THQ Inc. (THQI) will report fiscal 2Q07 results Friday before the open. An excerpt from our pre-earnings notes (full preview):
- Results will be positively impacted by a strong environment. We believe U.S. video game software sales grew more than 20% in 3Q06 to approximately $1.225 billion. With some of the biggest sellers during the quarter, we expect THQ to be a primary beneficiary of strong demand. We look for a 39% increase in sales to $199 million, in line with guidance and consensus estimates. We expect EBITDA of $3 million and GAAP EPS of $0.01, vs. EBTIDA losses of $0.3 million and EPS losses of $0.06 a year ago.
- THQ's fiscal 2Q07 top line is likely to exceed expectations. THQ likely outperformed its peers in a strong demand environment. Saints Row is a bona fide hit, which with strong carryover sales from Cars, and substantial contributions from Monster House, Barnyard, and Company of Heroes, virtually guarantees THQ will beat its guidance for fiscal 2Q07. Whisper number puts fiscal 2Q07 sales at $225 million+, which is plausible given the environment and THQ's strong line-up. If THQ fails to reach these expectations, investors are likely to be disappointed.
- Outlook for fiscal 2008 will be primary driver of price action. THQ is likely to beat fiscal 2Q07 sales estimates, and fiscal 2007 results could virtually be in the bag with Saints Row, WWE SmackDown! Vs. RAW 2007, and a strong line-up of mass market titles for the holiday season. Investors' greatest concern is what the follow-on will be for THQ in fiscal 2008. We do not expect any concrete guidance, but we think that comments regarding the company's line-up for fiscal 2008 are likely to drive investor sentiment.
- THQI has priced in the recovery in video game sales. Shares of THQI were up over 30% in 3Q06, as investors took accelerated retail sales as a signal the cycle had bottomed out. We think they are now fully valued. THQ has outperformed through the bottom of the cycle and is relatively inexpensive based on valuation, but the whole group looks rich and we would look for a pullback or greater visibility into fiscal 2008 before becoming more aggressive.
- Our $28 price target assumes nearly $130 million in FCF in 2009. We value THQI at 16.0x 2009 FCF of $126 million discounted at 11.25%. THQI is the least expensive video game stock based on fiscal 2007 and 2008 multiples, but we think they are fairly valued given THQ's strong results this year and the lower growth rate in the coming cycle which that implies. Shares of THQI are currently trading at approximately 1.5x calendar 2007E revenue, 15.7x 2007E EBITDA, a 2007E P/E of 29.1x and 23.4x 2007E FCF.
- We would view investment in shares of THQI as moderately risky. We caution investors that adverse market conditions may arise during the next-gen hardware transition as more focus and resources are spent on preparing for the next cycle. A drastic change in market demand, a decline in software pricing, setbacks in the release and supply of next-gen hardware, as well as delays in the release of software provide substantial risk to our forecast and projections.