#12 New position: TTWOc

On 4/30 we took a small (1%) position in Take-Two Interactive through Sep 15 calls (15 is the strike price). We paid $0.23 for each call, which is the right, but not the obligation to buy TTWO shares at $15 on the third Friday in September. TTWO is trading at around $9. First off, these calls are way out of the money. For us to make money, TTWO would have to rise to over $15.23 in September! That is a low probability event and explains why we were able to by a 4 month option for just $0.23.

However our thesis is that TTWO could be a takeover target. Last year, Electronic Arts bid $25 for the company and was rebuffed. We think it still makes sense for EA, or Activision (who has mentioned it is interested in acquisitions) or a large media company to make a bid again. A deal signed in September could close by February 2010, far ahead enough of the holiday 2010 season when TTWO's next iteration of Grand Theft Auto is scheduled to be released.

So this begs the question: why would anyone in their right mind pay $15+ (we think a deal could be had at $20) for a company trading at $9? Our answer is this: TTWO has a bloated SG&A and distribution system. A takeover by a larger player would allow the purchaser to eliminate (we think) at least 50% of TTWO's SG&A, which would be worth over $1 in TTWO eps. This means that if you put a 10x multiple on the post-tax synergies, you are getting a $10 value! This would also enable the deal to be accretive to the buyer's EPS. By the way both EA and Activision have large cash positions which make littl ein the way of interest income. Plus both stocks trade at 16x multiples (above TTWO's FY10 p/e of 10x)....all this leads me to think that a takeover of TTWO would be accretive to the buyer and thus a logical deal.

This is a small, 1% position because it is a lotto ticket. Our risk is that we lose our $0.23 premium. However our upside on a $20 deal would be $20-15-0.23 = $4.77. This is a 20:1 win/lose ratio for a scenario i think is possible.