THQ Marks a High Score, but Will It Soon Be ‘Game Over’?

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Christmas came early for THQ Inc. last year.


Now the question for investors and executives at the Agoura Hills-based video game publisher is how long will it last?


THQ’s stock traded as low as $18.96 in June before reaching a 52-week high of $34.43 in mid-December and has remained in the ballpark since, closing at $32.54 on Dec. 27.


The rapid growth in its share price is being partially attributed to the industry’s cyclical upswing, which has come amid the introduction of Sony’s PlayStation 3 and the strong sales of Nintendo’s new Wii platform.


THQ’s cross-town rival Activision Inc. also reached a 52-week high in December when it shares hit $18.19 in the early part of the month, but THQ may be the bigger beneficiary given Wii’s unexpectedly strong introduction.


This fall, all the talk was about the PlayStation 3, with its supposedly unparalleled graphics. But it also sported a price tag of $499 to $599 and has been in short supply since its November launch.


Then came the release of the Wii, which has a motion-sensitive controller that has drawn rave reviews from gamers; it has been the holiday season’s undeniable breakout hit. And that’s particularly good news for THQ, which derives 13 percent of its revenues from Nintendo games, while Activision gets 10 percent and industry giant Electronic Arts Inc. 7.5 percent.


“We planned this holiday season right on,” boasted THQ Chief Executive Brian Farrell, in an interview. He noted the company focused on producing titles for not only Nintendo’s Wii platform, but its DS system, as well as the older PlayStation 2 and Microsoft’s Xbox 360 platforms.


Indeed, THQ’s surge in sales this year has been impressive, driven by its “WWE’s Smackdown vs. Raw” game, which has moved 471,408 units, and its “Cars” game, based on the hit Walt Disney Co. movie. More than 287,000 of that game have been sold.


The video game business, including hardware and software, is expected to generate sales of $32 billion worldwide in 2006, up 10 percent from a year earlier, according to industry research firm DFC Intelligence.


But the key question for THQ and others in the industry is whether the momentum can be sustained. Of 23 analysts who cover the company, 12 rate it a “buy,” nine a “hold” and two a “sell,” according to Bloomberg News. That’s not exactly a ringing endorsement from Wall Street, and for good reason.


There’s a feeling that THQ and other stocks have had their run and are likely going nowhere. Or even worse, they may be in line for a correction.


Mike Hickey, an analyst with Janco Partners, has a strong “sell” rating on the stock. He doubts THQ will meet its fourth-quarter earnings goal on its “Supreme Commander” or “Stalker” games, and thinks it doesn’t have enough new titles to make up for game sales that disappoint.


“Total title count is expected to be roughly flat with fiscal ’07,” Hickey wrote.


Still, Hickey is in a minority among analysts. John McPeake, of Prudential Equity Group, believes that THQ, as well as Activision, are positioned to grow faster than Electronic Arts and other smaller competitors.


“We remain buyers of shares of Activision Inc. and THQ as year-on-year growth of 26 percent and 50 percent, respectively, continues to outpace the U.S. video game software industry,” McPeake wrote in a recent research report. Specifically, McPeake noted that in November THQ titles generated $72 million revenue in the U.S., 50 percent higher than for the same period the previous year. Those sales also exceeded McPeake’s estimate of $62 million.


However, THQ does have some problems not related to its creative output. The company has been caught up, like others, in a review of its stock option practices and whether those grants were backdated to maximize executive gains.


A review of its practices caused the company to delay its second-quarter earnings and in November it was informed by the Nasdaq it faced potential delisting. The company has appealed to an exchange listing qualifications panel, but the delay also has prompted the filing of a purported class action lawsuit.


So far, given the stock’s appreciation, the market has shrugged off the legal issues, while Farrell referred any questions to the company’s attorneys, Latham & Watkins. The law firm did not respond to calls.

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