It wasn't a pretty first quarter for publisher THQ. The company posted a net loss of over $30 million, as UFC 2010 Undisputed "underperformed," even though it shipped almost 2.7 million units. The problems run deeper than UFC not meeting expectations, however, according to Wedbush Morgan analyst Michael Pachter.
Pachter noted that THQ's challenges at this point "remain considerable." The analyst does not see THQ being profitable in fiscal 2011. "The company has lowered its cost structure to a manageable level, and appears poised to generate breakeven results at the $860 million revenue level. Because of this streamlined cost structure, the company will generate significant operating leverage once its revenues cross the $860 million threshold. Unfortunately, it appears that this will not happen in FY:11," he said.
One concern for THQ is that the publisher appears to be banking on licensed IP. "The company remains dependent upon a handful of licensed properties to sell extremely well, and has not been able to develop a breakout hit from its stable of owned intellectual properties. Games like Saint’s Row, Warhammer, Red Faction and Darksiders, while successful and modestly profitable, have not generated significantly more than 2 million units of sales, while certain licensed properties (notably WWE, UFC, Pixar and Nickelodeon titles) have generated anywhere from 2 – 7 million units per year in past years," Pachter explained. "The licensed properties carry two risks: first, some licenses (such as Nickelodeon) become stale, with declining sales each year; second, the more successful the license, the more likely competitive bidding will emerge, meaning that either THQ loses the license or pays more in future years. We think that the Pixar license is a good example of this, where, following the success of Cars, THQ overpaid for the succeeding four picture deal, releasing games based upon Ratatouille, WALL-E and Up that all generated far lower revenues."
He continued, "The latest license to come under scrutiny is the UFC license. The first iteration of the game came out in summer 2009, and sold over 2.5 million units. The second iteration received higher review scores, and yet sales have thus far lagged last year’s. In our view, there are 5 – 7 million potential purchasers of UFC games, and we think that most will be happy buying the game every two years or so. We do not view the franchise as an annual one, and think that there are insufficient differences in the games to induce most of last year’s purchasers to buy this year’s version. Further, we think that the audiences for UFC and WWE are different when the real world events are held, but are far more similar for the two games, which are essentially both fighting games. This fall, Electronic Arts will introduce its version of the genre, MMA, and we expect the EA game to impact catalog sales of THQ’s UFC games and new sales of its WWE offering. In other words, a crowded fighting field is about to get more crowded, and we fear that THQ has the most to lose from overcrowding. Once EA establishes its MMA game, we think that the company is likely to make overtures to the UFC and to compete when that license expires in 2012. It is possible that THQ has a renewal option (or right of first refusal), but we expect that any option would be at market rates, suggesting that the UFC will shop its license to the highest bidder."
Pachter is encouraged by upcoming owned IP from THQ, but unfortunately for the publisher, the games will be facing some very tough competition in the marketplace. "On the owned intellectual property side, THQ’s lineup looks very strong, with Homefront and Red Faction scheduled for release in the March 2011 quarter. Unfortunately for THQ, competitive products like Microsoft’s Gears of War 3, Sony’s Killzone 3 and Activision’s True Crime: Hong Kong are all scheduled for release the same quarter, making the early year AAA lineup one of the most competitive in recent memory," Pachter said. "With a very difficult competitive landscape, we are hard-pressed to give THQ credit and presume that its Q4 (ending March) releases will perform well enough to drive the profits that company guidance suggests."
