THQ Smacked Down on Poor UFC Game Sales

Videogame maker THQ, Inc (THQI) admitted today that results for the first quarter will be weaker than expected.  They lay the blame on sluggish sales of “UFC Undisputed 2010” and in addition the stronger dollar is weighing on results.  For the first quarter, the company now expects to lose 20 to 30 cents per share from previous guidance of break even.  Furthermore, sales will not meet previous estimates of $190 million to $200 million and now is more likely to come in around $155 million to $165 million.  As far as full year results, they expect to just about break even on sales of $845 million to $865 million down from previous estimates of EPS of 25-30 cents on sales of $905 million to $920 million.

Anytime a company has to back off of previous expectations it will be received poorly by the market, and THQ is no exception as their stock is down more than 12% as of the time of writing to $4.88.  Of course, slashing guidance does not inspire confidence among investors, and should prompt analysts to lower estimates over the coming days.  The UFC game’s predecessor was a hit selling nearly 4 million units, but unfortunately for THQ stiff competition around the release date in combination with a tough videogame sales environment led to slower sales than hoped.

Interestingly, this news should not have been a huge revelation as the company had made comments about sluggish sales only a week after the game debuted as Take-Two Interactive’s (TTWO) Red Dead Redemption saw wider initial success.  So, it is a bit surprising that the market has punished the stock so harshly for something that was already known.  We think that this may be an opportunity, albeit slightly speculative, to pick up a conservatively managed gaming stock with strong franchises.  THQ has license to produce games for both Ultimate Fighting and WWE (wrestling) games for years to come, and each have a devoted and growing fan base.  The UFC game that has struggled recently actually received strong reviews, but could not stand up to intense competition for gamers’ attention.

As far as valuation goes, of course it is not a positive development for our analysis that the company now expects to just break even this year.  We are not downplaying the importance of profitability, and this guide-down will work against THQI in our methodology.  However, the stock looks very cheap when looking at the price-to-sales per share multiple.  Over the last ten years, THQ has historically fetched between .72x and 1.76x times revenue per share, but using the middle of the new sales guidance, THQ is selling for only .39x times sales per share.  We think that long term investors may have an opportunity to buy this game maker because—according to our methodology—the stock has a decent margin of safety.  We could see this stock selling for $5.50 based on the fundamentals, and with the growing popularity of the sports it makes some of its games for, it could perhaps be a takeover target at such a low price.  With its “fighting” games and its other franchises, this stock has become too cheap following today’s decline and we are reaffirming our Undervalued stance.

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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