-12 at 4.40.36 PMThe interactive entertainment space is also an industry with attractive growth prospects and improving demographics. Global video game revenues are forecast to grow at a 6% CAGR over 2015-2019.Screen Shot 2016-02-12 at 4.41.27 PMFurthermore, the average age of gamers in the U.S. is 35 years old, an increase from the average gamer age in the 1990s and a positive for TTWO when considering the higher disposable income of gamers in this age bracket. This is especially relevant as we observe the shift occurring in the business models of video game publishers.

Interestingly, TTWO’s business model is shifting from one-off game sales to a model that focuses on ongoing user engagement through downloadable content, in-game purchases, and other recurrent consumer spending. Hit games such as GTA V now provide platforms upon which add-on content can be created and the Company has had wild success in the continued monetization of GTA V years after its initial launch due to add-on content that keeps gamers hooked. TTWO has experienced phenomenal growth as a result; in 3Q16, recurrent consumer spending grew by 45% year-over-year and now represents approximately 28% of TTWO’s total revenues.

This shift in TTWO’s business model also generates revenue streams with more favorable economics. Recurrent consumer spending is inherently higher margin than traditional game sales. Take virtual currency for example: TTWO sells virtual currency to gamers so that they are able to purchase in-game items. The marginal cost of selling additional units of virtual currency is zero so these sources of revenue are extremely attractive to TTWO.

In speaking to industry experts about virtual currency, the Montaka team was fascinated to learn that some game developers are hiring economists to monitor in-game inflation. Virtual currency such as “gold coins” can either be purchased or earned organically as a player progresses through a game. However, this adds to the money supply in that “virtual economy” and there are instances where game developers have been forced to introduce a second currency to combat inflation!

The possibilities for monetization of this additional content are only just being explored and this presents a significant opportunity for growth and margin expansion for TTWO. The Company’s games should now be thought of as an installed base which TTWO can monetize. Notably, the ability to get traction with recurrent spending is contingent on the game’s popularity; middling content fails to create an appetite for additional content. TTWO’s high quality gaming franchises put the Company in a privileged position to tap this new growth opportunity.

TTWO is beginning to see the fruit from this shift in their business model. In the Company’s most recent 3Q16 earnings call, management upgraded its FY16 adjusted EPS guidance to $1.65 to $1.75, significantly higher than the prior guidance of $1.00 to $1.15. We remain positive on the Company’s ability to continue to organically develop gaming content and to benefit from the attractive economics of recurrent consumer spend.

Montaka owns the shares of Take-Two Interactive Software (NASDAQ: TTWO).


George Hadjia is a Research Analyst with Montgomery Global Investment Management. To learn more about Montaka, please call +612 7202 0100.