Take-Two Gets a Second Chance

An SEC inquiry into the video-game maker's accounting led to revised results and a pummeled stock. Now, investors appear to be forgiving it

By Gene Marcial

Evidently many companies are still too slow to learn that fast and fair disclosure of information that's material to their operations is of paramount importance to shareholders and Wall Street.

The latest company to experience a backlash from failing to inform quickly is Take-Two Interactive Software (TTWO ), a video-game maker whose stock plunged from 15 a share on Friday, Dec. 14 to 10 on Monday Dec. 17. Trading in the stock was halted on Dec. 17, when Barron's reported that the Securities & Exchange Commission had raised questions about Take-Two's accounting methods.

The stock is back up over 15 on Tuesday, Dec. 18, after the company revised downward its sales and earnings results for all of fiscal 2000 (ending Oct. 31) and for the first nine months of fiscal 2001.


  The share-price rebound was impressive and was driven by the company's smart manuever in projecting higher earnings in the first quarter of 2002. The stock is also being buoyed by the hot video-game market, in which Take-Two's titles, including Grand Theft Auto III, have been in high demand. Another positive for the stock: Speculation that consolidation could hit the industry -- now that Microsoft is a big player (see BW, 12/17/01, "A Play for Take-Two?").

Microsoft's new video-game machine, Xbox, has been a big seller. Although the software giant makes its own games for Xbox, analysts think the company may want to acquire a video-game maker to widen its supply. Take-Two's games are compatible with Xbox as well as Sony's PlayStation 2, and Nintendo's GameCube.

Analyst Anthony Gikas of US Bancorp Piper Jaffray upgraded his rating on Take-Two from outperform to strong buy, after the company's Dec. 18 forecast of first-quarter 2002 earnings of 70 cents a share on revenues of $200 million. He thinks the bad news for Take-Two is behind it and that its fundamentals are improving. Gikas also says the game-maker remains an attractive takeover target. He raised his earnings estimates for 2000 to $1.25 a share from $1.03.


  However, Take-Two may not yet be completely out of the woods with the SEC. The agency hasn't cleared it of any misdoings or penalties. Is the SEC fully satisfied with what Take-Two has done to make amends for its accunting mistakes?

As it turns out, the Wall Street watchdog had been exchanging letters since May, 2001, with Take-Two Chief Financial Officer John David Jr. about the problems that the SEC's finance division discerned in Take-Two's method of recognizing sales and its valuation of some assets. The SEC's most recent letter was dated September, 2001. These SEC inquiries were never disclosed by the company.

Faced with pressure from shareholders after the Barron's article, Take-Two did its crash disclosure and restated earnings on Dec. 17. Revenues for the year ended Oct. 31, 2000, would be reduced by $12 million to $15 million -- or as much as 4% of Take-Two's reported sales of $387 million. And fiscal 2000 net income will be restated to between 75 cents and 77 cents a share, down from the previously reported 88 cents.


  For the first nine months of 2001, the company says it will reduce sales by about $9.5 million, some 3% of the $309 million previously reported. Earnings for the first nine months of 2001 will actually be restated upward some $300,000, adding 1 cent a share, from $12.9 million, or 38 cents a share, in the same period of 2000.

Why the revisions? The company explains that it had recorded as revenues sales from products that were sold to certain independent third-party distributors and were later returned or repurchased by Take-Two. In light of these restatements, CFO David was ousted from his job, and Albert Pastino was named to replace him in an effort to regain the Street's confidence.

Marc Cohodes, a general partner at Rocker Partners, a New York hedge fund that has shorted the stock, couldn't understand why investors reacted positively to the Dec. 17 restatement of results. He says Take-Two's announcement was evidence that it was using accounting gimmickry. He notes that the company had been selling products to itself, then recording those sales as part of its revenues.


  Take-Two President Paul Eibeler says he regrets that the restatement of results has overshadowed the company's "underlying strength." He adds that he's encouraged by the improvements in the company's balance sheet and cash flow, and its strong prospects for the first quarter and the rest of fiscal 2002.

Since the restatement of results, some analysts have either reiterated their buy ratings on the stock or upgraded them. Miguel Iribarren of Wedbush Morgan Securities retained his buy opinion and set a one-year price target of 25 a share. And Richard Zimmerman of Commerce Capital Markets reiterated his strong buy rating, with a price target of 20 a share. Apparently, the Street wants to continue playing Take-Two.

Clearly, the company can't afford to disappoint investors again. With Take-Two's credibility shaken by the SEC's inquiries, the margin for error from here on is almost zero.

Marcial is BusinessWeek's Inside Wall Street columnist

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