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1 Green Flag for Take-Two Interactive, and 1 Red Flag

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Fading tailwinds from folks staying home should be offset by easing supply-chain constraints.

Video-game developer Take-Two Interactive (TTWO -0.99%) is in the middle of a potentially volatile period for the business. The tailwinds that helped boost sales during the COVID-19 pandemic when the world's population demanded more in-home entertainment are fading away. 

Meanwhile, the industry is undergoing a significant upgrade of its gaming technology. Next-generation gaming consoles have been launched by the two primary providers, Sony and Microsoft. Let's look closer at the one red flag and one green flag for Take-Two Interactive. 

Image source: Getty Images.

The red flag: Economic reopening 

Take-Two Interactive derives a large part of its revenue and profits from content that people play at home. It's no surprise then that the business would experience a boost during the pandemic when hundreds of millions of people were forced to entertain themselves at home.

Indeed, sales increased by 15.8% in 2020. Typically, revenue increases are reserved for years when the company has a hit gaming title release.

With limited game launches in 2021 and momentum in economic reopening, Take-Two's revenue growth slowed to 9.2% for the year. With a strengthening arsenal in the battle against COVID-19, governments are opting to cautiously remove business restrictions. The trend will be a headwind to Take-Two Interactive which will, even more so, depend on hit titles to generate revenue.

The green flag: Easing supply-chain constraints 

As mentioned earlier, Sony launched the next iteration of its popular gaming console, the PlayStation 5, in 2020. Similarly, Microsoft launched the next-generation Xbox gaming console. Interestingly, Take-Two Interactive sells games for personal computers, mobile devices, and the aforementioned consoles. However, console game sales comprised 74.6% of its overall revenue in its fiscal 2021 year (ended March 31, 2021).

This segment from the company's 2021 annual report highlights the impact:

During console transitions, we may simultaneously incur costs both in continuing to develop and market new titles for prior-generation video game platforms, which may not sell at premium prices, and also in developing products for next-generation platforms, which may not generate immediate or near-term revenues. As a result, our business and operating results may be more volatile and difficult to predict during console transitions than during other times.

In other words, costs for the company increase while consumers decrease purchases and wait to upgrade to the new gaming systems.

To make matters worse, the coronavirus pandemic clogged supply chains worldwide, leading to shortages in supplies of these new gaming systems. Two years after launching, Sony's PlayStation 5 remains sold out at major retailers, and Microsoft's Xbox also has limited availability. 

The good news is that supply-chain constraints are easing. Fewer folks are getting severely ill with COVID-19, and when there are outbreaks, the mandatory quarantine requirements are less demanding. That should result in more output of the next-generation gaming consoles and subsequently consumer adoption and purchases in games for the new systems. 

The tailwind from easing supply chains should outweigh the headwind from people leaving their homes more often. Still, Take-Two's stock is not cheap, trading at a price-to-free cash flow ratio of 50.9, significantly higher than its peers. Investors appear to be pricing in excellent prospects for Take-Two Interactive. 

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