THQ's Second Childhood

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SAN FRANCISCO -- Video-game maker

THQ

(THQI)

is finally back off the bench.

In 1992, the Calabasas, Calif., company was a star of the technology sector, watching its stock rise to 86 with such hit titles as

Where's Waldo?

and

Home Alone

. But a slump in the gaming industry brought its stock price down to 1 in June 1995. After a painful restructuring under CEO Brian Farrell, the company is on the mend and the stock back up near 30. To weather the feast-or-famine nature of the video-game business, THQ has set up a new business model. Now, says James L. Lin, an analyst at

Wedbush Morgan Securities

, THQ looks more like a publishing house than a software developer. (WMS is an underwriter for THQ.)

Delays and competition between new game players such as

Sony

(SNE) - Get Report

PlayStation

and

Nintendo's 64

and

GameBoy

have made for volatile revenues at companies. THQ learned to adapt by seeking out high-profile titles at low cost. It does so by licensing titles from

DreamWorks

and cable TV's popular show

World Championship Wrestling

, selling them through mega-retailers such as

Toys R Us

(TOY)

and

Wal-Mart

(WMT) - Get Report

and outsourcing the development of the vast bulk of its games.

Such strategies have given THQ an edge over competitors, says Deborah Lake, THQ's investor-relations director. About 90% of the company's software-development jobs are done externally, with developers paid only when games reach predetermined stages of development. THQ only employs about 80 people, or one employee for every 26 at rival

Electronic Arts

(ERTS)

. And yet THQ's revenue is about a sixth of Electronic Arts'. THQ pays royalties to both the licensee and outside developers, which together average about 20% of the unit price sold to retail outfits.

Other gaming companies, such as

Acclaim Entertainment

(AKLM)

, have tried to morph into the publishing model but without success in managing channels and relationships with developers, Lin says. Acclaim now develops about 85% of its software in-house, while THQ outsources all but 10% of its development work.

So far, the formula has been working for THQ. The stock has more than doubled since early October in anticipation of future hit titles. Revenue grew at a 58% clip in the third quarter from a year ago, outpacing the 10% growth for the industry at large. Net income rose 62% on the year to 21 cents a share, beating

First Call

estimates by 4 cents. That marked the seventh quarter running that THQ has beaten the Street.

THQ has successfully recreated its revenue with new titles each quarter by using licenses from established brands, says Ken Trbovich, associate research director at

Red Chip Review

. The move has given THQ a more easily predictable revenue stream, a rarity in an industry where developing a hit product is tough.

Historically, THQ has built a stable revenue flow and has performed well despite having no new major titles. Instead, the company reorders and relaunches titles such as

Quest 64

, wrestling extravaganza

WCW vs. NWO

and fishing-themed

BASS Masters Classic

. The WCW games alone made up 60% of THQ's $104 million revenue in the first nine months of 1998.

The company also has recently nabbed licenses for high-profile children's movies. It introduced on Nov. 20 a game for the PlayStation platform based on

Nickelodeon's

Rugrats

TV show and

Rugrats the Movie

from

Viacom's

(VIA) - Get Report

Paramount Pictures

. On Dec. 2, it released a game based on

Disney

(DIS) - Get Report

and

Pixar's

(PIXR)

A Bug's Life

for Nintendo's GameBoy platform. THQ wouldn't say how many games have been shipped, but both films are doing well:

Rugrats

took in $73 million in its first four weeks, while

A Bug's Life

brought in $84 million in four weeks.

With 40 million PlayStation users around the world -- 12.8 million in the U.S. alone -- the

Rugrats

game seems to offer the bigger bounty. Analysts are anticipating 1998 total revenue to reach between $168 million and $179 million from only $89 million actual total revenue in '97. And the company has recently put a major marketing push behind its titles: It plunked down $3 million to tout the

Rugrats

game and $4 million to endorse the latest

WCW

title

WCW/NWO Revenge

.

And there's more to come. Next spring, THQ will release not only a GameBoy color version of the

Rugrats

game but also a GameBoy version of a game based on the much-anticipated new

Star Wars

movie,

Episode I: The Phantom Menace

.