At the risk of taking the punch bowl away from a raucous party, let me share my opinions on THQ.
This quarter is going to be huge for THQ. They can easily report $1 in EPS if they want to. Indeed, it will be the crowning achievement for a management team that has done a great job turning around a troubled company by fully exploiting the growth in popularity of World Championship Wrestling. Yes, it's going to be a great quarter, and everybody knows it.
But what everybody also knows – even if they hate to admit it – is that virtually all of THQ's earnings are coming from sales of WCW products. This is a problem – a big problem – because THQ's WCW license expires in 12 days (on December 28), and subsequently will be turned over to Electronic Arts.
What's left of THQ when WCW is gone? Not a lot, I'm afraid. If you eliminate the profits from selling WCW titles, then underlying earnings are no more than 50 cents per share this year – hardly sufficient to support a $28 stock price. Moreover, the recent contributors to these underlying earnings are principally Quest, Rugrats and various GameBoy titles, all of which face a questionable future.
Regarding Quest, there will never be another “first role-playing game on the N64.” Indeed, Quest 2 (if there is one) will face much stiffer competition. Moreover, the original Quest still hasn't sold anywhere close to the nearly 400,000+ units that THQ shipped during the second and third quarters. (Now you know why provisions for returns and discounts were so high at September 30.) And, interestingly, THQ management has decided against introducing Quest on the PSX platform – hardly the vote of confidence one would expect for a key THQ “brand.”
As for Rugrats, it is not clear that THQ has the rights to this sequel. If THQ does get the rights, you can be sure that Nickelodeon will make it a more costly deal the second time around. In addition, the next Rugrats title simply won't sell as well as the first. This is because: (1) its introduction will not coincide with the next Rugrats movie (unless THQ wants to wait until the Year 2000), and (2) Sony will not be providing the same level of advertising support.
As for Gameboy, this is a tiny piece of the THQ pie (maybe 7%), albeit consistently profitable. But GameBoy revenues are declining this year due to the loss of the Madden sports titles and are likely to continue declining in 1999 as the transition to the color GameBoy will pressure software sales in general.
But wait! I haven't mentioned THQ's new WWF license. That will be huge, right? Well, that is the $64 question. It is certainly eye opening to track the recent sales trends of WWF Warzone for N64. Indeed, by almost all accounts, Acclaim's Warzone is a technically superior product to WCW Revenge. But Revenge is selling great, while Warzone, following strong initial sales, is now dying on the vine at the height of the Christmas selling season. The reason? People simply like Turner Broadcasting's WCW better. For the next five years, ERTS will have the WCW license, and THQ will have to share WWF with Jakks Pacific. That's not an even trade – not even close. And don't think that Acclaim, GT Interactive and Midway won't also have wrestling titles on the shelf next Christmas. In fact, the bigger question is whether JAKK-THQ will have a WWF product out in 1999. If you were Acclaim, wouldn't you wait until the month before your WWF contract expires (November 18, 1999) and then ship a huge number of PSX and N64 games into the Christmas channel? This is certainly the strategy that THQ is pursuing right now as its WCW license is about to expire.
But if THQ doesn't have a wrestling title on the market next Christmas, then how will they match this year's earnings? Good question. It certainly will be difficult to replace $125 million in sales from titles like Brunswick Bowling and Bass Fishing.
And what about the terms of the WWF joint venture with Jakks Pacific? How good is this deal for THQ? Well, what we know is that this license is more expensive than WCW, both in terms of upfront payments and royalty rates. In addition, it appears that while the revenues from game sales will be split evenly, the costs are being borne disproportionately by THQ. So, however good this license turns out to be for Jakks, it will be less good for THQ. And while the value of the license is, at this time, difficult to quantify, we do know this: Since the joint venture agreement was inked last June, JAKK stock has continued to trade in the $10 range at which price Chairman Jack Friedman (the former THQ CEO) and fellow executives have been happy to sell over 500,000 shares. This raises a question: If securing the WCW license enabled THQ stock to go from $5 per share to the current $28, then why does securing the WWF license make JAKK go only from $8 to $10 (especially when JAKK has only half as many shares outstanding as THQI)? Perhaps Jack Friedman knows something you don't.
And today we learn that THQ CEO Brian Farrel sold 60,000 shares of THQ stock between November 10-12 at around $23 per share. Ditto on 20,000 shares at $25.50 for CFO Fred Gysi. The last time we saw sales this big was just before THQ announced it had lost the WCW license. This certainly seems strange for management of a company that is about to blow away consensus earnings estimates for the December quarter, is trading at less than 15x 1999 estimates, and is headed for 20% annual growth for the foreseeable future.
Do I hear the Fat Lady singing?
Once again let me say that this is my opinion, and since I have no intentions of responding to posts, consider my post food for thought or flame away.
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