THQ stands over the abyss as stock nosedives nearly 50%
We analyze what may be the publisher's last earnings call
The message in THQ's earnings call for the quarter ended September 30 is clear, if not clearly stated: We are witnessing the slow-motion death of a once-major game company. It's not a pleasant prospect: Jobs will be lost in the short term, lives will be disrupted, potentially interesting and fun games may never be completed. The odds for THQ to continue in its current form are long, though, and getting longer. Let's examine the evidence from the earnings call.
Chairman and CEO Brian Farrell reported the basic economic facts of the last quarter: Non-GAAP net sales of $92 million and a net loss of $1.76 per share. That's not good, but Farrell did note the sales were a bit more than expected and the loss per share was less than expected. Then he said this: “Darksiders II was our only key release during the quarter. While we are pleased with the quality of the game, with a Metacritic of 83, sales of the title were below our expectations.”
Not unexpected, since analysts had warned of this, but devastating nonetheless. When you only have one release, and it performs poorly, you're in trouble.
I said last year that THQ was dancing on the edge of an abyss. Now, it seems like THQ is emulating Wile E. Coyote, standing in mid-air over an abyss wondering exactly what is holding him up. Farrell continued: “In the last year we have made significant strides to transform THQ into a producer of high-quality game titles targeted at the core gamer.” There's a telling quote. Clearly THQ was not a producer of high-quality game titles before, according to the company's own CEO. Isn't it a little late in the game to be figuring out that making high-quality games would be worthwhile?
"We have made significant strides to transform THQ into a producer of high-quality game titles"
Farrell again: “Perhaps more importantly, in the months ahead we face a number of challenges and opportunities. I want to assure you that we are working diligently to resolve those challenges and to maximize our opportunities.” Challenges like running out of money. THQ has only $36 million in cash, and analyst Michael Pachter estimates that THQ is burning through around $15 million per month. THQ has some credit available, but only about $22 million of easily available credit; and it has to pay back a $100 million note in March of 2014. The next quarter should be a good one for sales, though there is no new product release scheduled. Beyond the end of the year, things look bleak.
CFO Paul Pucino gave financial details of the company's quarter and current status, and ended with this: “We are no longer providing net sales and earnings guidance, and we are withdrawing our previous guidance for fiscal 2013 and our projected operating model.” Essentially, this statement means that either THQ has no ability to predict with any precision what its financial future is, or that the future is so bleak it would rather not say.
Newly minted president Jason Rubin discussed the company's products, and revealed the core of the problem. “Darksiders II did not perform to our expectations or live up to its generally favorable reception. Observing this and other recent industry releases, one is left with a firm understanding that in the current marketplace, only the absolute top tier of releases is making an impact on the game consumer. I now have an opportunity to start impacting our next slate of products, and positioning them to compete in this marketplace. Unfortunately, when I joined THQ I did not find the three titles that had been scheduled for the release in the fourth quarter of this year in the same strong state of production as Darksiders 2. Company of Heroes 2, Metro: Last Light and South Park: The Stick of Truth were all challenged, and were guaranteed to fall significantly short of their designs specs if they were forced to make their announced release schedules.”
Rubin continued: “Additionally, in light of the aforementioned marketplace changes, even if completed they would not have had the extra time dedicated to the polish needed to make them shine in this competitive environment. The resulting two-month delay on each title is almost de minimis by game industry standards. Unfortunately, this delay places South Park outside of our fiscal year. Additionally, the delay in revenue generated by the three titles has further risks for the company.”
There you see the problem emerging. Rubin is looking at the schedule realistically, and seeing that rushing the games out to meet fiscal deadlines won't save THQ, but would doom it. At this point a low-quality release would mean not only reduced revenue, but lower any pre-orders for other titles substantially.
Rubin went on: “None of the above should lead anyone to believe I have any less confidence in the slate. Given the appropriate resources, THQ is as strong as ever. The opportunity for South Park is massive. It is one of the most anticipated titles of calendar 2013, and it richly deserves the anticipation. I believe the sheer size of the game, which is comparable to multiple seasons of show, and the incredible dedication and high standards of the creators will make the title worth the wait. I can personally say that I have probably had more laugh-out-loud moments in the last four months than my entire game career to date.” Was that when Rubin was looking over the financials, or just the sales projections for next year?
"We are no longer providing net sales and earnings guidance, and we are withdrawing our previous guidance for fiscal 2013 and our projected operating model"
Rubin closed by saying “I'm excited and satisfied with the content size, positioning, and our slate going forward. The ten projects in production within THQ are as good a lineup as we could hope for.” Rubin is doing a good job with the position he was handed, honestly assessing the state of development for the titles and their prospects. He's bounded by THQ's financial condition, though, which has reached the point where it's severely constraining the development process.
Farrell took over again to deliver closing remarks. “Considering the video game market we operate in today, it is clear that the only viable path for THQ to succeed is to deliver to consumers high-quality, highly-rated truly exciting game experiences. As Jason discussed, we've decided to move Company of Heroes 2 and Metro: Last Light to March release dates, which is later than we had planned initially and to move South Park: The Stick of Truth from March to early fiscal 2014. The new release timing, and our limited financial resources have created a need for additional capital, and as you know, we also have $100 million of face value in convertible notes outstanding that are due in less than two years. In order to help us address these challenges, we have hired Centerview Partners to evaluate our strategic alternatives. We will discuss the results of that engagement at the appropriate time.”
Centerview Partners is a financial consultant that helps companies find ways to raise additional capital, and also advises on mergers, acquisitions, and sales of companies. THQ is finally, officially, hanging out the "For Sale" sign with this action.
Farrell shut down what would no doubt have been a raucous round of questions from analysts: “And because of this process, we have been advised not to conduct a Q&A session following our prepared remarks today. We acknowledge many of you will have questions, and we hope that you understand that we are not in a position to answer those questions until our work with Centerview has run its course. I would like to close today's call by thanking our dedicated employees for their tireless efforts in moving THQ forward. We appreciate your continued interest in THQ and for joining us on the call today.”
THQ would no doubt like to find some white knight investor who would be willing to float the company a hundred million dollars or so to get their newest games out and lead them back into profitability. At this point that is just wishful thinking. The company's financial position is dire, and the current management and board (with the exception of Jason Rubin) is responsible for that. No reasonable investor would want to put large sums of money into a company when the management that screwed up before is still in charge.
"The saddest day of your life isn't when you decide to sell out. The saddest day of your life is when you decide to sell out and nobody wants to buy"
The current stock price of THQ is down almost 50 percent after yesterday's earnings call, and the market capitalization of the company is hovering around $11 million right now. In other words, the company is valued at far less than the development budget for even one title. Any interested buyer could have the company for a song, but no one wants it at that price. There are too many liabilities, and a management team that can't be relied upon to make the right decisions. The current trajectory of the stock means that THQ is getting cheaper by the hour, too. Anyone interested would be better off waiting to see how cheap it might get.
It seems most likely that THQ will get broken up and sold in pieces, either through a bankruptcy process or through a forced sale. Current investors in the stock are likely to be left with nothing, or nearly so, which is why the price is plummeting.
There's a quote from the classic science fiction novel Bug Jack Barron by Norman Spinrad that seems appropriate here: “The saddest day of your life isn't when you decide to sell out. The saddest day of your life is when you decide to sell out and nobody wants to buy.”
Update: It's worth noting that THQ officially closed down just over 50 percent at $1.50 on Tuesday.