Daily Double
November 11, 1999

Midway Games Inc.

Phone: 903-654-4691
Website: www.midway.com
Price (11/8/99): $20 7/8

By Paul Larson (TMF Parlay)

How Did it Double?

Investors who put one coin into video game maker Midway Games back in February are today getting three coins back. Midway's stock was selling below $8 per share just nine months ago, but the shares have in recent weeks scored new annual highs.

While the shares have had an excellent 1999, the two years prior were anything but memorable for shareholders. Even with the recent rise, Midway has yet to eclipse the old high scores above the $25 per share it reached back in 1997. Investors blitzed the exits for much of 1998 and through the beginning of 1999 as the company's growth got derailed. Total sales in fiscal 1999 were $351.8 million, below the $391.2 and $388.2 million reported in 1998 and 1997, respectively. Profit warnings, anemic sales, and major restructuring rattled the shares and were reported in a previous Daily Trouble.

But 1999 has proven to be a completely different story. Sales in the most recent quarter were $106.6 million, up nicely from the $89.3 million reported in the same quarter last year. More importantly, earnings were also up, and for the first time in a long time the company indicated confidence about the future profitability of the company. Between a rebound in the company's coin-operated business and a new market created by the successful launch of the Sega Dreamcast gaming platform, Midway said that it expects record revenues and net income for the coming year. This confidence in the future has certainly helped the stock look anything but Mortal in the recent past.

Business Description

Based in Chicago, Midway Games is one of the nation's leading developers of video games. The company makes both coin-operated arcade games as well as products for the home gaming market. Midway's games can be played on all three of the primary home platforms, namely Sony Playstation, Nintendo 64, and Sega Dreamcast.

Midway also owns the rights to the old Atari brand, responsible for such gaming classics as Pong, Missile Command, and Pac-Man. Two of Midway's most popular gaming brands today include Mortal Kombat and NFL Blitz.

The company first came public in 1996 as a subsidiary of WMS Gaming (NYSE: WMS). In April 1998, WMS spun off to shareholders its entire stake of Midway, making the company essentially an independent entity at that time.

Media mogul Sumner Redstone is Midway's largest shareholder, personally owning over 5.4 million of the company's shares and controlling roughly a 25% voting interest.

Financial Facts

Income Statement
12-month sales: $369.1 million
12-month income: $7.7 million
12-month EPS: $0.19
Profit Margin: 2.1%
Market Cap: $814.3 million

Balance Sheet (9/30/99)
Cash: $36.2 million
Current Assets: $181.9 million
Total Assets: $243.1 million
Current Liabilities: $50.3 million
Long-term Debt: none
Total Liabilities: $54.8 million
Shareholders' Equity: $188.3 million

Price-to-earnings: 110.5x
Price-to-sales: 2.2x

How Could You Have Found This Double?

One of the largest "buy" signals that was coming from Midway for many months was the copious amounts of insider buying happening at the company. Sumner Redstone and several of the company's board members and executives made literally dozens of open market purchases of the stock valued at several million dollars. They were, if you will, gobbling up shares like Pac-Man. As they say, insiders buy for only one reason -- they believe the stock will go up.

The company's board also believed enough in Midway's long-term prospects that it was periodically repurchasing and retiring shares over the past few years. While not nearly as strong a signal as the outright insider purchases, seeing the company use its excess cash to reduce the total shares outstanding was nevertheless a bullish signal.

Speaking of excess cash, even in Midway's darkest hour its balance sheet remained quite healthy looking. The company has never had any significant long-term debt, and the cash Midway had was more than enough to get the company through any temporary rough patch it hit.

Finally, Midway was featured as one of the Fool's Stocks to Love this past Valentine's Day. On select holidays, this special feature is run by the Fool, and most of the time there are some excellent ideas in the collectively written special. Check out the recent Halloween special for some sweet treats and scary tricks.

Where to From Here?

We're entering the Christmas season, which is the money season for all video game makers. This season promises to be a good one for Midway as it is the largest third party distributor of games for the new, popular Sega Dreamcast platform. Midway has said that it expects to ship fourteen new titles on five different home gaming platforms in the fourth calendar quarter. This compares to just five new games on three platforms in the most recent quarter. The company also recently regained the international distribution rights to its games, which should add some incremental sales.

For the full fiscal year, Midway has been bold enough to publicly predict record sales and earnings. Fiscal 1998, its best year to-date, saw the company draw $391.2 million in sales and $42.1 million in profits. Therefore, it's safe to say that fiscal 2000 will have figures above these. If the company just barely tops its old record and earns $43 million in the coming year, that would translate to $1.11 in diluted EPS. The mean analyst estimate calls for Midway to earn $1.16 next year, which seems to be easily achievable. That would put the stock, at this writing, somewhere near 18x forward earnings.

Is 18x forward earnings a bargain or a sucker's bet? It all depends on whether or not one believes Midway can get back to growing both its top and bottom lines. Luckily, the video game market as a whole is expanding in a healthy manner, and Midway stands to benefit. More importantly, Midway has taken steps to improve its strategic positioning and has also addressed the operational and cost issues related to getting kicked out of the WMS nest.

Either way, when a company has seen as much insider buying as Midway has, it certainly warrants further attention. While many of the purchases were made at levels significantly lower than today's, they still speak volumes about management's confidence in the long-term health of the company. Whatever the future brings, it appears that Midway's most difficult times are behind it.

Related articles:
Stocks Fools Love -- Midway Games (2/9/99)
Daily Trouble -- Midway Games (8/26/98)

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