Reading Take-Two's Tea Leaves

By Matt Richtel

Take-Two Interactive, the maker of the Grand Theft Auto game franchise, reported third-quarter earnings on Thursday that blew away Wall Street analysts' projections.

But for many investors, the most compelling numbers in the report may be the ones looking ahead to the company's fourth quarter and its fiscal 2008. Those numbers could lend some insights into whether Take-Two and Electronic Arts will remain independent or revive merger discussions that are currently flagging - if not moribund.

For the fourth quarter (the current one), Take-Two said it was lowering its financial guidance. The company said it expects to earn 1 cent to 5 cents a share and notch sales of $285 million to $335 million.

That's down sharply from the company's projection in June that it would earn 10 cents to 20 cents a share on sales of $300 million to $350 million. (Wall Street analysts had previously projected that the company would earn 19 cents a share in its fourth quarter on sales of $350 million.)

The company said it was lowering expectations for two reasons: because it is delaying to the end of the fourth quarter the release of several games (including Midnight Club: Los Angeles), but also because its strong third-quarter sales may have stolen thunder from its fourth quarter.

On the other hand, Take-Two said it expects its full fiscal year to exceed previous guidance. It now says that for the full year it will earn profits of $2.08 to $2.12 a share on sales of $1.5 billion to $1.55 billion. Previously, the company had projected full-year profits of $1.65 to $1.85 a share.

Take-Two said it was raising its guidance for the full year primarily because it performed so strongly in its third quarter.

So who cares, and why? The interested parties in this case extend beyond Take-Two's shareholders. Electronic Arts scrapped its hostile bid to buy Take-Two for $2 billion, or $25.74 a share, saying the economics no longer made sense for the company at that price. For its part, Take-Two has said repeatedly that such a price is too low, and that it believes it should receive more.

The sliver of hope left for a deal is that the two companies have agreed to a meeting to discuss the issue. Both sides have said the meeting is an opportunity for Take-Two to prove to Electronic Arts that it is worth more money than Electronic Arts has said it is willing to pay.

In other words, Take-Two hopes to demonstrate that its game portfolio can outperform expectations - both those of the market and those of Electronic Arts. And it must show it can outperform by a large margin, or Electronic Arts - at least based on its previous statements - would be unable to justify raising its price.

The numbers released by Take-Two on Thursday would seem to leave a mixed message. The company expects to outperform its previous forecast for the full year, but not for the fourth quarter. This could indicate that its long-term prospects are brighter than it had previously let on, but it also could mean that they are only brighter because the company had a third quarter that far exceeded expectations. In other words: has Take-Two's best moment already passed, or is it yet ahead?

Electronic Arts and Take-Two have said nothing about when they might meet, or even whether such a meeting is certain. (Both sides have signed non-disclosure agreements.)

Meantime, left on pins and needles are all the short-term arbitrage investors who banked on Electronic Arts coming around and buying Take-Two for a bit more than its offer price. They paid, typically, around $25 a share, and are hoping to get at least that back.

Thursday's earnings report gives them reason for hope, and for serious pause.