Game Company Needs Big Score

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In its heyday just two years ago, THQ Inc. was a force in the video game industry, known for its pro wrestling titles in which players slapped, smashed and body-slammed opponents around the ring. Now, the company has found itself on the ropes.

In the past 10 months, the Agoura Hills-based company has rung up a $334 million loss and burned through about half its cash. Its stock price has tumbled from around $20 to just above $2. With consumers expected to cut spending on video games due to the downturn, there’s increasing speculation that THQ could become a bargain-seeker’s takeover target. And at least one analyst thinks there’s a chance it could go bankrupt.

“You have mediocre product and you’re running out of cash,” said Michael Hickey, an analyst with Janco Partners Inc. in Denver, who put the odds of THQ going bankrupt at 50-50. “Not the situation they want to be in right now.”

THQ executives are scrambling. Chief Executive Brian Farrell last month launched an aggressive turnaround plan, slashing costs for next year by $220 million and laying off almost 600 employees.

Farrell dismissed talk of takeovers and bankruptcy as gossip.

“I know that makes for good print and sells newspapers, but those aren’t the kind of things we focus on right now,” Farrell told the Business Journal. “When the stock price is depressed, the naysayers can have their day in the sunshine. But we have a plan that we’re very confident will give us cash and return the company to profitability.”

Farrell said THQ has also begun searching for a line of credit as a fallback measure. The company currently does not have one, but it recently borrowed about $26 million against auction rate securities a form of long-term debt to bolster its balance sheet.

THQ’s troubles stem from what was its strength: Video games based on licensed properties. Its portfolio of licenses gave the company products with instant name recognition, such as Walt Disney Co.’s “Cars” and Viacom Inc.’s “SpongeBob SquarePants.” But THQ had to pay fees to the licensors and give them a share of the revenue.

Nevertheless, games from its licenses helped shoot THQ to more than $1 billion in revenue and record-breaking profits in 2007.

But the strong sales of its licensed products masked the fact that the company’s original games which provide fatter margins if successful never caught fire. Meanwhile, Nintendo Co.’s Wii became popular among young consumers who were playing casual games based on familiar characters such as plumber Mario. That took business away from THQ franchises.

The company’s misfortunes contrast with the other local video game publisher, Santa Monica-based Activision Blizzard Inc. While Activision publishes its share of licensed games such as “Spider-Man” and “James Bond,” revenue from those titles mostly supplement original franchises such as hit series “Guitar Hero.”


Losing license?

THQ likely will soon lose one of its storied licenses, the Disney-Pixar agreement. Under its current terms, THQ can publish two more games based on future Pixar films, including the movie “Up,” an animated adventure film due later this year. After that, industry analysts expect Disney will bring Pixar games to Disney Interactive, the company’s growing in-house video game division. Disney officials did not return phone calls seeking comment.

Losing the Disney-Pixar license would be a blow to THQ’s bottom line: Up to one-fifth of the company’s revenue used to come from Disney-Pixar products.

But Michael Pachter, an analyst with Wedbush Morgan Securities Inc. in Los Angeles, pointed out that THQ’s latest Pixar titles, “Ratatouille” and “Wall-E”, underperformed. That suggests the company’s Disney-Pixar license isn’t as lucrative as it once was.

Farrell declined to say whether THQ would bid on the Disney-Pixar license when it was up for renewal. “Disney and THQ have been great partners for many years, but it’s got to work for both sides,” he said.

THQ did not provide guidance for next year, but analysts said to stay healthy the company has to have revenue of between $750 million and $800 million compared with the $1 billion in revenue it did last year. To do that, THQ’s perennial franchises, such as “World Wrestling,” would have to perform well. And at least one of its new franchises, which include a game based on Ultimate Fighting Championship matches and a postapocalyptic combat title called “Darksiders” would have to reap significant sales. Analysts said both are possible, but the margin for error is thin.

Another way to keep the bottom line healthy is to cut costs, which THQ has already started. The company scaled back its mobile games and international divisions, closed five studios across the United States and plans to shutter more. By the end of the year, it projects its employee count will be down from 2,400 to about 1,800.

Farrell said the company now plans to release just one or two of what it calls its “high-end titles” a year, down from three to four in previous years. The “high-end titles” are designed to have market appeal for the hard-core gaming crowd.

“The idea is to put a lot of wood behind certain arrows,” Farrell said.

The first of those for this year is its UFC game and “Red Faction,” an action game that is carrying a lot of the company’s hopes.

If those titles fall flat, analysts said that more layoffs could come.


Takeover target

Farrell acknowledged his aim of restoring THQ to profitability next year is ambitious, given the state of the economy.

“The watchword for everyone in the company is to focus and execute,” he said. “We know how to do this.”

If THQ’s stock price remains depressed, it could be a tempting takeover target. The question is who would want to buy it? In the past, larger publishers such as Ubisoft Entertainment SA and even media companies like Disney have been mentioned as potential buyers of THQ.

But THQ’s license-heavy portfolio might make any potential buyers wary because it’s unclear how many of those licenses would transfer to a new owner.

“You want a strong basket of original properties that are of high quality, that’s what acquirers are looking for,” Hickey said. “Otherwise you have Midway.”

Midway Games, based in Chicago, is a once-storied video game publisher that has since fallen from glory and in February filed for bankruptcy.

It’s not the sort of company THQ wants to keep.

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