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Video Gamer THQ Grows Up

By Arlene Weintraub It takes just two words to make the average first-grader squeal with delight: SpongeBob SquarePants. The goofy cartoon, featuring Bob the sea invertebrate and his fishy friends, is a huge hit on Nickelodeon and has translated into a best-selling video game for THQ (THQI). The Calabasas Hills (Calif.) company is the exclusive publisher of games based on Nickelodeon's animated movies and TV shows for kids ages 6 to 14.

At this year's Electronic Entertainment Expo (E3), the video-game conference held May 21 to 24 in Los Angeles, THQ debuted more than 20 new games based on popular Nick shows, including Jimmy Neutron, Hey Arnold!, and Rugrats. The parade of cartoon characters should help drive THQ's revenues up 37% this year, to about $520 million, analysts say, with profit growth of 27%, to about $46 million.

THQ's popular titles have propelled it into the Big Three of independent game publishers, yet it consistently lags behind rivals Electronic Arts (ERTS) and Activision (ATVI) on Wall Street. Trading around $32.70 a share on May 23, THQ has a price-earnings ratio of 31. In contrast, Electronic Arts and Activision carry p-es of 95 and 37, respectively.

KIDS' STUFF. THQ has been overshadowed largely because it hasn't turned out blockbuster hits like EA's Madden football franchise or Activision's new Spider-Man game. But that may be about to change. If THQ can deliver on its promises and turn in a strong holiday season later this year, analysts predict its stock will soar past $40 over the next 12 months.

Up until now, THQ has focused much of its attention on the kid-friendly Gameboy handheld, releasing fewer games for the new consoles launched last year -- Microsoft's Xbox, Sony's PlayStation 2, and Nintendo's GameCube -- than its rivals have. To some extent, the strategy has worked: THQ owns the kids' corner of the video-game market. Problem is, it's a relatively small corner.

According to the Interactive Digital Software Assn., 40% of game players are older than 36 -- the folks most likely to be playing sports games on their Xboxes. Last year, only 3% of the best-selling games were children's titles. But at E3, THQ unveiled some new games aimed squarely at an older audience to address that issue. Industry analysts say the timing couldn't be better.

CONSOLE DROP. Game publishers are entering a critical selling period. Thanks to a price war that broke out just before E3, the new consoles could make their way beyond the small group of so-called "core gamers" and into the mass market, causing demand for games to skyrocket this holiday season. Microsoft (MSFT) dropped Xbox's price from $299 to $199, bringing it in line with PlayStation 2 from Sony (SNE). Nintendo (NTDOY) responded by knocking GameCube down $50, to $149.

THQ CEO Brian Farrell says he has been pushing for the cuts, especially with Xbox. "Coming out at such a huge premium was a self-inflicted wound for Microsoft," he says. "We've got to move past the core gamer. We want the mass market out there to be playing in droves."

And Farrell is working furiously to make sure THQ isn't left behind when the mass market starts shopping for games. At E3, THQ unveiled several new console titles based on one of its most valuable franchises: World Wrestling Entertainment (formerly WWF). Analysts hope new titles like WWE SmackDown! Shut Your Mouth and WWE WrestleMania X8 will help broaden THQ's appeal with console owners.

BROADER TARGET. THQ is also introducing more mature content, such as Red Faction, an alien-themed fighting game it developed in 2001. "Its strategy to hit more of the mass market should start to pay dividends soon," predicts Shawn Milne, an analyst for Soundview Technologies Group. A few small acquisitions THQ has made recently might also help nudge sales. At E3, it announced it would acquire ValuSoft, a publisher of value-priced computer games selling for under $20.

With $242.8 million in cash and no debt, THQ is entering this crucial selling season financially strong. "They don't need major blockbusters to continue to do well over time," says Michael Wallace, an analyst for UBS Warburg. "And the stock is still trading low compared to the company's growth rate." For investors searching for bargains in the pricey video-game market, THQ may deliver fun, games, and a healthy return. Weintraub writes for BusinessWeek in Los Angeles

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