THQ Earnings Outlook: No More Kids

THQ (NASDAQ:THQI) will report its fiscal Q3 2012 (ending December) results after market close on Thursday, February 2, with a conference call at 2:30pm PT (dial-in: 877-356-8075, conference ID: 43429454, webcast: http://investor.thq.com).

We expect results in-line with our estimates for revenue of $420 million and EPS of $0.78, compared with consensus estimates of $417 million and EPS of $0.64. On December 7, THQ lowered its Q3 revenue guidance by ≈ 25% to an implied $382.5 – 412.5 million, reflecting weak sales of the uDraw GameTablet on Xbox 360 and PS3. We note that the Q3 miss reflects a shortfall of almost all of the 2.3 million uDraw units we modeled, suggesting that either guidance is overly conservative, or that there is a bigger as-yet undisclosed problem. THQ did not update FY:12 guidance for revenue of $925 – 1,000 million and EPS of $(0.30) – 0.10, but the magnitude of the Q3 miss suggests a large downward revision.

On January 25, the company announced that it will exit its kids licensed business to focus on core franchises and digital initiatives. The company deemphasized kids games last year, incurring a $30 million charge in Q3:11. Although many recent kids games have struggled, we view the collective underperformance of many AAA titles (such as uDraw) as the primary driver of THQ’s woes.

THQ also announced on January 25 that it has shipped 3.8 million units of Saints Row: The Third. We estimated sell-in of 3 million units for Saints Row: TheThird for Q3, so the game appears to be tracking in-line with expectations. THQ expects lifetime sales of 5 – 6 million units, also in-line with our expectations.

THQ’s U.S. retail sales tracked up 17% in the December quarter according to NPD, below revised revenue guidance of up 18 – 28%. This suggests the potential for a top line miss, although we think sell-in may have exceeded sellthrough sufficiently to allow the company to hit our estimates.

It is unclear whether THQ’s valuation has hit a low point. The quality of upcoming games must improve significantly for the company to show earnings improvement, and execution remains uneven. We believe recent cost control measures are intended to preserve cash, but expect a cash squeeze by Summer.

Maintaining our NEUTRAL rating and 12-month price target of $1.50. Our price target reflects an enterprise value of $150 million, and incorporates the company’s key franchises, brand equity, and going concern status. Given THQ’s uneven financial performance and history of financial losses, we are uncomfortable valuing the company on an earnings multiple.

Michael Pachter is an analyst at Wedbush Morgan.

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