How Much to Hijack Grand Theft Auto?

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by Kyle Ackerman

Take-Two Interactive Software is the company behind some of the most popular games out on consoles, but behind the scenes, there is an extensive history of financial shenanigans. Take-Two owns labels like Rockstar Games, 2K Sports and 2K Play. They're the folks who publish the Grand Theft Auto games, Red Dead Redemption, BioShock, the recent Civilization games and annual sports franchises ranging from baseball to basketball to tennis. They're also controlled by a media company now taking in more pay for running the company than the CEO of any other game publisher.

BioShockTake-Two's storied but sketchy history starts with founder Ryan Brant, who launched the company in the '90s. Regulators alleged that under Brant's leadership Take-Two Interactive materially overstated revenues in 2000 and 2001 (the company was forced to restate its financials), including a period during which Brant sold over $20 million in stock. Brant and other executives settled with the Securities and Exchange Commission on charges of accounting fraud. While he neither admitted nor denied guilt, he paid millions in fines and was barred from serving as the officer of a public company. Brant was never officially found guilty, but the gist of the allegations is that he profited enormously from selling stock after falsifying financial data.

To make matters worse, Take-Two allegedly backdated stock options granted to persons including the company's "independent" directors (a fraudulent method of giving them extra money). Despite releasing several amazing and financially sound games such as Grand Theft Auto: San Andreas and Civilization IV around the time of the scandal, by early 2007, investors were fed up with Take-Two Interactive's mismanagement and looking for a better option. That's where Strauss Zelnick comes in. Zelnick had previously served as the Chief Executive Officer of BMG Entertainment (now Sony Music Entertainment) and of game developer Crystal Dynamics. In 2001, he co-founded ZelnickMedia to own and manage entertainment properties. ZelnickMedia has invested in companies such as SkyMall and UGO alongside other media companies.

ZelnickMedia Steps In

In March of 2007, Take-Two Interactive announced yet another quarterly loss and was facing class action suits concerning both the company's financial problems and the "Hot Coffee" scandal accusing the company of leaving explicit sexual content hidden in Grand Theft Auto: San Andreas. Take-Two Interactive was ripe for a hostile takeover, so Strauss Zelnick and ZelnickMedia seized the opportunity.

Grand Theft Auto: San AndreasOn March 4, 2007, a group of investors owning nearly half of Take-Two Interactive's outstanding stock, including Oppenheimer Funds, D. E. Shaw Valence Portfolios, S. A. C. Capital Management and Tudor Investment Corporation, signed an agreement that they would elect directors (including Strauss Zelnick and different from those recommended by Take-Two's management) and reduce the size of Take-Two's board of directors. Under the agreement, once the group controlled Take-Two's board, Take-Two's board would immediately appoint ZelnickMedia as the company's financial and management consultant. Ben Feder, co-founder of ZelnickMedia would be named Chief Executive Officer of Take-Two Interactive.

This group only needed a few more shareholders to vote with them to consummate the takeover, and they got the votes. When they appointed ZelnickMedia as financial and management consultant to Take-Two, ZelnickMedia was to receive $750,000 a year (plus expenses), with an annual bonus of another $750,000 if the company met certain performance requirements. On top of the potential $1.5 million, ZelnickMedia was given options to purchase at least 2.5% of the company's outstanding stock. That means as long as the stock price went up after the end of March, 2007, ZelnickMedia stood to make a lot of money.

What Stars off Sweet, Turns Sour

Initially, the takeover was a good deal. Take-Two's share price increased and investors responded positively. There were some extra expenses, since Take-Two had to offer severance to the officers and staff it fired during its reorganization, but the company looked poised for a turnaround. As large as the management fee was, it was a lot like other colossal CEO payment arrangements. Beyond the management fee, Take-Two only had to provide health benefits and expense reimbursement to Zelnick and Feder, along with access to the same plans and benefits available to other Take-Two executives. Take-Two continued to lose a lot of money over the course of 2007, despite the release of the critically acclaimed BioShock alongside several casual and sports games.

BioShockThings changed in February of 2008. ZelnickMedia's fees increased drastically. Given the timing of the announcement, some thought the massive increase in fees was related to Electronic Arts' offer to purchase Take-Two, but Take-Two's filings with the Securities and Exchange Commission claim that Take-Two's board started talking about increasing ZelnickMedia's compensation in December of 2007.

Effective on April 1, 2008, ZelnickMedia would be paid $2.5 million per year, plus a performance bonus of up to $2.5 million per year. On top of the already impressively large stock grants, ZelnickMedia would also be granted even more stock. 600,000 shares would be granted over three years, and another 900,000 if Take-Two met certain performance targets. Combined with the stock grants, ZelnickMedia's pay became extremely generous.

ZelnickMedia was doing something very different from the former CEO, Brant. ZelnickMedia's arrangement was approved by shareholders. Everything was in the open, and legal. But why the sudden massive increase in compensation? Why were there so many provisions to pay ZelnickMedia even more if Take-Two was purchased? It's tempting to try to make ZelnickMedia out to be Jimmy Pegorino of Grand Theft Auto IV's publisher, but Pegorino is a crook. Everything ZelnickMedia has done is perfectly legal, somehow stepping in to take over the family that publishes the crime games like Grand Theft Auto and Mafia, and then demanding to be paid even more to do so.

EA's Hostile Bid for Take-Two Illustrates ZelnickMedia's Interests

In early 2008, Electronic Arts offered to purchase Take-Two Interactive. EA offered $26 per share, in cash, for each share of Take-Two stock. That was 63% over the 30-day average of Take-Two's stock price and higher than previous offers made by EA. Take-Two rejected the offer, claiming that the release of Grand Theft Auto IV would show that Take-Two was worth far more than Electronic Arts was offering. EA made the bid hostile, appealing directly to the shareholders and bypassing Take-Two's management.

Take-Two implemented anti-takeover measures that ensured that ZelnickMedia would receive enormous stock grants in the event of a hostile takeover. Much of the stock award announced a month earlier would vest immediately and be worth tens of millions to ZelnickMedia. The measures also would have caused Take-Two Interactive's executives to receive as much as 1.5 times the value of 18 months of salary plus annual bonus. Take-Two refused to cooperate with the Federal Trade Commission's efforts to vet the potential purchase, stonewalling the FTC for as long as possible. When resisting a takeover, many companies will implement "poison pill" measures that allow shareholders to buy more shares at a discount. Instead, Take-Two made sure that management and ZelnickMedia would get big payouts.

Grand Theft Auto IVDespite impressive sales of Grand Theft Auto IV and strong results the quarter the game was released, poor financial performance in other quarters and the company's actions meant that investors weren't convinced that Take-Two was worth more than Electronic Arts had offered, and once EA allowed its bid to expire in September of 2008, Take-Two's stock price plummeted. While the stock is higher than it was after EA withdrew its takeover bid, to this day, Take-Two's stock remains substantially below the value of EA's offer.

The Electronic Arts offer is a prime example of Take-Two Interactive's leadership struggling to maintain control over the company and maximize personal profit, rather than doing their fiduciary duty and running the company on behalf of investors. Who said so? A class action lawsuit was filed against the company on March 7, 2008 claiming that Take-Two's officers and directors "...breached their fiduciary duties by... refusing to explore premium offers by Electronic Arts Inc. to acquire all the company's shares" and enacting measures to entrench Take-Two's current leadership.

ZelnickMedia Extends Its Management Through 2015

Take-Two's stock price languished long after EA allowed its takeover bid to lapse. Take-Two reported annual losses and even changed its fiscal year to make current results hard to compare to past results. The company reported massive losses in 2009, with the company's high-profile releases being games such as Civilization Revolution in mid-2008 and Borderlands in October of 2009.

BioShock 2The company's state started to improve over the course of 2010, when Take-Two released games such as BioShock 2, Red Dead Redemption, Mafia II and Civilization V. In late 2010, Take-Two announced that Strauss Zelnick himself would take over as Take-Two's CEO, and Ben Feder would depart on January 1, 2011. The company was finally beginning to look profitable for the first time since the release of Grand Theft Auto IV. Investors began to show increased interest in Take-Two, finally ticking up the stock price a bit more than two years after EA's failed bid.

Earlier this year, investors responded positively when Take-Two announced that its fiscal year ended March 31, 2011 was finally profitable, after far too long a period of losses. In light of that positive news, ZelnickMedia brought a new management agreement to investors. The new agreement pays ZelnickMedia $2.5 million a year, ups the potential bonus to $3.5 million annually, and increases both by 3% per year until the agreement expires in 2015. The agreement also states that if Take-Two is bought, ZelnickMedia gets paid all the annual fees and bonuses it might otherwise have received until the end of the contract. Everything is above-board and approved by investors.

Is ZelnickMedia That Much Better?

ZelnickMedia did something impressive. It got together with large investors that owned around half of Take-Two Interactive, and convinced them to pay ZelnickMedia a lot of money every year to run the company, and chase it with enormous stock grants. ZelnickMedia was then able, through its own compensation agreements and maneuverings, to block an acquisition by EA that (in hindsight) was clearly in the interest of Take-Two's shareholders.

Take-Two Interactive may have released some great games, but almost five years later, has the company been successful? It's lost a lot of money and failed to perform by most investor's standards. Only recently has the company begun to show a profit and seen its stock price climb since EA dropped its takeover bid. Is ZelnickMedia providing substantially more service than any other CEO of a game company? Should Take-Two effectively have the best compensated CEO in the industry? Zelnick's salary may officially be $1 plus benefits, but Zelnick Media is taking in millions in cash plus stock grants that could be used to build Take-Two and its games.

Why are investors allowing themselves to be held hostage by a management agreement that didn't perform for the first four years? ZelnickMedia is no Jimmy Pegorino. But Zelnick and his firm managed to hijack an entire company, and somehow keep the faith of a coterie of investors that keep ZelnickMedia very well compensated for its coup.

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This page contains a single entry by Editor published on October 15, 2011 2:59 PM.

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