GTIS Banking on an Oddball

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By Cory Johnson
Staff Reporter

His name is Abe. An unlikely name for a hero, even a sheepish hero, with bugged-out, bloodshot eyes, bony shoulders, a snakelike ponytail and big green feet. But as Abe ambles his way through the RuptureFarms meat-packing plant, the protagonist of the forthcoming video game

Oddworld: Abe's Oddysee

is trying to save more than his strange friends from a life of slavery.

GT Interactive Software

(GTIS)

is banking on sales of this

Sony Playstation

game to save the company's stock price, which has been hammered in the last year -- off nearly 50% from its high last October.

Though the game doesn't ship until Sept. 19 (a day the company has dubbed "OddFriday"), anticipated sales of

Oddworld

have driven the stock price up 102% from its recent low of 5 7/8 on April 22. And lovable Abe has the stock boards in a frenzy. "Oddworld is going to be a big hit," writes one poster on the

Motley Fool

. "The stock's going to 16!" But some other investors wonder: Can one hit save an entire company?

GT Interactive sure hopes so. "This continues to be a hit-driven business," says Alyyne Mills, a GT Interactive spokesperson. "Eighty percent of the games sold are from 20 percent of the games made. The game has tremendous buzz, and we are certainly planning on Abe being a triple-A hit."

But given GTI's shaky past, some salient observers aren't so hopeful. Shares were bruised in early November when the company lost the rights to distribute sequels to

Quake

(first reported here on

TheStreet.com

). Soon after, the company reported terrible fourth-quarter earnings and the stock cratered. An even bigger blow followed, when

Wal-Mart

(WMT) - Get Report

announced that it would no longer rely on GT Interactive to stock its shelves with video games.

Regardless of hit titles, analysts are wary of the company because of what it spends on those titles. "GTI has a history of paying more for their titles than anyone else in the business," says Lenny Brecken, an analyst with

Oppenheimer

(which has not done any underwriting for the company). "And that makes it harder to get the profitability leverage because the royalties are so high. So even if

Oddworld

is a breakout hit, the upside potential may be limited."

GTI spent an undisclosed amount to buy 50% of

Oddworld Inhabitants

, the company that created Abe. But Brecken, who rates GT Interactive a market perform, says the company's bookkeeping style helps to hide such costs from investors. Besides spending so much to get hit games, sometimes more than $1 million per game, Brecken says GTI will put these payments on the books as royalties, to be amortized over time, rather than as research and development costs that are expensed just once.

"So a company like

Electronic Arts

(ERTS)

will spend a million dollars on a game, take a one-time R&D expense on a game, and then sell a million units which are virtually all profit," says Brecken. "But GTI continues to pay and pay for games. For a lot of investors, GTI is a tremendous risk. They burn through a lot of cash and, when it comes down to it, when it all hits the fan, a GTI share could be worth zero."

GT Interactive admits that its bookkeeping is unique, but says that as a new company (it went public Dec. 15, 1995) it had to be aggressive to compete. "We will have more of an

Electronic Arts model going forwards, but that doesn't happen overnight," says GT investor relations manager Dawn Berrie. "We aim to have a model where 60 percent of our content is made internally. So for 60 percent of our product line, there won't be any royalty payments. But to compete now, we work with over 80 developers -- we have $70 million in advance royalties spread over a large number of developers. But that's the only way we can compete with entrenched competition."

In the fourth quarter of last year, GT Interactive found itself stuck with a lot of games that didn't sell and continuing royalty expenses. The only way they could stay afloat was to spend even more cash to acquire games for the future. "They burned though a ridiculous amount of cash," says Brecken. "The Street woke up to this risk, and that's what killed the share price. Look, a good game, even a great game, might make the quarter -- but it won't make the company."

In the quarter ended March 31, GT Interactive reported revenue of $93.4 million, up from $62.3 million one year earlier. But net income was zapped like the meat products in RuptureFarms, falling to $4.5 million, or 7 cents per share, from $5.1 million, or 9 cents a share, a year ago.

Abe's ability to solve that vexing problem looks doubtful.

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