The video game industry is splintering into the haves and the have-nots. THQ Inc. falls in the less fortunate camp.
The Calabasas publisher was at the top of its game two years ago. The company's $68-million profit and $1 billion in revenue put it within striking distance of crosstown rival Activision Inc. THQ released an ambitious plan to expand its game lineup and began acquiring development studios across the country. But now it's in retreat as it loses ground to publishers such as Nintendo and Activision, which strengthened through last year's merger with Vivendi's Blizzard Entertainment.
THQ, whose titles include World Wrestling Entertainment and SpongeBob SquarePants, is laying off 600 workers, a quarter of its development staff, cutting bait on flailing games and closing studios.
"In the past, the rising tide of game sales lifted all boats," said Colin Sebastian, an analyst with Lazard Capital Markets. "Today, the market is still growing, but there are fewer winners."
The cost-saving moves come in response to a dramatic sales decline and big losses that have eaten into THQ's once-rich cash reserves.
Many of its big-budget games have sold poorly, despite garnering favorable reviews. Its hold on kids' games, which are based on Nickelodeon TV shows and Pixar Animation movies, has slipped as children turn to the Internet to play free online games.
THQ's situation appeared grave enough for Mike Hickey, a Janco Partners analyst, to venture in an interview with the Los Angeles Business Journal that the company's had a 50-50 chance of filing for bankruptcy protection this year.
Most analysts who cover THQ don't share that view. Chief Executive Brian Farrell dismissed the prediction as "idle gossip." Though its reserves have dropped to $144 million from $458 million two years ago, he said the company was on track to generate positive cash flow this year.
"This is a good business," Farrell said in an interview. "It's just not as big as it used to be."
Farrell said THQ had embarked on a strategic plan to trim $220 million in annual costs by 2010 and invest in "fewer, better bets."
"Our strategy is to focus on bigger titles," he said. "The formula is to make great games and market them effectively. High review scores lead to high sales and high profits. We think we have a plan in place to do that and return the company back to profitability."
Analysts say THQ faces formidable headwinds. Though sales of game software grew 25% in 2008, the recession has led consumers to buy fewer titles. In response, retailers are reluctant to stock games that don't immediately sell well or have solid track records. Companies with top-10 titles did well; those that didn't suffered.
Adding to the difficulty is the higher cost of making a video game. Development budgets, which ranged between $5 million and $10 million per game five years ago, now routinely hit $25 million, said John Taylor, a managing director with Arcadia Investment Corp.
"Budgets have skyrocketed, but the audience hasn't grown accordingly," Taylor said.
Farrell says the industry's economics are a lot tougher than when he joined the company as its chief financial officer in 1991 and became CEO in 1995. Development costs then were measured in the hundreds of thousands of dollars.
"Budgets are bigger now, so we just can't make as many bets as we used to," he said. "It's a matter of where you place those bets."
THQ's success depends largely on its ability to generate hits. Topping its priority list is an upcoming game based on the Ultimate Fighting Championship franchise, a license it secured two years ago. With the license up for renewal in 2011, it is under pressure to prove it can make a knockout game and hang on to the license.
Analysts say THQ could become an acquisition target if its stock price continues to dwindle. Its shares gained 27 cents to $2.58 Wednesday, but are down 86% in the last year. Its market value is only $173 million. "There are a number of companies, media companies as well as game publishing companies, that are in a position to make an offer for THQ," Sebastian said.
Farrell declined to comment on whether THQ was in discussions with potential buyers. "We think we can create the most value by executing on our plan," he said.
Bob Aniello, THQ's former senior vice president of marketing, urged patience, saying the two- to three-year development cycle for games means that improvements take time to bear fruit.
"THQ may be late, but being late has been part of its DNA, and it has always survived," said Aniello, who left the company in December. "It's too early to count them out."
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CEO: Brian Farrell
2008 revenue: $1 billion*
2008 net loss: $35.3 million*
Cash and short-term investments: $144 million**
Key franchises: Saints Row, Red Faction, Destroy All Humans, de Blob and Dawn of War. THQ also has licenses to produce games based on World Wrestling Entertainment, Ultimate Fighting Championship, Nickelodeon TV shows such as "SpongeBob SquarePants" and Pixar Animation movies including "Cars."
* Fiscal year ended March 31, 2008
** As of Dec. 31, 2008
Source: Times research