The Real Casino Action Is With the Game Makers

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With all the action going on in the casino industry, I decided to take a look at the companies that make the games that go on the casino floors.

What got me curious about the sector is the recent buyout activity going on. First, Scientific Games (NASDAQ: SGMS) agreed to buy WMS Industries (NYSE: WMS) for $1.5 billion. Then this month Bally Technologies (NYSE: BYI) agreed to buy SHFL Entertainment (NASDAQ: SHFL) for $1.3 billion. These companies have their eye on more than just the casino floor. They're looking to capitalize with online games as well.

The thinking behind the deals

Consolidation in the gaming sector makes sense for these players. By combining their operations, it not only reduces costs, but gives them a greater footprint to challenge the biggest company in the sector,  International Game Technology (NYSE: IGT). The combined companies can now offer nearly all the products required to run a casino.

Scientific Games and WMS

Scientific Games expects to achieve significant synergies with the WMS acquisition. Annual cost savings are expected to be $90 million and cash flow savings could add another $20 million due to lower capital expenditure needs. Without anticipated synergies, the combined companies had revenues last year of approximately $1.6 billion and combined EBITDA of $579 million.

The deal is especially positive for Scientific Games in that by acquiring WMS, it will return to profitability. The deal also combines Scientific's businesses that make instant lottery tickets, lottery and video gaming systems with the businesses of WMS that supply gaming machines and interactive gaming content. Scientific CEO A. Lorne Weill said of the transaction:

We expect to combine our game content, technology, operational capabilities and respective geographic footprints to create an enterprise poised to capitalize on significant growth opportunities around the globe.

The combination of these two companies will create a combined iLottery and iGaming platform and content. WMS has a well-developed iGaming platform which includes social and mobile gaming. Scientific has an advanced platform for iLottery, sports book and loyalty/rewards. Now the companies can cross-sell these products to their respective customers.

Bally and SHFL

The acquisition of SHFL Entertainment, which makes the popular Shuffle Master product that shuffles cards, gives Bally a bigger presence on the casino floors. The acquisition will especially strengthen Bally's presence in Asia where casino gaming is growing the fastest.

The acquisition will benefit SHFL after the company dropped its purchase of online game company Ongame. Prior to being acquired by Bally, SHFL was looking to develop its own platform. Now it can direct its resources to working with Bally on its iGaming platform.

The combined company will have revenues of approximately $1.3 billion with $644 million being recurring revenues. EBITDA will be roughly $415 million and cost savings are expected to be about $30 million.

The target competitor

International Game Technology is the world's largest manufacturer of slot machines. The company has been buying companies as well to increase its online gaming offerings. Last year the company bought DoubleDown Interactive for around $500 million, which makes social games for Facebook. Active users at DoubleDown jumped 25% to 1.7 million in the most recent quarter and surpassed Zynga poker as the top-grossing casino game on Facebook.

In its earnings report this past week, the company reported that revenues increased 9% to $579 million. Earnings per share rose 43% to $0.33. Slot machine revenues increased 12% to $259.2 million. Online gaming revenue increased 69% to $72.5 million. The gross margin for this sector in the quarter was 63%. For the full year, the company is forecasting earnings of $1.26 to $1.32 per share. This implies growth of 22% to 28% over last year.

Going forward, International Game Technology has about $520 million remaining on its share repurchase program. The company plans to use up this authorization within the next two to four years. The company also just increased the dividend for the third consecutive quarter. The company now pays an annual dividend of $0.36 per share for a yield of 1.8%. The dividend payout ratio is only 27%, so there's room to increase the dividend in the future.

Foolish assessment

My recommendation is to go with the market leader and own International Game Technology. The other four companies are going to be busy integrating their respective companies while International Game Technology focuses on growing its business and market share. International Game Technology is also the cheapest with a PEG ratio of 1 and a P/E of 18. For these reasons, International Game Technology is the best bet.

Mark Yagalla has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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