It’s not uncommon for companies to hire business consulting firms to help them grow their businesses. However, it is almost unheard of for the consulting company’s CEO to become the consulted company’s chief executive as well. A situation like this, which is a hotbed for all kinds of conflicts of interest, calls into question many of the motives of the parties involved, including the board and top stockholders. And this is exactly the situation at Take-Two Interactive (NASDAQ: TTWO).

The maker of video games such as Grand Theft Auto has had a management deal with ZelnickMedia, a media business management firm, since March 2007. That’s when the firm was hired to run Take-Two after then-chairman and CEO Ryan Brant pled guilty to misrepresenting business records.

The relationship between Take-Two and Zelnick was expected to be relatively short lived. Analysts told 24/7 Wall St. that when ZelnickMedia began running the company, it was looking to sell quickly. Electronic Arts (NASDAQ: EA) offered to buy the company for $26 a share in February 2008, but the company’s board rejected the offer, calling the deal “inadequate,” and EA was unsuccessful in a hostile takeover. Since then, no one has made an offer for Take-Two. The stock trades at less than $10 a share these days.

As soon as ZelnickMedia was hired, Strauss Zelnick, the co-founder of the firm, became chairman of Take-Two Interactive. ZelnickMedia co-founder Ben Feder became CEO. But as the management deal lengthened, the ZelnickMedia  further dug its claws into the company, and partner Karl Slatoff was appointed executive vice president in 2008.

Of course, as a public company, Take-Two must report compensation to top executives, but both Zelnick and Slatoff aren’t paid directly by the company. According to the terms of their agreement, T2 pays a management fee of $2.5 million to ZelnickMedia a year, with 3% annual increases. On top of the fee, in 2008, the company granted ZelnickMedia a restricted stock award of 600,000 shares of the company, which have now fully vested. It isn’t therefore totally clear how much of that money Zelnick, Feder or Slatoff individually received for their work over the years. But ZelnickMedia currently owns about 2.9 million shares of the company — worth some $28.4 million at current prices —  that represent about 3.3% of shares outstanding.

Perhaps no one would take note of this somewhat odd situation if Take-Two had shown progress. But since ZelnickMedia began running the company, shares have fallen approximately 60%. Meanwhile, Take-Two’s competitors have had a mixed record. Shares of Activision Blizzard (NASDAQ: ATVI) have risen more than 30% while shares of EA have fallen more than 75%.

Take-Two has even struggled to turn a profit. In total, the company has lost $238 million from fiscal 2007 through fiscal 2012. It also announced in May that it is  delaying the release of “BioShock Infinite” from October 2012 to February 2013. Another game, “Max Payne 3,” was finally released in May after a delay of nearly three years. Originally, it was due to launch in late 2009 but got moved back several times.

In fiscal year 2011, the company lost $108.8 million, or 47 cents per share. For this fiscal year, analysts expect earnings per share of $2.29, much of that due to the hype for “Max Payne 3.” However, earnings per share are expected to drop to $1.17 in the next fiscal year.

Despite the poor performance, ZelnickMedia remains in charge. In fact, an indemnification clause was included as part of the summary of the terms for the management agreement between Take-Two and ZelnickMedia. It reads:

“Neither ZelnickMedia nor any of its affiliates, directors, officers, employees, counsel, agents or representatives shall be liable to the Company or its subsidiaries or affiliates for any loss, claim, liability, damage or expense arising out of or in connection with the performance of services contemplated by this Agreement, other than any loss, claim, liability, damage or expense to the extent determined by the final judgment of a court of competent jurisdiction to have been caused from the gross negligence, fraud, bad faith or willful misfeasance of ZelnickMedia or its affiliates.”

Take-Two spokesman Alan Lewis told 24/7 Wall St. the clause was mandated by law and is provided for all company officers and directors consistent with the company bylaws and Delaware laws for public companies.

RELATIONSHIP WITH ICAHN

Still, the clause shouldn’t prevent the board to act on behalf of the company’s shareholders. With such poor performance it is unclear why Take-Two hasn’t fired Zelnick and his firm yet. But the lack of action can perhaps be partly explained by the relationship between Zelnick and the company’s largest stockholder, billionaire and activist investor Carl Icahn.

Through Icahn Associates Corporation Icahn owns 8.1% of the company, but his relationship with Zelnick began long ago. After Icahn gained a large stake in Blockbuster, he placed himself, Zelnick and Edward Bleier on the beleaguered company’s board. When Icahn was overhauling the board of Take-Two shortly after he bought a large stake in the company back in 2009, three board members were forced out, but Zelnick was allowed to remain despite a slumping share price. In addition to Zelnick, Carl’s 31-year-old son Brett, Icahn Enterprises executive SungHwan Cho, and Icahn Enterprises board member James Nelson all joined the board in 2010.

Combined, ZelnickMedia and Icahn Enterprises control about 11.4% of the company shares but hold four of the eight voting seats. According to a January 2010 report in the Los Angeles Times,  Zelnick and his firm struck a deal with Icahn where three board members, including Feder, wouldn’t run for re-election if Icahn didn’t publicly criticize the board leadership and didn’t vote for the proxy measures opposed by the company at the annual meeting that April. Feder also stepped down as CEO job and Zelnick took his place in 2011.

It would stand to reason that holding such a large stake Icahn would operate with the intention of increasing shareholder value. Icahn has reduced his stake from over 14% at some point to the current amount. Somehow, throughout all this turbulence Zelnick & Co. remain firmly in charge.

GOOD FOR SHAREHOLDERS?

The deal between Take-Two and ZelnickMedia received mixed reviews from analysts. Eric Handler, an analyst with MKM Partners, can’t  think of another company with a relationship similar to Take-Two’s relationship with ZelnickMedia. However, he said it should be viewed more as a private-equity style relationship and less like a management consulting  relationship.

“My perception is that Take-Two Interactive is a major focus  for Strauss Zelnick and he has a strong  hands-on role with the company,” Handler said in a phone interview.

Handler believes the drop in share price should be taken with a grain of salt. Thehiring of ZelnickMedia was before the global financial crisis devastated stocks, and Handler said the interactive media industry has been struggling in the past several years.

But Morningstar analyst Carr Lanphier isn’t as fond of the plan.

“Since (former CEO) Feder has taken the reins, TTI has awarded  ZelnickMedia more than 3 million shares in stock compensation, stonewalled a lucrative acquisition bid by EA by implementing golden parachutes for executives, and filled almost all of its executive positions with past and current ZelnickMedia employees,” Lanphier said in a May research note. “We find these actions contrary to the best interests of shareholder value.”

Samuel Weigley

^{Note: One of 24/7 Wall St.’s editors served on a board with Zelnick from 2000 to 2003}

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