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AUGUST 22, 2002 NEWSMAKER Q&A It's "Gold Rush" Time for THQ CEO Brian Farrell of the video-game maker says despite the sour economy, gaming is booming, "and we're supplying the gold pans"
THQ is an obvious beneficiary of the intense competition between Microsoft and Nintendo for dominance of the electronic gaming market. Last Christmas, they launched two new game platforms, Xbox and GameCube, respectively. That spurred millions of fans to upgrade to the sophisticated new technology -- and buy new games. And Sony's Playstation2, which came out in 2000, is still a hot seller. Anticipating a strong Christmas this year, THQ increased its earnings guidance for 2002 to between $1.24 and $1.31 per share on revenue of $515 million to $525 million, an increase of 23% to 30% over 2001. That said, THQ's stock hasn't been immune to the general market malaise. The shares got a small lift the week of Aug. 19, but at around $25, they're still a long way from the 52-week high of $43. The stock, with a price-earnings ratio of 26, is trading at a serious discount to its peers: No. 1 video-game publisher Electronic Arts (ERTS ) sports a p-e of 62. On Aug. 19, Farrell spoke with BusinessWeek Online reporter Jane Black about why he's so optimistic about the industry. Edited excerpts follow: Q: Despite the economy, you're bullish on the video-game industry. Why? A: If you look at the environment right now, you know how negative everything is. But this industry will grow between 20% and 25% this year. And our company is on target to grow between 35% and 40% -- on the top line and the bottom line. [Sony's] PlayStation2 will have an installed-unit base of between 15 million and 17 million. [Microsoft's] Xbox and [Nintendo's] GameCube are hitting their stride. All of our core markets are firing on all cylinders. We're looking at our business and saying, "Wow, this is great." And then we look at the [stock] and say, "Hmmm, that's not so great." We think there's a disconnect. Q: Well, it's clear that the economy's continued slump has some concerned that as disposable income falls, so will video-game sales. A: There's not much empirical data to support that. If you look at the last recession, in 1991, there were two systems launching then -- Sega Genesis and Super Nintendo. And sales curves were right in line with expectations, despite [the recession]. At the price points we're talking about -- $149 for GameCube, $79 and under for Game Boy Advance [Nintendo's handheld game player], $199 for PlayStation and Xbox -- Santa Claus still comes at those prices. Q: The console makers you mentioned will be battling for market share this Christmas. How do the console wars affect THQ? A: When we look at the business, we want to know how big the pie is. The more intense the competition, the better it is for us. This is like the gold rush of '49, and we're supplying the gold pans. We've been pretty steadfast in our belief that that Sony [PlayStation] will get around 50% of that market. And so far, we've been right. That means there's another 50% for Microsoft and Nintendo to carve up. How that breaks out doesn't matter that much to us. Q: Your strategy to date has been to leverage partnerships with brand-name media companies such as Nickelodeon. Why is that important for THQ? A: A key part of our business is brand management. The partnership with Nickelodeon has allowed us to do a number of things. For example, we've done $250 million [in sales] on Rugrats [a Nickelodeon cartoon franchise] over the last several years. Now we're doing the same thing with new franchises such as SpongeBob SquarePants and another new franchise called Fairly OddParents that has been tracking well. Because of the long-standing relationship, we can capitalize on these brands while they're hot. We can co-market much more effectively than [in the traditional licensor/licensee role] where we were handed material only after the franchise hit its stride. Co-marketing is essential. If you have some huge amount of marketing and advertising money being spent by a media company, it creates a tremendous opportunity for a game-development company like ours. Besides Nickelodeon, we have a great deal with Disney and Pixar. It's their first long-term, multi-project, multi-territory deal. We're working with them on their next three films: Finding Nemo, which comes out in summer '03; The Incredibles, for fall '04; and Cars for fall '05. For a game publisher like us, that's key. Right at the time when the consoles selling like hotcakes at Wal-Mart and Target and Toys 'R' Us, we'll have these three franchise properties bringing in between $80 million and $100 million a year. Q: That makes revenues more predictable, which is important in the entertainment category, where you never know quite what will be a hit. A: Exactly. A lot of games sell between 250,000 and 500,000 copies, and that can be extremely profitable as a business. As a public company, they are things we can do year in and year out. They don't sell 1 million units, but it's predictable revenue, earnings, and cash flow. We're telling the Street: Don't value us on hits. We've got a portfolio of titles developing steady revenue and cash flow. That's worth a lot. Q: What about online gaming? There's lots of buzz about it these days. A: There's no doubt you'll see a lot of arm-waving about online gaming this fall when [Sony will start selling a network adaptor to link its console to the Net and Microsoft begins pushing Xbox' online features]. But you won't see a lot of money made. There are still a lot of issues to work out. How does it work? Who owns the customers? If you listen to what Microsoft is saying, they're promising to have tens of thousands of users year. I mean, here we're looking at an installed base of worldwide consoles of 50 million. A base of tens of thousands, while getting a lot of press, doesn't drive the market. Q: Is the outlook as grim for mobile gaming? A: We're much more bullish on mobile gaming. Unlike for online, there's a business model there. All of us are used to paying for services on our mobile phones. We don't expect it to be free. We can charge to download the game or a subscription for a suite of games. There's a billing connection through the carriers. All the things that plague online gaming are nonexistent in handheld gaming. We're the largest independent publishers of handheld games. Taking it onto mobile devices isn't a huge leap. I think the market will take a lot of people by surprise. It's such a great time waster. You're on a bus, subway, or waiting for a plane, mobile gaming is perfect. The breakthrough will come next year as the installed base [of next-generation phones with larger, color screens] reaches 100 million units.  Edited by Patricia O'Connell Get BusinessWeek directly on your desktop with our RSS feeds.  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