Electronic Arts Inc. (ERTS) dropped its $2 billion hostile takeover of video game publisher Take-Two Interactive Software Inc. (TTWO) yesterday (Monday), but the two companies have entered into private discussions that may finally result in a friendly merger.

Relations between the two companies began to thaw Friday, when Electronic Arts Chief Executive Officer John Riccitiello placed a call Take-Two Chairman Strauss Zelnick.  After a weekend of discussions, EA announced that after six months, it would not extend the deadline for its hostile takeover bid.

EA said yesterday that its $25.74 a share offer was contingent on being able to distribute Take-Two products during the 2008 Christmas season. But since there is no longer any chance of that happening, EA must “validate the assumptions” inherent in its previous offer.

To assuage EA’s concerns Take-Two has agreed to present the company with its three-year product lineup, as well as financial forecasts.

In a letter made public yesterday, Take-Two’s Zelnick said his company looks forward to showing EA, and its board members, “the significant strides made by Take-Two since [Electronic Arts] last undertook a detailed review of our business in early 2007.”

However, Zelnick also reiterated his previous claim that a bid of $25.74 a share “undervalues Take-Two’s franchise and financial performance.”

EA initially offered $26 dollars a share for Take-Two in February, but lowered the bid to $25.74 a share after Take-Two issued additional shares. EA extended the deadline for the offer five times in an attempt to wear Take-Two investors down, and to give antitrust regulators ample time to review the deal.

“They are both posturing,” Wedbush Morgan analyst Michael Pachter told The Associated Press. “EA is saying ‘we want to pay less,’ Take-Two is saying they want more. The important thing is that they are talking.”

EA is very interested in Take-Two’s hit “Grand Theft Auto” series, which has garnered a reputation among parents and young adults alike for its graphic violence and sexually charged content. The latest installment of the series, “GTA IV,” was released on April 29 and been a boon for Take-Two.

The game sold 11 million units and pulled in gross revenue of $500 million in its first week. GTA IV’s success alone was enough to push fiscal 2008 revenue estimates to a range of $1.4 billion to $1.5 billion. The previous range was $1.25 billion to $1.4 billion.

Sales from the Grand Theft Auto franchise accounted for 78% of Take Two’s total sales last quarter.

Outside of Grand Theft Auto, Take-Two’s product line runs thin but includes well-known games such as “Civilization” and “BioShock,” which is being made into a movie. And EA is looking to bolster its arsenal to compete with rival Activision Bizzard Inc. (ATVI), maker of the hit “Guitar Hero” series.

"A mutual deal is going to have to be higher than $25.74, in order for the board of Take-Two to save face – call it a dollar or two dollars more," Hudson Square Research analyst Daniel Ernst told Reuters. "EA can certainly afford to pay more."

News and Related Story Links:

• Money Morning:
  Take-Two Banks on Gruesome “Grand Theft Auto” Sales in Fending Off EA Bid

• Associated Press:
  Electronic Arts won’t extend Take-Two deadline

• Wall Street Journal:
  Did Grand Theft Auto IV Make Take-Two More Valuable?

• Reuters:
  EA drops hostile Take-Two bid and enters talks