As Game Maker Girds for Battle, Investors are Wary.

Computer game software publisher THQ Inc. is known for such titles such as "WWF Royal Rumble" and "Jedi Power Battle." But in the past few weeks, the Calabasas-based company has been preparing for its own kind of warfare.

On Aug. 20, THQ filed for an offering of 2.5 million shares, a move that is expected to generate between $100 million and $125 million. Shortly thereafter, THQ announced the hiring of former Lucas Arts Entertainment President Jack Sorensen as executive vice president. Sorensen will be responsible for THQ's six internal development studios.

The moves indicate THQ is trying to position itself to challenge Redwood City-based Electronic Arts and Santa Monica-based Activision for leadership in a computer games software market that could grow as much as 30 percent over the next year.

"The cash isn't enough to buy another publisher," said Miguel Iribarren, research analyst for Wedbush Morgan Securities in Los Angeles. "But it's enough to make some opportunistic acquisitions (such as games production studios) as well as bidding aggressively (against EA and Activision) for product licenses."

All three companies have shown revenue growth amid a flattening economy and what Iribarren termed a "console transition phase" for the games software industry.

EA and Activision reported revenues of $1.3 billion and $620 million, respectively, for the year ended March 31. THQ's revenues for the year ended Dec. 31, 2000 were $347 million.

Because leading hardware systems like Sega's Dreamcast, Sony's PlayStation 2, the Nintendo GameCube and Microsoft Xbox will have been introduced between late 1999 and November 2001, the "transition" to the new systems causes software companies to lose sales from outdated titles. So while the games software market in the U.S. is projected to top the $8 billion figure in 2002, its $6 billion figure for this year is just a slight increase over 2000's $5.8 billion.

Revenue surge, investor wariness

Despite this, THQ Inc. reported net income of $3.5 million (15 cents per diluted share) for the second quarter ended June 30, compared with a loss of $8.6 million (43 cents) for the like year-earlier period. Second-quarter revenues were $55.2 million, vs. $32.4 million.

THQ has also been the most effective in translating this growth to the bottom line. "They're very focused on profits, (especially) operating profit," said Jeffrey Thomison, an entertainment industry analyst at Louisville, Ky.-based Hilliard Lyons. "On that basis, THQ has by far the best statistics in the industry."

As of last week, THQ was trading at $49, a 118 percent increase over the beginning of the year. But while Iribarren continues to rate THQ a "buy," Thomison is more cautious, believing that THQ's prospects are already represented in its stock price.

"The first thing I think of (about THQ) is a quality company," said Thomison. "That doesn't always mean its time to load up (on the stock)."

Indeed, THQ's stock surge has been met with a dose of skepticism. From July 16 to Aug. 15, a period when THQ's stock stayed essentially flat, the volume of shorted shares nearly doubled to 2.19 million, about 12 percent of THQ's float.

"There may be some investors that share our viewpoint of the stock's valuation," said Thomison, though he added that investor speculation of a public offering, and resulting dilution, was a factor. "Whenever you see the stock price go up and hold steady, the possibility is higher that they would issue some shares."

By reducing both cost of production and royalties to external publishers, THQ has generated operating profit for both the second quarter and the year ended December 31, 2000. By comparison, Activision and EA posted operating losses for its most recent quarters.

Key acquisitions, licensing deals

"Through good management, good games and a little bit a luck, they've made themselves into a good company," said Steve Youngwood, vice president of interactive products and book publishing at Nickelodeon, a Viacom unit.

Youngwood, who first worked with THQ on its "Rugrats" licensing agreement in 1998, noted that THQ has benefited from the burgeoning popularity of "Rugrats" and WWF. But he also considered THQ a "low risk" licensing partner because of its strong financial position and its ability to produce quality games.

Sorensen's hiring reflects THQ's efforts to fuel its growth internally rather than by out-sourcing game production. And in addition to generating cash from the public offering, THQ has been increasing its cash balances. The company had $70 million in cash on hand as of June 30, more than twice its balance as of year-end 2000.

THQ Inc.
Shares have been climbing all year.
Sept. 6, 2000  $22.56
Sept. 6, 2001  $48.85
Note: Table made from line graph