February 26 2008: 4:39 PM EST
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Zap! Videogame takeover fight heats up

Electronic Arts may well end up with Take-Two, but it will have to pay a higher price, and still deal with a rocky legacy.

By Scott Moritz, writer

Take-Two, maker of the popular but controversial Grand Theft Auto series, is now in play.

(Fortune) -- The game plan is clear for Electronic Arts and its takeover target Take-Two Interactive, but the price of the deal will simply have to be sweeter.

On Monday, Take-Two rejected the $2 billion hostile offer from Electronic Arts, leaving both video game players in a curious spot. Electronic Arts needs a new game franchise to jumpstart growth. And Take-Two, having rebuffed an offer from a rival, is suddenly in play in a market where media giants are shopping for new growth opportunities and video games are on the ascent. Even so, Take-Two's sometimes rocky history may make it a difficult acquisition no matter who ends up owning it.

Take-Two (TTWO) shares jumped 52% Monday on the news as investors see a rich exit in the near future. Most observers agree that Electronic Arts needs Rockstar - the development team behind Grand Theft Auto, Take-Two's massive hit game. EA's stale roster of sports titles like Madden '08 and NCAA games has tugged down sales growth and an infusion of new games would be well timed. Price is the big issue, say analysts and industry observers.

At the end of 2007, it was becoming clear that Electronic Arts (ERTS) was slipping. Analysts like Deutsche Bank's Jeetil Patel pointed to the weak signals lurking under the end of the year surge in sales. Patel was particularly concerned over EA's dipping market share, a situation only made worse by the price cuts necessary to keep the games moving.

Just as Microsoft (MSFT, Fortune 500) took an unsolicited approach to start public deal talks with Yahoo!, Electronic Arts is eager to get the process rolling, says UBS analyst Ben Schachter, in a research note. Take-Two is particularly attractive at the moment given the pending April release of Grand Theft Auto IV, the latest version of its blockbuster, controversial hit.

The EA bid comes as Take-Two completes its first year under new management. Strauss Zelnick took over as executive chairman and Ben Feder was named CEO in March after the previous executive team was voted out. It was clear to investors that Zelnick's job was to: "fix the big problems and sell it," according to a UBS analyst report Monday.

And some big problems have been fixed. The company settled a CEO options backdating investigation by the Securities and Exchange Commission a year ago for $6.3 million and in 2006, the company paid $7.5 million to settle an SEC investigation into its accounting practices.

However, Take-Two still has some problems to deal with. In an earlier version of Grand Theft Auto, players could access animated porn in a feature dubbed "Hot Coffee," which prompted bad publicity and multiple lawsuits. In its rejection letter to Entertainment Arts, Take-Two addresses some of those issues. The company says it has secured a preliminary settlement of the "Hot Coffee" class action lawsuit and made significant progress in resolving the New York District Attorney and SEC actions that have been pending against Take-Two since June 2006 and July 2006, respectively.

Take-Two's new "in play" status now is expected to stir interest among big media shops looking for new growth areas. Analysts point to names like Viacom, News Corp. (NWS, Fortune 500) and Time Warner (TWX, Fortune 500) - parent company of Fortune.com - as potentially interested parties.

But one Wall Street analyst says Electronic Arts has the most to lose and therefore the highest motivation to grab Take-Two. "They didn't come with their best last offer," says the analyst of EA's $26 a share bid. "They will have to sweeten it a bit."  To top of page