Should Activision Buy Take-Two?

The Wall Street rumor mill has been alive with chatter for the past couple of weeks about whether video game king of the hill Activision-Blizzard should buy Take-Two Interactive Software.

It's a merger that makes sense on some levels—but is absolutely baffling on others.

Activision , after all, has shown that it can monetize franchises better than most publishers in the business. And Take-Two has not only the most powerful brand in the gaming world — "Grand Theft Auto" — but several other titles that are both familiar to and beloved by gamers, including "Red Dead Redemption," "Civilization" and "BioShock."

Grand Theft Auto IV
Source: Take Two Interactive Software
Grand Theft Auto IV

A purchase would give Activision a wider collection of hits, while allowing the company to diversify its portfolio, which has become very narrow in the past month with the cancellation of the "Guitar Hero" franchise as well as "Tony Hawk" and GTA-wannabe "True Crime" games.

Take-Two, meanwhile, would benefit from Activision's deep pockets, something that could be essential as the next generation of consoles rolls around, which will once again increase development costs.

The company's current management team, also, will finally have the exit strategy it has been seeking.

Among the proponents of a rumored deal is Sterne Agee analyst Arvind Bhatia, who thinks a Take-Two buyout would put a big chunk of change in the Activision coffers.

"We think Take-Two can generate average annual operating profits of around $135 million, once the MLB contract expires in early 2012," he says. "In addition, we conservatively see at least $50M in cost synergies from the combination. … Including these potential synergies, Take-Two could generate $185M($0.15/share) in annual pretax profits for Activision."

While there's certainly an upside, not every industry observer is as convinced as Bhatia that the two companies would make a good pair.

"I think it would be a massive mistake," says Mike Hickey of Janco Partners. "[Activision's] vision is to increase the digital side [of its business] and expand margins and to buy a big publishing company would run contrary to that."

Additionally, Activision has something of a reputation problem among the development community – a lingering effect of the ugly separation between the company and the studio heads of "Modern Warfare" developer Infinity Ward (which has resulted in an ongoing legal battle). That could be problematic for Sam and Dan Houser, the studio leads (and heart and soul) of the Rockstar Games division, which is responsible for Take-Two's biggest games.

Losing them would be a devastating blow, regardless of the power of the franchise names, and Hickey says he's not convinced a combined company would be able to convince them to stay on board.

And while Take-Two has dabbled in the digital space, it has not made many authoritative moves in it. Digital expansions to "Grand Theft Auto IV" were profitable, but did not sell nearly as well as expected. The company did see greater success with "Red Dead Redemption" add-ons.

This isn't the first time a big competitor has courted Take-Two, of course. Electronic Arts made a $2 billion offer for the company in 2008, which was quickly rejected as "inadequate".

The market has changed a lot since then, though. Carl Icahn now owns 11.5 percent of the Take-Two's stock and controls three seats on the board. The company, meanwhile, is more motivated to sell, having completed the turnaround the management team was striving for.

Source: Activision

Bhatia's calculations suggest any deal would likely range between $1.9 billion and $2.4 billion – a premium of 21 percent to 53 percent above the company's current share price. That's well within Activision's cash reserves.

"We think an all-cash deal or a predominantly cash deal with some stock component is possible," he said.

The chatter is nothing more than speculation and rumor, of course. Activision may not even be interested in the competitor.

That hasn't stopped investors from paying attention, though. Since the Street started talking about a possible combination of the companies, Take-Two's stock has increased nearly 20 percent since the beginning of the month.

The companies aren't immediately commenting.

Questions? Comments?