Midway braces for bad Q3 report

Wedbush Morgan Securities analyst Michael Pachter downgraded his rating on Midway stock today from Hold to Sell after the company warned that it would again miss its quarterly expectations.

Citing poor retailer reorders of The Suffering: Ties That Bind and L.A. Rush, and the delay of products from the end of 2005 into 2006, Midway revised its expectations for both the third quarter and fiscal year 2005. Midway's fiscal year runs concurrent with the calendar year, and so it ends December 31.

For the third quarter, Midway still expects to hit its $30 million revenue target, but now expects to lose $29 million instead of the previously announced $19 million. The company blames the higher expenditures on increased product development costs primarily associated with third- and fourth-quarter releases. For the year, Midway reduced revenue expectations from $200 million to $145 million. The company also expects its losses for the year to increase more than 50 percent over the previously expected $60 million to $95 million.

Given the announced slipping of products into 2006, the significant drop in expected fourth-quarter revenue, and Gauntlet: Seven Sorrows' position as the last major release in Midway's 2005 calendar, it's tempting to conclude that the company had delayed the dungeon hack-and-slasher. However, Midway representatives insisted to GameSpot that the game was still on track for a December 2005 release, and merely said that more detail will be given in the company's third-quarter conference call November 7.

While Pachter downgraded his rating of the stock, he reiterated his long-term faith in the company's ongoing rebuilding efforts.

"We remain admirers of the company's portfolio of owned properties, its management, and its development prowess," Pachter wrote to investors. "However, we believe that Midway shares have appreciated to a level where it will be unable to use its stock as currency for acquisitions, and we believe that the share price must retrace to lower levels in order to be acceptable to a desirable target."

Midway shares closed the day yesterday at $19.88, then fell in after-hours trading once the company's revised estimates were sent out. As of press time, Midway's stock was trading at $19.24, a little more than 3 percent off yesterday's close. Pachter's report established a 12-month price target of $15 for the stock. The reason it isn't there already is because Viacom CEO Sumner Redstone has repeatedly acquired large chunks of Midway stock at high prices, something Pachter says "borders on the irrational."

Pachter isn't alone in scratching his head over Redstone's lust for Midway stock. In September, UBS analysts Michael Wallace and Stephen Tam said in their report that "If Sumner Redstone were not buying this stock, we think it would be below $5."