As we have made clear before, we were not big fans of the mega mergers in the supplier side of the gaming industry.
We’re more comfortable with targeted acquisitions such as those made over the past year by Aristocrat, and more recently by Ainsworth, than with companies becoming conglomerates.
Scientific Games has been especially aggressive in merging, in effect acquiring Bally, WMS and SHFL. As a result, SGMS now has heavy debt at eight times EBITDA and sprawling operations.
The debt, is a drag on earnings, introduces risk and reduces management flexibility. The geographic sprawl and the need to combine separate corporate cultures have created significant execution risks. The need to slash jobs and shut down operations has been a morale buster.
The difficulties were made clear on November 9 when Sci Games announced earnings that missed expectations, and write offs of $535 million on its acquisitions and $103.6 million on gaming operations.
Investors, who should have seen this coming, were shocked and ran away in a panic.
Already low-priced shares plunged 16 percent in one day. They fell again when the retirement of CFO Scott Schweinfurth was announced.
By the stock’s intraday low on the 16th, an investor could scoop up SGMS for $7.51 a share, 35 percent below the price eight days before.
So where does that leave us on SGMS?
Bullish. That’s where.
The sell off in Sci Games has been overdone, as they say.
This is a company that will do more than $2.5 billion a year in sales, yet has a market cap of under $700 million as of this writing.
It has a lot of debt, to be sure, but its $264.2 million in third quarter EBITDA compares favorably to its $166.8 million in interest expense. Plus, the company paid down $73 million in debt in the quarter and SGMS’ cost-cutting program is on target.
More than anything, SGMS has solid businesses. The lottery cranks out money every quarter. So do slot machine leases. SGMS has the industry’s strongest casino systems business. It dominates the shuffler and proprietary table game businesses.
And the gaming segment outlook is far from gloomy. Twenty-four percent of respondents in the latest Eilers-Fantini Quarterly Slot Survey plan to spend about 24 percent of their money buying SGMS machines, about the same as normal. And the number of executives citing SGMS as having the most anticipated new premium lease games was a robust 27 percent.
Further, debt is going down and interest expense will steadily become less of a drag on earnings.
Finally, SGMS has what everyone agrees is superb leadership in CEO Gavin Isaacs.
That doesn’t mean SGMS is a growth story. It has challenges. Lottery revenue declined in the third quarter. Slots competition in North America continues to intensify. Fewer new and expanding casinos will further dampen sales. The slots industry overall is stagnant.
The point is that this company isn’t going to disappear, that it generates a lot of revenue that will increasingly fall to the bottom line, and that it has great leadership.
In other words, SGMS has the look of a bargain at a stock price of 30 percent of annual sales.
That low price-to-sales ratio comes even after many investors jumped back after Isaacs and Chairman Ron Perleman bought shares in the open market to send the message that they think shares are cheap, too.
