A Gaming Company with a Strong Balance Sheet Is a Rarity

Mark is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Note: A previous version of this article inaccurately referenced Bally Technologies operations. This has been corrected.

It is rare to find gaming companies with a strong balance sheet like SHFL Entertainment (NASDAQ: SHFL), since the management of many gaming companies act like gamblers themselves, loading up their companies with debt. In contrast, SHFL Entertainment has negligible debt supported by strong free cash flow.

SHFL Entertainment is a global gaming supplier, providing products in five distinct categories: utility products, which include automatic card shufflers and roulette chip sorters; proprietary table games, which includes live games, side bets and progressives; electronic table systems, which include various e-table game platforms; electronic gaming machines, which include video slot machines; and iGaming, which features online versions of SHFL entertainment's table games, social gaming, and mobile applications.

Moats that matter

In a tightly controlled industry like gaming, laws and regulations are the strongest barriers to entry. Internally, gaming companies need to have a robust intellectual property strategy to protect themselves from copycats and also earn licensing fees. Externally, industry players have to keep track of the latest gaming regulations to stay on the right side of the law and capitalize on opportunities that might arise. In SHFL Entertainment’s case, it has more than 2,500 registered and pending trademarks, patents and copyrights. More than half of these relate to trademarks specifically and cover many of gaming’s most well-known brands such as Ultimate Texas Hold’em, Blackjack Switch and Three Card Poker.

Gaming is one of the most regulated industries in the market. In addition to the standard review and approval of gaming products, owners and key management of gaming companies typically must submit personal and financial information to regulators and pass stringent background checks. The onerous qualification process creates a strain on both time and financial resources, creating a barrier for new entrants. Furthermore, companies still need to meet ongoing reporting requirements on internal controls, related party transactions and changes in shareholdings, to maintain their licensed status.

Growth drivers

With more than half of revenue coming from outside the country and a diversified product portfolio, SHFL Entertainment is not dependent on the North American slot replacement cycle for growth.

SHFL Entertainment’s different product categories have their own unique growth drivers. Its utility segment is benefiting from customer upgrades as its MD1 shuffler reaches the end of its product lifecycle, where replacement parts will no longer be available. For its proprietary table games, SHFL Entertainment tends to see increased placement of its products in jurisdictions with new casinos or relaxation of restrictions on live table games. Slot machines represent more of a geographical expansion story for SHFL Entertainment, which sees Asia Pacific and Latin America as key markets for growth. According to a 2011 research report on the geographical spread of gaming machines globally, the ratio of people per machine is 66,158 and 12,919 for Mexico and the Philippines, respectively, compared with a ratio of 39 and 108 for Macau and Australia, respectively.

Peer comparison

SHFL Entertainment’s peers include Bally Technologies (NYSE: BYI) and International Game Technology (NYSE: IGT).

Bally Technologies manufactures and distributes advanced technology-based gaming devices, systems, server-based solutions, custom mobile applications, and interactive applications. In February 2013, Bally Technologies signed an agreement with OpenBet, a leading provider of interactive gaming and betting solutions to allow its content to be available through operators on PCs, tablets, and mobile devices, as part of its international online strategy. Bally Technologies delivered the highest return on assets, at 12.6% for the last twelve months, among the companies in the peer group, but it exposes shareholders to high financial risk with a debt-to-equity ratio of 284%.

International Game Technology is a global gaming company specializing in the design, development, manufacture, and marketing of electronic gaming equipment and systems products, including online and mobile solutions. International Game Technology is highly leveraged with a debt-to-equity of 147%, but redeems itself by being the only dividend paying stock among the three, with a yield of 1.6%. In addition, it declared a cash dividend of $0.08 per share in March 2013, representing a 33% increase quarter-on-quarter and the 40th consecutive quarter of dividend payment.

All three stocks are similarly valued at 9 to 10 times trailing twelve months EV/EBITDA, but forward P/E separates them based on EPS growth rates and balance sheet strength. SHFL Entertainment trades at a forward P/E of 19, which represents a premium over its peers. Bally Technologies and International Game Technology are valued by the market at 15 and 13 times forward P/E, respectively. The market is efficient in this case, rewarding SHFL Entertainment with higher valuations than its peers, based on its net cash financial position and three-year EPS CAGR of 34%.

Conclusion

Growth comes at a price, and in this case it is reflected in SHFL Entertainment’s higher forward P/E. Fortunately for investors, high risk does not accompany high growth here. SHFL Entertainment has negligible financial risk, with cash and cash equivalents exceeding its total debt. 


Mark Lin 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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